Proportional, Progressive, and Regressive taxes
Taxes are distinguished by the impact they have on the allocation of income and wealth. A proportional tax is one that impinges the same relative onus on every taxpayer—i.e., in the case where tax liability and income move in equal proportion. A progressive tax is characterized by a more than proportional increase in the tax onus relative to the increase in income, and a regressive tax is recognised by a less than proportional increase in the relative onus. Thus, progressive taxes are regarded as removing inequalities in income distribution, while regressive taxes are believed to cause an increase in these inequalities.
The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, can become less so in the upper-income demographic—particularly if a taxpayer is permitted to reduce his tax base by declaring deductions or by leaving out some certain income parts from his taxable income. Proportional tax rates which are applied to lower-income groups can also be more progressive if exemptions of a personal nature are made.
Income measured over a given period may not absolutely provide the most suitable measure of taxpaying requirements. For example, transitory growth in income could be saved, and in temporary declines in income a taxpayer might elect to provide for consumption by taking from savings. So, if taxation is compared along with “permanent income,” it should be less regressive (or more progressive) than if made comparable with annual income.
Sales taxes and excises (with the exception of luxuries) are generally regressive, because the share of own income consumed or spent on a specific good lowers as the amount of personal income increases. Poll taxes (also known as head taxes), nominated as a flat amount per capita, patently are regressive.
It is difficult to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In considering the economic effect of taxation, it is essential to differentiate between several concepts of tax rates. The statutory rates will include those nominated in legislature; usually these are marginal rates, but occasionally they are median rates. Marginal income tax rates indicate the fraction of incremental income taken by taxation when income is increased by one dollar. Hence, if tax burden increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax laws often contain graduated marginal rates—i.e., rates that rise as income grows. Structured analysis of marginal tax rates must regard provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points greater than indicated by the statutory rates. Since marginal rates display how after-tax income changes in response to changes in before-tax income, they are the necessary ones for considering incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applied to income from business and capital, as it may be reliant on considerations 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 nil under a consumption-based tax.
Average income tax rates display the percentage of total income that is required in taxation. The pattern of average rates is the one that is necessary for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally grow with income, both because personal allowances are permitted for the taxpayer and dependents and also because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households may dwarf these effects, forcing regressivity, as displayed by average tax rates that lessen as income grows.
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