Taxes are distinguished by the effect they have on the placement of income and wealth. A proportional tax is the kind of tax that places the same relative onus on every taxpayer—i.e., when tax liability and income increase in equal levels. A progressive tax is characterizable by a more than proportional rise in the tax burden in relation to the increase in income, and a regressive tax is recognisable by a less than proportional rise in the relative burden. Hence, progressive taxes are regarded as reducing inequity in income distribution, while regressive taxes may have the result of an increase in these inequalities.

The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, could become less so in the upper-income categories—especially if a taxpayer is able to lessen his tax base by declaring deductions or by leaving out certain income aspects from his taxable income. Proportional tax rates if applied to lower-income groups could also be more progressive if exemptions of a personal nature are claimed.

Income measured over the period of a given year might not definitely come up with the most suitable measure of taxpaying requirements. For example, transitory rises in income could be saved, and during temporary declines in income a taxpayer could elect to provide for consumption by decreasing savings. Therefore, if taxation is regarded alongside “permanent income,” it can be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (with the exception of luxuries) tend to be regressive, because the portion of individual income consumed or spent on specific goods decreases as the rate of personal income is raised. Poll taxes (also termed head taxes), calculated as a flat amount per capita, obviously are regressive.

It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden lays fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.

In regarding the economic effect of taxation, it is important to distinguish between various ideas of tax rates. The statutory rates will include those dictated in legislation; often these are marginal rates, but for some cases they are average rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income rises by one dollar. Hence, if tax onus grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax regulations often contain graduated marginal rates—i.e., rates that increase as income rises. Heavy analysis of marginal tax rates are required to consider 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 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 regarding incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate to apply to income from business and capital, since it may rely on such considerations 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 nothing under a consumption-based tax.

Average income tax rates show the part of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for judging 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 permitted for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received fundamentally by high-income households could dampen these effects, producing regressivity, as displayed by average tax rates that lessen as income grows.

For MYOB Brisbane expert advice, contact Stone Consulting today. Stone Consulting also runs MYOB training in Brisbane.