Taxes are distinguished by the impact they have on the placement of income and wealth. A proportional tax is the kind of tax that impinges the same relative onus on all taxpayers—i.e., in the case where tax liability and income increase in the same scale. A progressive tax is recognised by a greater than proportional increase in the tax burden relative to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the comparative burden. Hence, progressive taxes are regarded as removing inequalities in income distribution, whereas regressive taxes are found to have the result of increasing these inequalities.
The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so within the upper-income group—particularly if a taxpayer is able to reduce his tax base by declaring deductions or by taking particular income elements from his taxable income. Proportional tax rates when applied to lower-income classes can also be more progressive if exemptions of a personal nature are made.
Income measured over the course of a given period does not necessarily give the most suitable measure of taxpaying status. For example, transitory growth in income might be saved, and during temporary declines in income a taxpayer may decide to pay for consumption by decreasing savings. Thus, if taxation is made comparable with “permanent income,” it will be less regressive (or more progressive) than when held in comparison with annual income.
Sales taxes and excises (with the exception of luxuries) tend to be regressive, because the dissemination of personal income consumed or spent for a specific good lessens as the amount of personal income is raised. Poll taxes (also termed head taxes), nominated as a standard amount per capita, clearly are regressive.
It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests crucially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In analysing the economic effect of taxation, it is essential to differentiate between several concepts of tax rates. The statutory rates will be specified in legislation; commonly these are marginal rates, but occasionally they are mean rates. Marginal income tax rates note the fraction of incremental income taken by taxation when income rises by one dollar. Hence, if tax liability increases by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax regulations generally contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates should take into account provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than nominated within the statutory rates. Since marginal rates display how after-tax income increases or decreases in response to changes in before-tax income, they are the important ones for appraising incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate to apply to income from business and capital, because it may be reliant on considerations 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 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 relevant for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates commonly rise with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households could dwarf these effects, allowing regressivity, as signified by average tax rates that lower as income rises.
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