Taxes can be differentiated by the effect they have on the allocation of income and wealth. A proportional tax is the kind of tax that puts the same relative liability on all the taxpayers—i.e., when tax liability and income increase in the same scale. A progressive tax is characterized by a more than proportional growth in the tax onus in relation to the growth in income, and a regressive tax is recognised by a less than proportional rise in the relative burden. Ergo, progressive taxes are viewed as fighting the lack of equality in income distribution, but regressive taxes are found to have the effect of an increase in these inequalities.

The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, could become less so in the upper-income categories—particularly if a taxpayer is allowed to lower his tax base by claiming deductions or by excluding some certain income elements from his taxable income. Proportional tax rates if applied to lower-income demographics can also be more progressive if exemptions of a personal nature are made.

Income measured over the course of a given period does not necessarily give the most suitable measure of taxpaying ability. For example, transitory rises in income may be saved, and in temporary declines in income a taxpayer could opt to finance consumption by taking from savings. Ergo, if taxation is held in comparison along with “permanent income,” it can be less regressive (or more progressive) than if compared with annual income.

Sales taxes and excises (save those on luxuries) are generally regressive, because the spread of own income consumed or spent for a specific good lowers as the amount of personal income is raised. Poll taxes (aka head taxes), levied as a flat amount per capita, obviously are regressive.

It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the lack of certainty regarding 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 decided.

In considering the economic effect of taxation, it is necessary to differentiate between differing concepts of tax rates. The statutory rates are specified in legislation; generally speaking these are marginal rates, but in some cases they are average rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income grows by one dollar. Thus, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax regulations usually contain graduated marginal rates—i.e., rates that grow as income grows. Careful analysis of marginal tax rates should regard provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than nominated in the statutory rates. Since marginal rates signify how after-tax income increases or decreases in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applicable to income from business and capital, because it may be dependant on considerations such 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 zero under a consumption-based tax.

Average income tax rates determine the portion of total income that is demanded in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates generally grow with income, both because personal allowances are permitted for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received mostly by high-income households can dwarf these effects, allowing regressivity, as signified by average tax rates that fall as income grows.

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