Proportional, Progressive, and Regressive taxes
Taxes can be categorized by the effect they have on the allocation of income and wealth. A proportional tax is one that applies the same relative liability on each taxpayer—i.e., when tax liability and income increase in the same proportion. A progressive tax is recognisable by a higher than proportional growth in the tax onus relative to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the relative onus. Therefore, progressive taxes are seen as fighting a lack of equality in income distribution, whereas regressive taxes might result in increasing these inequalities.
The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, might become less so for the upper-income demographic—in particular if a taxpayer is able to reduce his tax base by nominating deductions or by removing particular income elements from his taxable income. Proportional tax rates which are applied to lower-income demographics would also be more progressive if such exemptions of a personal nature are claimed.
Income measured over the period of a year might not absolutely give the most appropriate measure of taxpaying status. For example, transitory rises in income can be saved, and during temporary declines in income a taxpayer might select to provide for consumption by reducing savings. So, if taxation is regarded along with “permanent income,” it will be less regressive (or more progressive) than if it is made comparable with annual income.
Sales taxes and excises (save on luxuries) are mostly regressive, because the dissemination of own income consumed or spent for a specific good lessens as the level of personal income increases. Poll taxes (aka head taxes), calculated as a set amount per capita, clearly are regressive.
It is complicated to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the 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 considering the economic effects of taxation, it is relevant to differentiate between varied points of tax rates. The statutory rates will be specified in law; generally speaking these are marginal rates, but in some cases they are mean rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income increases 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 legislature often contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates need to take into account provisions other than 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 greater than nominated by the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the appropriate ones for appraising 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 rely on factors including 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 zero under a consumption-based tax.
Average income tax rates indicate the portion of total income that is taken in taxation. The pattern of average rates is the one that is necessary for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly increase with income, both because personal allowances are allowed for the taxpayer and dependents and due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received mostly by high-income households could swamp these effects, allowing regressivity, as shown by average tax rates that lessen as income increases.
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