Proportional, Progressive, and Regressive taxes
Taxes are distinguished by the impact they have on the allocation of income and wealth. A proportional tax is a tax that applies the same relative onus on all taxpayers—i.e., in the case where tax liability and income increase in relative scale. A progressive tax is recognisable by a greater than proportional growth in the tax onus relative to the growth in income, and a regressive tax is recognised by a less than proportional increase in the comparative liability. Ergo, progressive taxes are viewed as removing the lack of equality in income distribution, but regressive taxes might have the effect of increasing these inequalities.
The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, may become less so within the upper-income categories—particularly if a taxpayer is permitted to reduce his tax base by claiming deductions or by leaving out some income elements from his taxable income. Proportional tax rates if applied to lower-income demographics will also be more progressive if such exemptions of a personal nature are declared.
Income measured over the course of a given period might not definitely give the most suitable measure of taxpaying ability. For example, transitory growth in income can be saved, and within temporary declines in income a taxpayer might choose to finance consumption by reducing savings. Ergo, if taxation is made comparable alongside “permanent income,” it will be less regressive (or more progressive) than when made comparable with annual income.
Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the share of individual income consumed or spent on a specific good declines as the level of personal income increases. Poll taxes (also called head taxes), levied as a fixed amount per capita, patently are regressive.
It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the 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 is dependant essentially on whether a national or a subnational (that is, provincial or state) tax is being debated.
In considering the economic purposes of taxation, it is important to distinguish between differing points of tax rates. The statutory rates will include those specified in law; often these are marginal rates, but occasionally they are average rates. Marginal income tax rates signify the fraction of incremental income that is taken by taxation when income rises by one dollar. Therefore, if tax liability rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes often contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates must review provisions in addition to 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 more than specified in the statutory rates. Since marginal rates indicate how after-tax income changes in response to changes in before-tax income, they are the important ones for regarding incentive effects of taxation. It is even more difficult to know the marginal effective tax rate applied to income from business and capital, because it may rely on such considerations as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates indicate the portion of total income that is required 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 grows with income. Average income tax rates commonly increase with income, both because personal allowances are permitted for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received predominantly by high-income households could swamp these effects, forcing regressivity, as shown by average tax rates that lower as income increases.
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