Taxes can be distinguished by the effect they have on the placement of income and wealth. A proportional tax is the kind of tax that impinges the same relative requirement on all the taxpayers—i.e., in the case where tax liability and income increase in relative proportion. A progressive tax is recognisable 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 increase in the relative burden. Hence, progressive taxes are thought of as fighting the lack of equality in income distribution, but regressive taxes are found to have the result of increasing these inequalities.
The taxes that are often regarded as progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, may become less so within the upper-income group—particularly if a taxpayer is allowed to lessen his tax base by claiming deductions or by removing some income components from his taxable income. Proportional tax rates if applied to lower-income groups 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 necessarily give the most accurate measure of taxpaying status. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer may elect to provide for consumption by reducing savings. So, if taxation is compared along with “permanent income,” it will be less regressive (or more progressive) than if made comparable with annual income.
Sales taxes and excises (with the exception of luxuries) are usually regressive, because the spread of own income consumed or spent on specific goods lessens as the amount of personal income grows. Poll taxes (aka head taxes), levied as a set amount per capita, obviously are regressive.
It is not easy to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being determined.
In analysing the economic effect of taxation, it is relevant to distinguish between several points of tax rates. The statutory rates are dictated in law; generally these are marginal rates, but sometimes they are median rates. Marginal income tax rates note the fraction of incremental income demanded by taxation when income rises by one dollar. So, if tax liability increases 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 rise as income increases. Careful analysis of marginal tax rates are required to 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 more than specified 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 appropriate ones for regarding incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applied to income from business and capital, as it may rely on such factors as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem determines that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates determine the part of total income that is taken in taxation. The pattern of average rates is the one that is in consideration 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 increase with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households can dwarf these effects, producing regressivity, as displayed by average tax rates that decline as income grows.
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