08 Jul 10 Proportional, Progressive, and Regressive taxes
Taxes are distinguished by the impact they have on the placement of income and wealth. A proportional tax is the kind that imposes the same relative requirement on all taxpayers—i.e., where tax liability and income increase in equal levels. A progressive tax is recognisable by a greater than proportional rise in the tax onus in regard to the increase in income, and a regressive tax is recognised by a less than proportional rise in the related burden. Ergo, progressive taxes are seen as removing inequalities in income distribution, but regressive taxes may have the result of increasing these inequalities.
The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so within the upper-income categories—especially if a taxpayer is able to reduce his tax base by nominating deductions or by removing certain income aspects from his taxable income. Proportional tax rates which are applied to lower-income classes can also be more progressive if such personal exemptions are claimed.
Income measured over the period of a given year does not necessarily come up with the best measure of taxpaying status. For example, transitory increases in income can be saved, and within temporary declines in income a taxpayer may decide to pay for consumption by decreasing savings. Therefore, if taxation is compared with “permanent income,” it can 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 spread of own income consumed or spent on specific goods lowers as the amount of personal income grows. Poll taxes (also called head taxes), nominated as a standard amount per capita, clearly are regressive.
It is difficult to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to a lack of certainty about 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 for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.
In analysing the economic effects of taxation, it is necessary to distinguish between several ideas of tax rates. The statutory rates will include those dictated in law; often these are marginal rates, but occasionally they are median rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income increases by one dollar. Therefore, if tax onus grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax regulations often contain graduated marginal rates—i.e., rates that increase as income grows. Careful analysis of marginal tax rates must consider provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points more than indicated in the statutory rates. Since marginal rates specify how after-tax income moves in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applied to income from business and capital, as it may be reliant on factors including 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 nothing under a consumption-based tax.
Average income tax rates display the portion of total income that is required in taxation. The pattern of average rates is the one that is necessary for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly rise with income, both because personal allowances are allowed for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received mostly by high-income households can dampen these effects, forcing regressivity, as displayed by average tax rates that decline as income increases.
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