Taxes can be distinguished by the effect they have on the distribution of income and wealth. A proportional tax is a tax that places the same relative burden on every taxpayer—i.e., where tax liability and income increase in equal scale. A progressive tax is recognised by a larger than proportional rise in the tax liability in relation to the rise in income, and a regressive tax is characterizable by a less than proportional growth in the relative onus. So, progressive taxes are regarded as fighting a lack of equality in income distribution, while regressive taxes are believed to result in increasing these inequalities.
The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so within the upper-income demographic—especially if a taxpayer is permitted to lower his tax base by declaring deductions or by taking some particular income parts from his taxable income. Proportional tax rates that are applied to lower-income categories can also be more progressive if such personal exemptions are made.
Income measured over a given period may not necessarily offer the best measure of taxpaying requirements. For example, transitory increases in income could be saved, and during temporary declines in income a taxpayer might select to provide for consumption by reducing savings. Ergo, if taxation is regarded alongside “permanent income,” it can be less regressive (or more progressive) than if it is held in comparison with annual income.
Sales taxes and excises (excepting luxuries) are usually regressive, because the share of own income consumed or spent for specific goods declines as the amount of personal income is raised. Poll taxes (also known as head taxes), calculated as a standard amount per capita, obviously are regressive.
It is difficult to determine 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 deciding who bears the tax burden depends essentially on whether a national or a subnational (that is, provincial or state) tax is being debated.
In assessing the economic purpose of taxation, it is necessary to differentiate between various ideas of tax rates. The statutory rates are those dictated in law; often these are marginal rates, but for some cases they are average rates. Marginal income tax rates denote the fraction of incremental income taken by taxation when income rises by one dollar. Hence, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws commonly contain graduated marginal rates—i.e., rates that rise as income rises. Heavy analysis of marginal tax rates need to regard provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points higher than indicated by the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the relevant ones for appraising incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate applicable to income from business and capital, because it may be reliant on factors including 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 indicate the portion of total income that is paid in taxation. The pattern of average rates is the one that is relevant for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates commonly rise 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 for the most part by high-income households can dwarf these effects, forcing regressivity, as indicated by average tax rates that decline as income rises.
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