Proportional, Progressive, and Regressive taxes
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Taxes can be differentiated by the impact they have on the allocation of income and wealth. A proportional tax is a kind that places the same relative liability on every taxpayer—i.e., where tax liability and income grow in relative scale. A progressive tax is characterizable by a larger than proportional rise in the tax liability in relation to the rise in income, and a regressive tax is recognisable by a less than proportional growth in the related burden. Thus, progressive taxes are regarded as reducing inequity in income distribution, but regressive taxes can have the result of an increase in these inequalities.
The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, might become less so within the upper-income categories—in particular if a taxpayer is able to lessen his tax base by claiming deductions or by taking particular income components from his taxable income. Proportional tax rates that are applied to lower-income groups could also be more progressive if such personal exemptions are declared.
Income measured over the course of a given year might not definitely provide the most accurate measure of taxpaying ability. For example, transitory growth in income may be saved, and in temporary declines in income a taxpayer could decide to finance consumption by taking from savings. Therefore, if taxation is compared with “permanent income,” it would be less regressive (or more progressive) than when it is made comparable with annual income.
Sales taxes and excises (save luxuries) are mostly regressive, because the spread of one’s income consumed or spent for specific goods lowers as the level of personal income increases. Poll taxes (aka head taxes), calculated as a standard amount per capita, clearly are regressive.
It is difficult to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of 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 rests crucially on whether a national or a subnational (that is, provincial or state) tax is being determined.
In analysing the economic effects of taxation, it is important to differentiate between several ideas of tax rates. The statutory rates will include those specified in legislation; commonly these are marginal rates, but in some cases they are median rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income increases by one dollar. Hence, if tax burden rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax regulations usually contain graduated marginal rates—i.e., rates that rise as income increases. Heavy analysis of marginal tax rates should take into account provisions apart from 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 more than specified in the statutory rates. Since marginal rates signify how after-tax income is changed in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more difficult to know the marginal effective tax rate applied to income from business and capital, since 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 holds that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.
Average income tax rates determine the portion of total income that is required in taxation. The pattern of average rates is the one that is necessary for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates generally grow with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received for the most part by high-income households can swamp these effects, producing regressivity, as signified by average tax rates that lower as income grows.
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