Taxes can be differentiated by the effect they have on the allocation of income and wealth. A proportional tax is a kind that imposes the same relative onus on each taxpayer—i.e., in the case where tax liability and income move in relative levels. A progressive tax is recognised by a more than proportional growth in the tax liability in regard to the increase in income, and a regressive tax is characterized by a less than proportional rise in the related burden. Thus, progressive taxes are seen as removing the lack of equality in income distribution, whereas regressive taxes can result in an increase these inequalities.

The taxes that are often thought to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so within the upper-income categories—in particular if a taxpayer is allowed to lower his tax base by nominating deductions or by leaving out particular income aspects from his taxable income. Proportional tax rates if applied to lower-income classes will also be more progressive if exemptions of a personal nature are declared.

Income measured over a given period may not necessarily give the most suitable measure of taxpaying status. For example, transitory growth in income may be saved, and within temporary declines in income a taxpayer might choose to pay for consumption by reducing savings. Thus, if taxation is held in comparison with “permanent income,” it would be less regressive (or more progressive) than when held in comparison with annual income.

Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the portion of individual income consumed or spent on specific goods declines as the rate of personal income is raised. Poll taxes (also known as head taxes), nominated as a flat amount per capita, clearly are regressive.

It is not easy to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden is dependant fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.

In assessing the economic purposes of taxation, it is important to distinguish between several concepts of tax rates. The statutory rates are dictated in legislature; usually these are marginal rates, but sometimes they are median rates. Marginal income tax rates indicate the fraction of incremental income taken by taxation when income increases by one dollar. Ergo, if tax onus increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that increase as income grows. Structured analysis of marginal tax rates need to take into account provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points higher than nominated within the statutory rates. Since marginal rates signify how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for appraising incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate applicable to income from business and capital, because 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 determines that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates show the portion of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received mostly by high-income households can dwarf these effects, producing regressivity, as displayed by average tax rates that decline as income increases.

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