Regressive vs. Proportional vs. Progressive Taxes: An Overview

Tax systems fall into three main categories: regressive, proportional, and progressive. Regressive taxes have a greater impact on low-income individuals than they do on high-income earners.

A proportional tax, also referred to as a flat tax, impacts low-, middle-, and high-income earners relatively equally. They all pay the same tax rate, regardless of income.

A progressive tax has more of a financial impact on higher-income individuals and businesses than on low-income earners.

Regressive Taxes

Low-income individuals pay a higher amount of their incomes in taxes compared to high-income earners under a regressive tax system because the government assesses tax as a percentage of the value of the asset that a taxpayer purchases or owns. This type of tax has no correlation with an individual's earnings or income level.

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Comparing Regressive, Proportional and Progressive Taxes

Regressive taxes include real estate property taxes and excise taxes on consumables, such as gasoline or airfare. Excise taxes are fixed and they're included in the price of the product or service.

"Sin taxes," a subset of excise taxes, are imposed on certain commodities or activities that are perceived to be unhealthy or have a negative effect on society, such as cigarettes, gambling, and alcohol. They're imposed in an effort to deter individuals from purchasing these products. Sin tax critics argue that these disproportionately affect those who are less well off.

Many also consider Social Security to be a regressive tax. Social Security tax obligations are capped at a certain level of income called a wage base—$137,700 in 2020. An individual's earnings above this base are not subject to the 6.2% Social Security tax. Therefore, the annual maximum that an individual pays in Social Security tax is capped at $8,537.40 in 2020, whether she earns $137,701 or $1 million. Employers pay an additional 6.2% on behalf of their workers, and self-employed individuals must pay both halves on earnings up to the wage base.

Higher-income employees effectively pay a lower proportion of their overall income into the Social Security system than lower-income employees do because it's a flat rate for everyone and because of this cap.

Proportional Taxes

A proportional tax system, also referred to as a flat tax system, assesses the same tax rate on everyone regardless of income or wealth. It's meant to create equality between marginal tax rates and average tax rates paid. Nine states use this income tax system as of 2019: Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah.

Some other examples of proportional taxes include per capita taxes, gross receipts taxes, and occupational taxes.

Proponents of proportional taxes believe they stimulate the economy by encouraging people to work more because there's no tax penalty for earning more. They also believe that businesses are likely to spend and invest more under a flat tax system, putting more dollars into the economy.

Just as Social Security can be considered a regressive tax, it's also a proportional tax because everyone pays the same rate, at least up to the wage base.

Progressive Taxes

Taxes assessed under a progressive system are based on the taxable amount of an individual's income. They follow an accelerating schedule, so high-income earners pay more than low-income earners. Tax rate, along with tax liability, increases as an individual's wealth increases. The overall outcome is that higher earners pay a higher percentage of taxes and more money in taxes than do lower-income earners.

This sort of system is meant to affect upper-class people more low- or middle-class individuals to reflect the presumption that they can afford to pay more.

The current U.S. federal income tax is a progressive tax system. Its schedule of marginal tax rates imposes a higher income tax rate on people with higher incomes, and a lower income tax rate on people with lower incomes. The percentage rate increases at intervals as taxable income increases. Each dollar the individual earns places him into a bracket or category, resulting in a higher tax rate once the dollar amount hits a new threshold.

Part of what makes the U.S. federal income tax progressive is the standard deduction that lets individuals avoid paying taxes on the first portion of income they earn each year. The amount of the standard deduction changes from year to year to keep pace with inflation. Taxpayers can elect to itemize deductions instead if this option results in a greater overall deduction.

Many low-income Americans pay no federal income tax at all because of these deductions. As many as 44% of U.S. citizens did not pay income taxes in 2018 because their earnings weren't sufficient to reach the lowest tax rate.

Estate taxes are another example of progressive taxes as they mainly affect high net worth individuals and they increase with the size of the estate. Only estates valued at $11.4 million or more are liable for federal estate taxes as of 2019, although many states have lower thresholds.

As with any government policy, progressive tax rates have critics. Some say progressive taxation is a form of inequality and amounts to a redistribution of wealth as higher earners pay more to a nation that supports more lower-income earners. Those who oppose progressive taxes often point to a flat tax rate as the most appropriate alternative. 

Regressive vs. Proportional vs. Progressive Taxes Examples

Shoppers pay a 6% sales tax on their groceries whether they earn $30,000 or $130,000 annually, so those with lesser incomes end up paying a greater portion of total income than those who earn more. If someone makes $20,000 a year and pays $1,000 in sales taxes consumer goods, 5% of his annual income goes to sales tax. But if he earns $100,000 a year and pays the same $1,000 in sales taxes, this represents only 1% of his income.

Under a proportional income-tax system, individual taxpayers pay a set percentage of annual income regardless of the amount of that income. The fixed rate doesn't increase or decrease as income rises or falls. An individual who earns $25,000 annually would pay $1,250 at a 5% rate, whereas someone who earns $250,000 each year would pay pays $12,500 at that same rate.

Federal progressive tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37% as of 2019. The first tax rate of 10% applies to incomes of $9,700 or less for single individuals, and $19,400 for married couples filing joint tax returns. The highest tax rate of 37% applies to incomes over $510,300 for single taxpayers, $612,35 for joint married filers.

A single taxpayer who has taxable income of $50,000 would not pay the third rate of 22% on her full income. Instead, she would owe 10% on the first $9,700 of income, 12% on her income from $9,701 to $39,475, and 22% for the balance that falls into the third tax bracket. The taxpayer in this example owes a total of $6,858.50: The 10% rate on the first $9,700 is $970, the 12% rate on the next $29,775 is $3,573, and the 22% rate on the remaining $10,525 is $2,315.50.

A single taxpayer with taxable income of $25,000 would owe $970 on the first $9,700 and 12% or $1,836 on the balance, for a total of $2,806.

Key Takeaways

  • A regressive tax is thought to be disproportionately difficult on lower-income individuals because it's the same percentage of products or goods purchased regardless of the buyer's income.
  • A proportional tax applies the same tax rate to all individuals regardless of income.
  • A progressive tax imposes a greater percentage of taxation on higher income levels, operating on the theory that high-income earners can afford to pay more.