Taxes are distinguished by the impact they have on the allocation of income and wealth. A proportional tax is a tax that applies the same relative onus on all taxpayers—i.e., where tax liability and income move 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 recognisable by a less than proportional rise in the related burden. Hence, progressive taxes are thought of as reducing a lack of equality in income distribution, while regressive taxes are found to have the result of an increase in these inequalities.

The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so within the upper-income class—particularly if a taxpayer is able to lower his tax base by claiming deductions or by taking some income components from his taxable income. Proportional tax rates when applied to lower-income classes would also be more progressive if such exemptions of a personal nature are declared.

Income measured over the period of a year may not absolutely offer the best measure of taxpaying status. For example, transitory rises in income could be saved, and within temporary declines in income a taxpayer could choose to provide for consumption by taking from savings. Ergo, if taxation is held in comparison 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 those on luxuries) tend to be regressive, because the portion of one’s income consumed or spent for a specific good lessens as the level of personal income increases. Poll taxes (aka head taxes), nominated as a flat amount per capita, patently are regressive.

It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.

In assessing the economic effect of taxation, it is necessary to differentiate between several ideas of tax rates. The statutory rates include those dictated in the law; usually these are marginal rates, but occasionally they are median 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 rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes commonly contain graduated marginal rates—i.e., rates that grow as income rises. Structured analysis of marginal tax rates are required to review provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than specified in the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more difficult to understand 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 determines that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates show the part of total income that is paid in taxation. The pattern of average rates is the one that is in consideration for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally rise with income, both because personal allowances are permitted for the taxpayer and dependents and due to that 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 dampen these effects, producing regressivity, as shown by average tax rates that lower as income grows.

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