Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the placement of income and wealth. A proportional tax is a kind that imposes the same relative onus on all the taxpayers—i.e., in the case where tax liability and income increase in relative proportion. A progressive tax is recognised by a higher than proportional growth in the tax liability in relation to the rise in income, and a regressive tax is recognised by a less than proportional increase in the related burden. Thus, progressive taxes are viewed as removing inequalities in income distribution, while regressive taxes are found to result in increasing these inequalities.
The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so within the upper-income group—especially if a taxpayer is allowed to lower his tax base by declaring deductions or by removing certain income aspects from his taxable income. Proportional tax rates which are applied to lower-income categories could also be more progressive if such exemptions of a personal nature are claimed.
Income measured over a given year does not necessarily provide the most accurate measure of taxpaying requirements. For example, transitory increases in income can be saved, and within temporary declines in income a taxpayer could decide to pay for consumption by decreasing savings. Ergo, if taxation is made comparable alongside “permanent income,” it will be less regressive (or more progressive) than when compared with annual income.
Sales taxes and excises (with the exception of luxuries) are usually regressive, because the spread of individual income consumed or spent for a specific good decreases as the amount of personal income increases. Poll taxes (also termed head taxes), levied as a flat amount per capita, patently are regressive.
It is difficult to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to a lack of certainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden rests for the most part on whether a national or a subnational (that is, provincial or state) tax is being decided.
In analysing the economic effect of taxation, it is necessary to differentiate between varied points of tax rates. The statutory rates are specified in the law; generally these are marginal rates, but in some cases they are average rates. Marginal income tax rates note the fraction of incremental income that is demanded by taxation when income rises by one dollar. Ergo, if tax liability increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation often contain graduated marginal rates—i.e., rates that grow as income rises. Structured analysis of marginal tax rates must consider provisions apart from 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 higher than indicated by the statutory rates. Since marginal rates signify how after-tax income increases or decreases in response to changes in before-tax income, they are the important ones for assessing incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate to apply to income from business and capital, as it may depend on considerations including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates show the part of total income that is paid 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 usually increase with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received mostly by high-income households can dwarf these effects, forcing regressivity, as signified by average tax rates that decline as income increases.
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