Taxes can be categorized by the effect they have on the distribution of income and wealth. A proportional tax is a tax that places the same relative onus on all the taxpayers—i.e., where tax liability and income grow in equal scale. A progressive tax is characterizable by a more than proportional rise in the tax onus in relation to the increase in income, and a regressive tax is recognised by a less than proportional increase in the comparable onus. Thus, progressive taxes are thought of as fighting a lack of equality in income distribution, while regressive taxes can have the result of an increase in these inequalities.

The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, can become less so within the upper-income class—in particular if a taxpayer is permitted to lower his tax base by nominating deductions or by removing some particular income parts from his taxable income. Proportional tax rates when applied to lower-income groups will also be more progressive if such personal exemptions are made.

Income measured over the period of a year does not necessarily come up with the best measure of taxpaying ability. For example, transitory increases in income might be saved, and during temporary declines in income a taxpayer could elect to finance consumption by reducing savings. Ergo, if taxation is regarded with “permanent income,” it can be less regressive (or more progressive) than when it is held in comparison with annual income.

Sales taxes and excises (save luxuries) are generally regressive, because the portion of individual income consumed or spent for a specific good lowers as the level of personal income increases. Poll taxes (also known as head taxes), levied as a standard amount per capita, clearly are regressive.

It is hard to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the 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 lays crucially on whether a national or a subnational (that is, provincial or state) tax is being debated.

In analysing the economic effect of taxation, it is relevant to differentiate between various ideas of tax rates. The statutory rates will be dictated in the legislation; often these are marginal rates, but sometimes they are average rates. Marginal income tax rates signify the fraction of incremental income that is demanded by taxation when income increases by one dollar. Thus, if tax onus rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation often contain graduated marginal rates—i.e., rates that grow as income rises. Careful analysis of marginal tax rates should consider provisions as well as 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 in the statutory rates. Since marginal rates indicate how after-tax income is changed in response to changes in before-tax income, they are the important ones for appraising incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applied to income from business and capital, since it may rely on considerations 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 show the portion of total income that is required in taxation. The pattern of average rates is the one that is important for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally increase with income, both because personal allowances are allowed for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received for the most part by high-income households could swamp these effects, producing regressivity, as signified by average tax rates that decline as income grows.

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