Types of Tax Systems

Taxes can be differentiated by the impact they have on the placement of income and soveign wealth. A proportional tax is one that applies the same relative onus on every taxpayer – i.e., when tax liability and income grow in the same levels. 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. Ergo, progressive taxes are regarded as taking away inequalities in income distribution, but regressive taxes may have the effect of an increase in these inequalities.

The taxes that are normally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so in the upper-income class – in particular if a taxpayer is allowed to lessen his tax base by claiming deductions or by taking particular income aspects from his taxable income. Proportional tax rates when applied to lower-income groups could also be more progressive if such exemptions of a personal nature are claimed.

Income measured over the period of a year might not definitely give the most suitable measure of taxpaying requirements. For example, transitory increases in income may be saved, and within temporary declines in income a taxpayer could choose to pay for consumption by taking from savings. So, if taxation is held in comparison along with “permanent income,”it would be less regressive (or more progressive) than if it is made comparable with annual income.

Sales taxes and excises (save on luxuries) are mostly regressive, because the dissemination of individual income consumed or spent on specific goods declines as the rate of personal income increases. Poll taxes (also known as head taxes), nominated as a fixed amount per capita, clearly are regressive.

It is complicated to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the uncertainty 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 regarding the economic purposes of taxation, it is relevant to distinguish between varied points of tax rates. The statutory rates will include those dictated in the legislation; often these are marginal rates, but for some cases they are average rates. Marginal income tax rates note the fraction of incremental income that is demanded by taxation when income increases by one dollar. Hence, if tax burden rises by 45 cents when income rises 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 rises. Careful analysis of marginal tax rates need to review 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 growth in income, the marginal rate is 20 percentage points more than nominated by the statutory rates. Since marginal rates display how after-tax income is changed in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate to apply to income from business and capital, as it may depend on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates indicate the fraction of total income that is required in taxation. The pattern of average rates is the one that is necessary for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income.

Average earnings tax rates commonly rise with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the other hand, preferential treatment of income received mostly by high-income households might dampen these effects, allowing regressivity, as signified by average tax rates that lessen as income rises.

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