Proportional, Progressive, and Regressive taxes
Taxes are categorized 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., where tax liability and income grow in the same proportion. A progressive tax is characterized by a higher than proportional rise in the tax onus in relation to the rise in income, and a regressive tax is recognised by a less than proportional increase in the comparable onus. Ergo, progressive taxes are regarded as removing inequity in income distribution, whereas regressive taxes might cause an increase in these inequalities.
The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, may become less so in the upper-income categories—in particular if a taxpayer is able to lower his tax base by claiming deductions or by taking some income parts from his taxable income. Proportional tax rates which are applied to lower-income classes would also be more progressive if such personal exemptions are declared.
Income measured over the course of a given period does not definitely give the best measure of taxpaying status. For example, transitory increases in income may be saved, and during temporary declines in income a taxpayer may opt to pay for consumption by reducing savings. So, if taxation is made comparable with “permanent income,” it can be less regressive (or more progressive) than if made comparable with annual income.
Sales taxes and excises (excepting those on luxuries) tend to be regressive, because the spread of own income consumed or spent for specific goods declines as the amount of personal income is raised. Poll taxes (aka head taxes), nominated as a fixed amount per capita, patently are regressive.
It is not easy to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden rests essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In regarding the economic effects of taxation, it is relevant to distinguish between various ideas of tax rates. The statutory rates will include those specified in the legislation; generally speaking these are marginal rates, but sometimes they are median rates. Marginal income tax rates indicate the fraction of incremental income taken by taxation when income increases by one dollar. Hence, if tax burden rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that increase as income rises. Careful analysis of marginal tax rates should consider provisions as well as 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 greater than indicated by the statutory rates. Since marginal rates specify how after-tax income changes in response to changes in before-tax income, they are the relevant ones for appraising incentive effects of taxation. It is even more difficult to know the marginal effective tax rate to apply to income from business and capital, as 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 holds that the marginal effective tax rate in income from capital is zero under a consumption-based tax.
Average income tax rates signify the fraction 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 rises with income. Average income tax rates commonly grow 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 fundamentally by high-income households could dampen these effects, forcing regressivity, as signified by average tax rates that decrease as income increases.
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