Taxes can be categorized by the impact they have on the allocation of income and wealth. A proportional tax is the kind of tax that places the same relative onus on each taxpayer—i.e., where tax liability and income grow in relative scale. A progressive tax is recognised by a higher than proportional growth in the tax onus relative to the rise in income, and a regressive tax is recognisable by a less than proportional growth in the related onus. Ergo, progressive taxes are regarded as removing inequalities in income distribution, but regressive taxes are found to result in an increase these inequalities.
The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, can become less so in the upper-income categories—in particular if a taxpayer is able to reduce his tax base by nominating deductions or by excluding certain income parts from his taxable income. Proportional tax rates which are applied to lower-income categories could also be more progressive if exemptions of a personal nature are claimed.
Income measured over the period of a year might not necessarily come up with the most appropriate measure of taxpaying requirements. For example, transitory increases in income might be saved, and in temporary declines in income a taxpayer could select to finance consumption by reducing savings. Ergo, if taxation is made comparable alongside “permanent income,” it can be less regressive (or more progressive) than when made comparable with annual income.
Sales taxes and excises (save on luxuries) are usually regressive, because the spread of own income consumed or spent for a specific good lowers as the amount of personal income grows. Poll taxes (also known as head taxes), levied as a standard amount per capita, clearly are regressive.
It is not easy to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being determined.
In regarding the economic purposes of taxation, it is relevant to distinguish between several ideas of tax rates. The statutory rates include those specified in legislation; usually these are marginal rates, but in some cases they are average rates. Marginal income tax rates signify the fraction of incremental income that is taken by taxation when income increases by one dollar. Therefore, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that rise as income rises. Heavy analysis of marginal tax rates need to take into account provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points more than indicated within the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the necessary ones for considering incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate to apply 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 zero under a consumption-based tax.
Average income tax rates display the part of total income that is paid in taxation. The pattern of average rates is the one that is relevant for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually grow with income, both because personal allowances are permitted for the taxpayer and dependents and also because marginal tax rates are graduated; on the other side of things, preferential treatment of income received for the most part by high-income households might dwarf these effects, allowing regressivity, as indicated by average tax rates that decline as income rises.
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