Taxes can be categorized by the effect they have on the allocation of income and wealth. A proportional tax is a tax that applies the same relative onus on all the taxpayers—i.e., in the case where tax liability and income move in relative scale. A progressive tax is recognisable by a more than proportional increase in the tax liability in regard to the growth in income, and a regressive tax is recognisable by a less than proportional growth in the relative burden. Thus, progressive taxes are thought of as taking away inequalities in income distribution, but regressive taxes can cause an increase in these inequalities.
The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so in the upper-income group—particularly if a taxpayer is permitted to reduce his tax base by declaring deductions or by removing certain income elements from his taxable income. Proportional tax rates when applied to lower-income demographics will also be more progressive if such exemptions of a personal nature are claimed.
Income measured over the course of a given period might not definitely offer the best measure of taxpaying requirements. For example, transitory growth in income can be saved, and in temporary declines in income a taxpayer might choose to pay for consumption by taking from savings. So, if taxation is held in comparison with “permanent income,” it would be less regressive (or more progressive) than when held in comparison with annual income.
Sales taxes and excises (with the exception of luxuries) are usually regressive, because the share of own income consumed or spent for a specific good declines as the amount of personal income is raised. Poll taxes (also known as head taxes), nominated as a set amount per capita, patently are regressive.
It is not simple to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden rests for the most part on whether a national or a subnational (that is, provincial or state) tax is being determined.
In considering the economic purposes of taxation, it is important to differentiate between various ideas of tax rates. The statutory rates are dictated in legislation; generally these are marginal rates, but for some cases they are median rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income rises by one dollar. So, if tax liability grows 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 regard provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated in the statutory rates. Since marginal rates display how after-tax income changes in response to changes in before-tax income, they are the appropriate ones for regarding incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applicable to income from business and capital, as 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 holds that the marginal effective tax rate in income from capital is zero under a consumption-based tax.
Average income tax rates signify 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 increases with income. Average income tax rates usually increase 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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