Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the allocation of income and wealth. A proportional tax is the kind of tax that applies the same relative onus on all taxpayers—i.e., where tax liability and income move in equal proportion. A progressive tax is characterizable by a higher than proportional growth in the tax liability in relation to the increase in income, and a regressive tax is characterized by a less than proportional increase in the relative liability. Hence, progressive taxes are seen as reducing the lack of equality in income distribution, while regressive taxes might result in increasing these inequalities.
The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, might become less so in the upper-income group—in particular if a taxpayer is allowed to lessen his tax base by claiming deductions or by leaving out particular income aspects from his taxable income. Proportional tax rates which are applied to lower-income classes can also be more progressive if exemptions of a personal nature are declared.
Income measured over a given year might not absolutely come up with the most appropriate measure of taxpaying ability. For example, transitory growth in income may be saved, and in temporary declines in income a taxpayer might opt to finance consumption by decreasing savings. Therefore, if taxation is made comparable along with “permanent income,” it should be less regressive (or more progressive) than if it is made comparable with annual income.
Sales taxes and excises (save luxuries) are mostly regressive, because the dissemination of individual income consumed or spent for specific goods lowers as the amount of personal income grows. Poll taxes (also known as head taxes), levied as a fixed amount per capita, clearly are regressive.
It is hard to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden lays essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In regarding the economic purposes of taxation, it is relevant to distinguish between several concepts of tax rates. The statutory rates are those nominated in legislation; often these are marginal rates, but sometimes they are mean rates. Marginal income tax rates denote the fraction of incremental income demanded by taxation when income is increased by one dollar. Ergo, if tax liability increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature generally contain graduated marginal rates—i.e., rates that grow as income grows. Heavy analysis of marginal tax rates need to take into account provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points more than indicated within the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the relevant ones for regarding incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate to apply to income from business and capital, as it may depend on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem holds that the marginal effective tax rate in income from capital is zero under a consumption-based tax.
Average income tax rates show the percentage of total income that is taken in taxation. The pattern of average rates is the one that is relevant for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly grow with income, both because personal allowances are allowed for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households might dwarf these effects, forcing regressivity, as shown by average tax rates that lessen as income grows.
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