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Taxes are differentiated by the effect they have on the allocation of income and wealth. A proportional tax is one that applies the same relative liability on every taxpayer—i.e., where tax liability and income increase in relative scale. A progressive tax is characterizable by a more than proportional increase in the tax burden in relation to the growth in income, and a regressive tax is recognised by a less than proportional increase in the comparable burden. So, progressive taxes are viewed as removing the lack of equality in income distribution, while regressive taxes are found to have the result of increasing these inequalities.

The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so within the upper-income class—especially if a taxpayer is able to lower his tax base by claiming deductions or by leaving out some certain income elements from his taxable income. Proportional tax rates when applied to lower-income classes can also be more progressive if such exemptions of a personal nature are made.

Income measured over a given period does not absolutely provide the most appropriate measure of taxpaying ability. For example, transitory growth in income may be saved, and within temporary declines in income a taxpayer may choose to finance consumption by taking from savings. Thus, if taxation is made comparable alongside “permanent income,” it would be less regressive (or more progressive) than if compared with annual income.

Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the dissemination of one’s income consumed or spent for specific goods lowers as the level of personal income increases. Poll taxes (aka head taxes), nominated as a standard 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 because of a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining 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 purposes of taxation, it is essential to differentiate between varied ideas of tax rates. The statutory rates include those dictated in the law; often these are marginal rates, but for some cases they are median rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income is increased by one dollar. So, if tax burden increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation commonly contain graduated marginal rates—i.e., rates that increase as income rises. Careful analysis of marginal tax rates are required to review provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls 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 display how after-tax income changes in response to changes in before-tax income, they are the appropriate ones for regarding incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate applied to income from business and capital, because it may rely on considerations such as 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 nothing under a consumption-based tax.

Average income tax rates indicate the percentage of total income that is taken in taxation. The pattern of average rates is the one that is in consideration for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually increase with income, both because personal allowances are provided for the taxpayer and dependents and due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received fundamentally by high-income households can dampen these effects, forcing regressivity, as signified by average tax rates that lessen as income increases.

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