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Taxes can be distinguished by the impact they have on the allocation of income and wealth. A proportional tax is a kind that imposes the same relative liability on all the taxpayers—i.e., in the case where tax liability and income increase in equal proportion. A progressive tax is recognised by a larger than proportional increase in the tax liability relative to the growth in income, and a regressive tax is characterizable by a less than proportional growth in the related burden. So, progressive taxes are seen as reducing a lack of equality in income distribution, but regressive taxes may result in increasing these inequalities.

The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, can become less so in the upper-income demographic—especially if a taxpayer is permitted to lessen his tax base by claiming deductions or by removing particular income components from his taxable income. Proportional tax rates if applied to lower-income groups would also be more progressive if such personal exemptions are claimed.

Income measured over a given period does not definitely give the best measure of taxpaying status. For example, transitory increases in income could be saved, and within temporary declines in income a taxpayer may elect to finance consumption by reducing savings. So, if taxation is compared alongside “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 luxuries) tend to be regressive, because the portion of individual income consumed or spent for a specific good lessens as the rate of personal income rises. Poll taxes (also called head taxes), calculated as a set amount per capita, clearly are regressive.

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

In analysing the economic effect of taxation, it is essential to differentiate between several points of tax rates. The statutory rates will be nominated in law; commonly these are marginal rates, but in some cases they are median rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income increases by one dollar. Hence, if tax liability grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that rise as income increases. Careful analysis of marginal tax rates are required to take into account provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points higher than nominated within the statutory rates. Since marginal rates specify how after-tax income moves in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more difficult 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 nothing under a consumption-based tax.

Average income tax rates signify the part of total income that is paid in taxation. The pattern of average rates is the one that is in consideration for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates commonly increase with income, both because personal allowances are allowed for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received mostly by high-income households might dampen these effects, allowing regressivity, as indicated by average tax rates that lessen as income increases.

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