Taxes are distinguished by the effect they have on the placement of income and wealth. A proportional tax is the kind that applies the same relative requirement on all the taxpayers—i.e., when tax liability and income grow in equal scale. A progressive tax is characterized by a larger than proportional rise in the tax liability in relation to the increase in income, and a regressive tax is recognisable by a less than proportional rise in the comparable liability. Hence, progressive taxes are seen as fighting the lack of equality in income distribution, while regressive taxes are believed to have the effect of an increase in these inequalities.
The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, can become less so in the upper-income demographic—in particular if a taxpayer is permitted to reduce his tax base by claiming deductions or by leaving out some particular income parts from his taxable income. Proportional tax rates if applied to lower-income demographics will also be more progressive if exemptions of a personal nature are declared.
Income measured over the course of a given year does not necessarily provide the best measure of taxpaying requirements. For example, transitory growth in income might be saved, and in temporary declines in income a taxpayer might decide to finance consumption by taking from savings. Ergo, if taxation is regarded with “permanent income,” it should be less regressive (or more progressive) than when compared with annual income.
Sales taxes and excises (with the exception of luxuries) tend to be regressive, because the portion of individual income consumed or spent on specific goods lessens as the rate of personal income is raised. Poll taxes (also known as head taxes), calculated as a fixed amount per capita, obviously are regressive.
It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the lack of certainty regarding 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 crucially on whether a national or a subnational (that is, provincial or state) tax is being debated.
In considering the economic effects of taxation, it is necessary to differentiate between differing concepts of tax rates. The statutory rates include those dictated in legislation; generally these are marginal rates, but in some cases they are median rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income grows by one dollar. Ergo, if tax onus grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations usually contain graduated marginal rates—i.e., rates that increase as income increases. Heavy analysis of marginal tax rates need to consider provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than nominated in the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the relevant 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, as it may be dependant on considerations such 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 zero under a consumption-based tax.
Average income tax rates show the percentage of total income that is demanded 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 granted for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received fundamentally by high-income households might dwarf these effects, allowing regressivity, as indicated by average tax rates that decrease as income rises.
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