08 Jul 10 Proportional, Progressive, and Regressive taxes
Taxes can be differentiated by the effect they have on the placement of income and wealth. A proportional tax is a kind that impinges the same relative onus on all the taxpayers—i.e., when tax liability and income grow in the same levels. A progressive tax is characterizable by a larger than proportional rise in the tax onus in regard to the growth in income, and a regressive tax is recognisable by a less than proportional rise in the comparable liability. Therefore, progressive taxes are thought of as fighting inequalities in income distribution, whereas regressive taxes might result in an increase these inequalities.
The taxes that are normally regarded as progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, could become less so for the upper-income group—in particular if a taxpayer is able to lower his tax base by declaring deductions or by taking some certain income components from his taxable income. Proportional tax rates that are applied to lower-income demographics could also be more progressive if such exemptions of a personal nature are claimed.
Income measured over the period of a given year might not necessarily provide the most suitable measure of taxpaying requirement. For example, transitory rises in income could be saved, and during temporary declines in income a taxpayer might decide to provide for consumption by decreasing savings. Ergo, if taxation is regarded along with “permanent income,” it will be less regressive (or more progressive) than when it is made comparable with annual income.
Sales taxes and excises (excepting those on luxuries) are mostly regressive, because the spread of one’s income consumed or spent on specific goods declines as the level of personal income rises. Poll taxes (also known as head taxes), calculated as a flat amount per capita, patently are regressive.
It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden rests for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.
In considering the economic purposes of taxation, it is essential to differentiate between differing concepts of tax rates. The statutory rates are those nominated in the legislation; usually 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 grows by one dollar. Hence, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation generally contain graduated marginal rates—i.e., rates that increase as income grows. Careful analysis of marginal tax rates are required to consider 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 increase in income, the marginal rate is 20 percentage points greater than nominated within the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the important ones for considering incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applied to income from business and capital, because it may rely on considerations such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem determines that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates signify the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is important for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually rise with income, both because personal allowances are provided for the taxpayer and dependents and also because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households can dampen these effects, producing regressivity, as indicated by average tax rates that decline as income rises.
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