Proportional, Progressive, and Regressive taxes
July 8th, 2010Taxes can be differentiated by the effect they have on the allocation of income and wealth. A proportional tax is the kind of tax that puts the same relative onus on every taxpayer—i.e., in the case where tax liability and income grow in relative proportion. A progressive tax is recognised by a more than proportional rise in the tax onus relative to the increase in income, and a regressive tax is characterizable by a less than proportional growth in the related onus. Hence, progressive taxes are regarded as reducing a lack of equality in income distribution, but regressive taxes might have the effect of increasing these inequalities.
The taxes that are normally regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so in the upper-income categories—particularly if a taxpayer is allowed to lessen his tax base by nominating deductions or by taking particular income components from his taxable income. Proportional tax rates if applied to lower-income categories can also be more progressive if personal exemptions are declared.
Income measured over the course of a given year does not absolutely come up with the most suitable measure of taxpaying requirements. For example, transitory growth in income may be saved, and within temporary declines in income a taxpayer might elect to pay for consumption by taking from savings. So, if taxation is compared along with “permanent income,” it would be less regressive (or more progressive) than if it is held in comparison with annual income.
Sales taxes and excises (excepting luxuries) are usually regressive, because the spread of individual income consumed or spent for a specific good declines as the rate of personal income increases. Poll taxes (also termed head taxes), nominated as a standard amount per capita, obviously are regressive.
It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the lack of certainty surrounding 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 debated.
In regarding the economic effects of taxation, it is relevant to differentiate between differing points of tax rates. The statutory rates are those nominated in law; usually these are marginal rates, but sometimes they are average rates. Marginal income tax rates denote the fraction of incremental income demanded by taxation when income rises by one dollar. So, if tax liability grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations generally contain graduated marginal rates—i.e., rates that grow as income increases. Structured analysis of marginal tax rates need to review 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 greater than specified in the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the important ones for regarding incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate applied to income from business and capital, because it may depend 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 zero under a consumption-based tax.
Average income tax rates signify the fraction of total income that is required in taxation. The pattern of average rates is the one that is important for appraising 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 provided for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received mostly by high-income households can swamp these effects, forcing regressivity, as indicated by average tax rates that decline as income rises.
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