Proportional, Progressive, and Regressive taxes

July 8th, 2010

Taxes can be differentiated by the effect they have on the distribution of income and wealth. A proportional tax is the kind of tax that puts the same relative liability on all the taxpayers—i.e., where tax liability and income grow in equal scale. A progressive tax is characterizable by a greater than proportional increase in the tax burden in regard to the increase in income, and a regressive tax is characterizable by a less than proportional rise in the comparative onus. So, progressive taxes are viewed as reducing the lack of equality in income distribution, whereas regressive taxes are found to result in an increase these inequalities.

The taxes that are often thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, can become less so within the upper-income categories—especially if a taxpayer is allowed to reduce his tax base by declaring deductions or by excluding particular income parts from his taxable income. Proportional tax rates when applied to lower-income groups could also be more progressive if exemptions of a personal nature are made.

Income measured over the period of a given year may not necessarily provide the most accurate measure of taxpaying requirements. For example, transitory increases in income could be saved, and in temporary declines in income a taxpayer might opt to finance consumption by decreasing savings. Therefore, if taxation is made comparable with “permanent income,” it can be less regressive (or more progressive) than if it is held in comparison with annual income.

Sales taxes and excises (excepting those on luxuries) tend to be regressive, because the portion of own income consumed or spent for a specific good lowers as the rate of personal income is raised. Poll taxes (also called head taxes), nominated as a fixed amount per capita, patently are regressive.

It is difficult to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of a lack of certainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden is dependant fundamentally on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic purpose of taxation, it is relevant to differentiate between varied concepts of tax rates. The statutory rates will be nominated in law; usually these are marginal rates, but for some cases they are mean rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income grows by one dollar. Ergo, if tax onus increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations commonly contain graduated marginal rates—i.e., rates that increase as income increases. Heavy analysis of marginal tax rates should review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than nominated in the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the necessary ones for appraising incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate applicable to income from business and capital, because it may depend on such factors as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem determines that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates determine the portion of total income that is taken in taxation. The pattern of average rates is the one that is relevant for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households could dampen these effects, allowing regressivity, as shown by average tax rates that decrease as income rises.

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