Proportional, Progressive, and Regressive taxes

July 8th, 2010

Taxes are distinguished by the effect they have on the allocation of income and wealth. A proportional tax is one that puts the same relative liability on all taxpayers—i.e., in the case where tax liability and income grow in equal scale. A progressive tax is recognised by a larger than proportional growth in the tax burden in relation to the increase in income, and a regressive tax is recognised by a less than proportional rise in the relative onus. So, progressive taxes are thought of as reducing a lack of equality in income distribution, whereas regressive taxes are found to result in increasing these inequalities.

The taxes that are often regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so for the upper-income group—in particular if a taxpayer is allowed to reduce his tax base by nominating deductions or by removing particular income elements from his taxable income. Proportional tax rates which are applied to lower-income categories can also be more progressive if exemptions of a personal nature are claimed.

Income measured over the period of a given year may not absolutely offer the most appropriate measure of taxpaying status. For example, transitory increases in income might be saved, and within temporary declines in income a taxpayer could opt to provide for consumption by decreasing savings. So, if taxation is held in comparison alongside “permanent income,” it can be less regressive (or more progressive) than when it is compared with annual income.

Sales taxes and excises (except luxuries) are usually regressive, because the spread of one’s income consumed or spent for specific goods lessens as the amount of personal income increases. Poll taxes (aka head taxes), levied as a fixed amount per capita, obviously are regressive.

It is difficult to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden lays crucially on whether a national or a subnational (that is, provincial or state) tax is being debated.

In analysing the economic purposes of taxation, it is important to differentiate between various points of tax rates. The statutory rates will include those nominated in law; often these are marginal rates, but occasionally they are mean rates. Marginal income tax rates signify the fraction of incremental income that is demanded by taxation when income increases by one dollar. Hence, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation commonly contain graduated marginal rates—i.e., rates that rise as income rises. Structured analysis of marginal tax rates need to consider provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points higher than specified within the statutory rates. Since marginal rates indicate how after-tax income moves in response to changes in before-tax income, they are the relevant ones for appraising incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate to apply to income from business and capital, since it may be dependant on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates determine the portion of total income that is required in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually rise with income, both because personal allowances are provided for the taxpayer and dependents and due to that marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households could swamp these effects, forcing regressivity, as shown by average tax rates that lessen as income increases.

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