Tax systems fall into three main categories within the Tax Code: regressive, proportional and progressive taxes. Regressive taxes are those that have a greater impact on low-income individuals than high-income individuals. A proportional tax, also known as lump-sum tax, has a relatively similar effect on low, middle and high earners. A progressive tax has a greater impact on people and companies with higher incomes and has less financial impact on low paid workers.
Regressive Taxes
Under a regressive tax system, low-income individuals and organizations pay a higher share of that income in taxes compared to high-income workers. Instead of introducing a tax liability based on individual or corporate solvency, the government assesses the tax as a percentage of the asset that the taxpayer acquires or owns.
For example, a sales tax is assessed on the purchase of everyday products or services as a percentage of the purchased item and is the same for each individual or unit. A 7% sales tax, however, puts a heavier burden on low earners than the wealthy, as their solvency is not taken into account. Regressive taxes include property taxes, state and local sales taxes and excise duties on consumables such as cigarettes, gasoline, airline tickets or alcohol.
Interested in which countries the regressive tax system is implemented? Which types of economies are common to regressive tax systems?
Proportional Taxes
A proportional tax system, also known as a lump-sum taxation system, rates the taxpayer the same tax rate regardless of income or assets. It should create equality between the marginal tax rate and the average tax rate paid. With a proportional tax system, individual taxpayers pay a percentage of their income, regardless of their total income.
For example, an income tax of 10%, which does not increase or decrease with rising or falling income, leads to a proportional tax. In this example, a person earning $ 20,000 pays $ 2,000 annually under a proportional tax system, while someone who earns $ 200,000 a year pays $ 20,000 in taxes. Some examples of proportional taxes are per capita taxes, gross receipts and operating taxes.
What do you think? Should the US switch to a flat tax?
Progressive Taxes
Current federal income tax in the US is a progressive tax system as the proportion of tax debt increases with increasing income of an individual or a company. Tax burdens are more likely to be imposed on wealthy, high earning earners than low or middle class individuals.
In a progressive tax system, taxes on income and corporate profits are based on a progressive or increasing tax rate. Border tax rates under a progressive tax system are often higher than the average tax rates that are paid. Estate taxes are another example of progressive taxes as they create a greater burden on wealthy individuals.
There is a debate about whether progressive taxes are a fair tax policy. Read on here - What are the pros and cons of a progressive tax policy and who benefits most from it? and are progressive taxes fairer than flat-rate taxes?