Proportional, Progressive, and Regressive taxes
Taxes are categorized by the impact they have on the placement of income and wealth. A proportional tax is one that imposes the same relative requirement on every taxpayer—i.e., when tax liability and income grow in relative levels. A progressive tax is characterized by a greater than proportional growth in the tax liability in regard to the increase in income, and a regressive tax is characterizable by a less than proportional increase in the comparative liability. Hence, progressive taxes are viewed as reducing a lack of equality in income distribution, whereas regressive taxes may have the result of increasing these inequalities.
The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so in the upper-income demographic—in particular if a taxpayer is permitted to lessen his tax base by nominating deductions or by excluding some certain income aspects from his taxable income. Proportional tax rates when applied to lower-income demographics would also be more progressive if exemptions of a personal nature are declared.
Income measured over a given year does not absolutely offer the most accurate measure of taxpaying ability. For example, transitory growth in income might be saved, and during temporary declines in income a taxpayer might select to finance consumption by reducing savings. So, if taxation is regarded along with “permanent income,” it should be less regressive (or more progressive) than if it is compared with annual income.
Sales taxes and excises (except luxuries) are generally regressive, because the spread of own income consumed or spent for specific goods lessens as the level of personal income increases. Poll taxes (aka head taxes), calculated as a flat amount per capita, clearly are regressive.
It is complicated to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to uncertainty 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 for the most part on whether a national or a subnational (that is, provincial or state) tax is being decided.
In regarding the economic effect of taxation, it is important to differentiate between varied ideas of tax rates. The statutory rates are those specified in law; often these are marginal rates, but in some cases they are median rates. Marginal income tax rates note the fraction of incremental income demanded by taxation when income increases by one dollar. Thus, if tax liability increases by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax laws generally contain graduated marginal rates—i.e., rates that grow as income grows. Heavy 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) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than nominated in the statutory rates. Since marginal rates specify how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for assessing incentive effects of taxation. It is even more complicated to realise 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 grants that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates determine the fraction of total income that is taken in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally increase with income, both because personal allowances are allowed for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received fundamentally by high-income households might dampen these effects, producing regressivity, as shown by average tax rates that lower as income rises.
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