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Taxes are distinguished by the impact they have on the distribution of income and wealth. A proportional tax is the kind of tax that puts the same relative requirement on all taxpayers—i.e., when tax liability and income grow in equal levels. A progressive tax is recognisable by a larger than proportional rise in the tax burden in regard to the increase in income, and a regressive tax is recognised by a less than proportional rise in the related burden. Ergo, progressive taxes are regarded as reducing inequity in income distribution, but regressive taxes are believed to result in increasing these inequalities.

The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so for the upper-income categories—particularly if a taxpayer is able to lessen his tax base by declaring deductions or by leaving out some particular income parts from his taxable income. Proportional tax rates if applied to lower-income groups can also be more progressive if such exemptions of a personal nature are declared.

Income measured over the course of a given year might not definitely provide the most appropriate measure of taxpaying status. For example, transitory increases in income might be saved, and in temporary declines in income a taxpayer could elect to provide for consumption by taking from savings. Thus, if taxation is held in comparison alongside “permanent income,” it should be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (save those on luxuries) are generally regressive, because the share of own income consumed or spent for specific goods decreases as the amount of personal income increases. Poll taxes (aka head taxes), calculated as a fixed amount per capita, patently are regressive.

It is not easy to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of a lack of certainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden is dependant for the most part on whether a national or a subnational (that is, provincial or state) tax is being determined.

In assessing the economic effects of taxation, it is essential to differentiate between various ideas of tax rates. The statutory rates will include those nominated in legislature; commonly these are marginal rates, but sometimes they are mean rates. Marginal income tax rates denote the fraction of incremental income demanded by taxation when income increases by one dollar. Thus, if tax burden rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax laws usually contain graduated marginal rates—i.e., rates that increase as income increases. Structured analysis of marginal tax rates need to take into account provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than nominated by the statutory rates. Since marginal rates indicate how after-tax income changes in response to changes in before-tax income, they are the necessary ones for appraising incentive effects of taxation. It is even more complicated to know the marginal effective tax rate to apply to income from business and capital, as it may be dependant 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 indicate the percentage of total income that is paid in taxation. The pattern of average rates is the one that is relevant for considering 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 also because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households could dampen these effects, allowing regressivity, as displayed by average tax rates that fall as income grows.

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