Proportional, Progressive, and Regressive taxes
Taxes are categorized by the impact they have on the distribution of income and wealth. A proportional tax is a kind that applies the same relative liability on all taxpayers—i.e., when tax liability and income grow in the same proportion. A progressive tax is recognisable by a greater than proportional rise in the tax onus in relation to the increase in income, and a regressive tax is characterized by a less than proportional rise in the relative onus. Therefore, progressive taxes are regarded as removing the lack of equality in income distribution, but regressive taxes are found to cause an increase in these inequalities.
The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so for the upper-income group—particularly if a taxpayer is able to reduce his tax base by nominating deductions or by leaving out some certain income elements from his taxable income. Proportional tax rates when applied to lower-income categories could also be more progressive if such personal exemptions are made.
Income measured over the period of a given year may not necessarily offer the most appropriate measure of taxpaying requirements. For example, transitory increases in income can be saved, and within temporary declines in income a taxpayer may decide to pay for consumption by taking from savings. So, if taxation is regarded with “permanent income,” it should be less regressive (or more progressive) than when it is compared with annual income.
Sales taxes and excises (excepting luxuries) are usually regressive, because the portion of individual income consumed or spent on a specific good declines as the amount of personal income rises. Poll taxes (aka head taxes), levied as a flat amount per capita, obviously are regressive.
It is complicated to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being debated.
In regarding the economic effects of taxation, it is important to differentiate between varied concepts of tax rates. The statutory rates are dictated in the legislation; commonly these are marginal rates, but in some cases they are average rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income grows by one dollar. Therefore, if tax onus increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that grow as income increases. Careful analysis of marginal tax rates need to consider provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated in the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the important ones for appraising incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applied to income from business and capital, as it may depend on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem holds that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.
Average income tax rates display the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for assessing 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 permitted for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the flip side, preferential treatment of income received fundamentally by high-income households may dampen these effects, allowing regressivity, as indicated by average tax rates that lower as income grows.
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