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Taxes can be categorized by the effect they have on the distribution of income and wealth. A proportional tax is one that puts the same relative burden on all taxpayers—i.e., in the case where tax liability and income grow in equal scale. A progressive tax is recognisable by a greater than proportional growth in the tax liability relative to the rise in income, and a regressive tax is characterizable by a less than proportional growth in the comparable burden. Therefore, progressive taxes are viewed as removing inequalities in income distribution, but regressive taxes may result in an increase these inequalities.

The taxes that are usually regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, might become less so within the upper-income categories—especially if a taxpayer is allowed to reduce his tax base by claiming deductions or by leaving out particular income parts from his taxable income. Proportional tax rates if applied to lower-income groups could also be more progressive if such exemptions of a personal nature are claimed.

Income measured over the course of a given year may not definitely come up with the best measure of taxpaying status. For example, transitory increases in income may be saved, and in temporary declines in income a taxpayer might opt to provide for consumption by decreasing savings. Ergo, if taxation is regarded 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 luxuries) tend to be regressive, because the dissemination of own income consumed or spent for a specific good lowers as the level of personal income is raised. Poll taxes (also known as head taxes), calculated as a set amount per capita, obviously are regressive.

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

In considering the economic effect of taxation, it is relevant to distinguish between various concepts of tax rates. The statutory rates are dictated in law; generally speaking these are marginal rates, but in some cases they are average rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income increases by one dollar. Ergo, if tax onus rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that grow as income increases. Heavy analysis of marginal tax rates should review provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than indicated 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 important ones for appraising incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applicable to income from business and capital, because 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 shows 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 taken 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 increases with income. Average income tax rates commonly rise with income, both because personal allowances are granted for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other side of things, preferential treatment of income received predominantly by high-income households may dampen these effects, forcing regressivity, as signified by average tax rates that decline as income rises.

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