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Taxes can be categorized by the effect they have on the allocation of income and wealth. A proportional tax is the kind of tax that impinges the same relative requirement on all the taxpayers—i.e., when tax liability and income increase in relative proportion. A progressive tax is characterized by a larger than proportional rise in the tax onus in regard to the increase in income, and a regressive tax is characterizable by a less than proportional growth in the comparable burden. So, progressive taxes are thought of as fighting inequity in income distribution, whereas regressive taxes are believed to increase these inequalities.

The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so in the upper-income class—in particular if a taxpayer is permitted to lessen his tax base by nominating deductions or by excluding certain income elements from his taxable income. Proportional tax rates that are applied to lower-income classes can also be more progressive if personal exemptions are made.

Income measured over the course of a given year might not definitely give the best measure of taxpaying ability. For example, transitory increases in income could be saved, and within temporary declines in income a taxpayer might choose to pay for consumption by taking from savings. Ergo, if taxation is regarded alongside “permanent income,” it would be less regressive (or more progressive) than when it is compared with annual income.

Sales taxes and excises (excepting luxuries) are mostly regressive, because the share of own income consumed or spent on specific goods lowers as the amount of personal income is raised. Poll taxes (also called head taxes), levied as a fixed amount per capita, patently are regressive.

It is not simple to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden rests essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In regarding the economic effect of taxation, it is necessary to distinguish between differing concepts of tax rates. The statutory rates are specified in the legislation; usually these are marginal rates, but in some cases they are average rates. Marginal income tax rates denote the fraction of incremental income taken by taxation when income rises by one dollar. Hence, if tax burden rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws often contain graduated marginal rates—i.e., rates that rise as income increases. Careful analysis of marginal tax rates should take into account provisions in addition to 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 nominated by the statutory rates. Since marginal rates indicate how after-tax income moves in response to changes in before-tax income, they are the relevant ones for appraising incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applicable to income from business and capital, since 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 signify the percentage of total income that is required in taxation. The pattern of average rates is the one that is in consideration for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly grow with income, both because personal allowances are permitted for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households might dampen these effects, producing regressivity, as signified by average tax rates that lessen as income grows.

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