Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the distribution of income and wealth. A proportional tax is the kind that imposes the same relative requirement on each taxpayer—i.e., when tax liability and income grow in relative levels. A progressive tax is characterizable by a larger than proportional increase in the tax burden relative to the growth in income, and a regressive tax is characterizable by a less than proportional increase in the related onus. Therefore, progressive taxes are regarded as taking away the lack of equality in income distribution, whereas regressive taxes are seen to result in an increase these inequalities.
The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so in the upper-income categories—especially if a taxpayer is able to lessen his tax base by nominating deductions or by leaving out certain income parts from his taxable income. Proportional tax rates which are applied to lower-income groups would also be more progressive if personal exemptions are made.
Income measured over the period of a year may not absolutely offer the most suitable measure of taxpaying ability. For example, transitory rises in income might be saved, and in temporary declines in income a taxpayer could elect to finance consumption by taking from savings. So, if taxation is regarded alongside “permanent income,” it will be less regressive (or more progressive) than if held in comparison with annual income.
Sales taxes and excises (excepting luxuries) are mostly regressive, because the dissemination of individual income consumed or spent on a specific good decreases as the amount of personal income rises. Poll taxes (aka head taxes), calculated as a set amount per capita, clearly are regressive.
It is not easy to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests crucially on whether a national or a subnational (that is, provincial or state) tax is being determined.
In assessing the economic purpose of taxation, it is important to differentiate between differing concepts of tax rates. The statutory rates are dictated in the legislation; generally speaking these are marginal rates, but in some cases they are mean rates. Marginal income tax rates note the fraction of incremental income taken by taxation when income increases by one dollar. Ergo, if tax burden increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws generally contain graduated marginal rates—i.e., rates that grow as income increases. Heavy analysis of marginal tax rates must review 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 rise in income, the marginal rate is 20 percentage points higher than nominated by the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the appropriate ones for assessing incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate to apply to income from business and capital, because it may be reliant on such considerations 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 nothing under a consumption-based tax.
Average income tax rates determine the part of total income that is demanded in taxation. The pattern of average rates is the one that is important for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates usually rise with income, both because personal allowances are permitted for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households can swamp these effects, allowing regressivity, as indicated by average tax rates that fall as income rises.
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