Mack and Mark

Taxes are differentiated by the effect they have on the distribution of income and wealth. A proportional tax is a kind that applies the same relative requirement on every taxpayer—i.e., when tax liability and income grow in the same scale. A progressive tax is characterized by a greater than proportional rise in the tax liability in relation to the rise in income, and a regressive tax is characterized by a less than proportional rise in the comparative burden. So, progressive taxes are thought of as taking away inequalities in income distribution, whereas regressive taxes are seen to have the effect of increasing these inequalities.

The taxes that are usually regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, might become less so within the upper-income demographic—particularly if a taxpayer is able to lower his tax base by claiming deductions or by leaving out certain income aspects from his taxable income. Proportional tax rates which are applied to lower-income classes would also be more progressive if such personal exemptions are declared.

Income measured over the period of a given year may not definitely provide the most appropriate measure of taxpaying requirements. For example, transitory increases in income could be saved, and in temporary declines in income a taxpayer could select to provide for consumption by taking from savings. Therefore, if taxation is compared with “permanent income,” it will be less regressive (or more progressive) than when it is compared with annual income.

Sales taxes and excises (with the exception of luxuries) tend to be regressive, because the spread of individual income consumed or spent on specific goods lowers as the rate of personal income grows. Poll taxes (also known as head taxes), nominated as a flat amount per capita, patently are regressive.

It is hard to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden is dependant crucially on whether a national or a subnational (that is, provincial or state) tax is being determined.

In regarding the economic effect of taxation, it is relevant to differentiate between differing ideas of tax rates. The statutory rates are those nominated in legislation; often these are marginal rates, but in some cases they are average rates. Marginal income tax rates note the fraction of incremental income that is demanded by taxation when income rises by one dollar. Hence, if tax onus rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that increase as income grows. Careful analysis of marginal tax rates must regard provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than indicated by the statutory rates. Since marginal rates signify how after-tax income moves in response to changes in before-tax income, they are the appropriate ones for assessing 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 be reliant on considerations including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.

Average income tax rates indicate the percentage of total income that is paid in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly rise with income, both because personal allowances are allowed for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other side of things, preferential treatment of income received predominantly by high-income households might dwarf these effects, forcing regressivity, as shown by average tax rates that fall as income rises.

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