Loading the player...

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 earners. A proportional tax, also referred to as a flat tax, impacts low-, middle- and high-income earners relatively equally. A progressive tax has more of a financial impact on higher-income individuals and businesses, and less  on low-income earners. The U.S. federal tax system and local and state tax systems use all three types to collect tax revenue.

Regressive Taxes

Under a regressive tax system, individuals and entities with low incomes pay a higher amount of that income in taxes compared to high-income earners. Rather than basing the tax on the individual or entity's earnings or income level, the government assesses tax as a percentage of the asset that the taxpayer purchases or owns.

For example, a sales tax on the purchase of everyday products or services, such as food and clothing, is assessed as a percentage of the item bought, and is the same for every individual or entity. Shoppers pay, say, a 6% sales tax on their grocieries, whether they earn $30,000 or $130,000 annually. Because the buyer's weath (and hence, ability to pay) is not taken into consideration, this sales tax – while nominally the same for all shoppers – effectively places a greater burden on lower-income earners than it does on the wealthy: The former end up paying a greater portion of total income than the latter. For instance, if a person makes $20,000 a year and pays $1,000 in sales taxes on clothing and other consumer goods, then 5% of his annual income goes to sales tax. If a person makes $100,000 a year and pays the same $1,000 in sales taxes, then only 1% of his income goes to sales tax.

Aside from state and local sales taxes, regressive taxes include real estate property taxes and excise taxes (a fixed tax included in the price of the product or service) on consumables such as gasoline or airfare. Sin taxes, a subset of excise taxes, are imposed on certain commodities or activities perceived to be unhealthy or have a negative effect on society, such as cigarettes, gambling and alcohol (in an effort to deter individuals from purchasing those products). Sin-tax critics argue that these disproportionately affect the less well-off not just because of economics, but because these lower-income groups tend to indulge more in these items or activities.

Many also consider Social Security a regressive tax. Social security tax obligations are capped at a certain level of income. This means that once an individual reaches that income threshold ($128,700 in 2018), any wages he earns above that are not subject to the 6.2% FICA bite. In other words, the annual maximim one pays in Social Security tax is "capped" at $7,979 (in 2018) – whether one earns $128,701 or $300,00 or $1 million. Because of this cap, higher-income employees effectively pay a lower proportion of their overall income into the Social Security system than lower-income employees do.

You might also check out In what types of economies are regressive tax systems common?

Progressive Taxes

Under a progressive tax system, the taxes assessed – say, on income or business profits – are based on the taxable amount, and follow an accelerating schedule. High-income earners pay more than low-income earners, and the tax rate, along with tax liability, increases as an individual or entity'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 fact 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. As taxable income increases, the percentage rate increases at each interval as the income level moves across the schedule. With a marginal tax rate, each dollar the individual earns places him into a bracket or category, resulting in a higher tax rate once the dollar amount enters a new category.

To understand the marginal tax rate system, consider the following schedule: a first tax rate of 10% for taxable income less than $10,000, a second rate of 15% for taxable income between $10,000 and $30,000 and a third rate of 25% for taxable income between $30,000 and $60,000.

According to the schedule, if a taxpayer's  income is $50,000, the third rate of 25% does not apply to the full $50,000 of income. Instead, the taxpayer owes 10% for the first $10,000 of income, 15% for $20,000 of income at the second rate amount between $10,000 and $30,000, and 25% for the remaining $20,000 that falls into the third tax rate. The taxpayer in this example owes a total of $9,000, because the 10% rate on the first $10,000 is $1,000, the 15% rate on the next $20,000 is $3,000 and the 25% rate on the remaining $20,000 is $5,000.

Part of what makes the U.S. federal income tax progressive is the personal exemption, a feature that has been available since the first taxes were collected in 1915. The personal exemption means individuals do not pay taxes on the first bit of income they earn each year, and this amount changes from year to year. Due to personal exemptions, deductions and tax credits, many low-income Americans pay no federal income tax at all. When the economy is stable and unemployment is low, as many as 40% of U.S. citizens don't pay income taxes because their earnings are too small to reach the lowest tax rate.

Estate taxes are another example of progressive taxes, as they mainly affect on high net worth individuals, and rise with the size of the estate.

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. (See What are the pros and cons of a progressive tax policy and who benefits the most from it? )

Proportional Taxes

A proportional tax system, also referred to as a flat tax system, assesses the same tax rate regardless of income or wealth. It is meant to create equality between marginal tax rate and average tax rate paid.

For example, under a proportional income-tax system, individual taxpayers would pay a set percentage of their annual income, regardless of the size of that income. Say the fixed rate is 10%. Since it does not increase or decrease as income rises or falls, an individual who earns $20,000 annually pays $2,000, while someone who earns $200,000 each year pays $20,000 in taxes.

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

Proponents of proportional taxes believe they stimulate the economy more by encouraging people to work more, as well as spend more. They also believe businesses are likely to spend and invest more as well under a flat tax system, putting more dollars into the economy.

What do you think?  Are progressive taxes fairer than flat taxes?   Should the U.S. switch to a flat tax?

The Bottom Line

A progressive tax is one that increases along with an individual's means, while a regressive tax doesn't consider the individual's means (and thus often penalizes those with less). Proportional taxes are applied equally to all income groups.

  1. Who first came up with the idea of a progressive tax?

    Learn how the progressive income tax system developed in the United States and became the federal government's primary revenue ... Read Answer >>
  2. In which countries do high-income earners pay the most tax?

    Find out which countries require high net worth individuals to pay the most taxes. Most of these countries are in the European ... Read Answer >>
Related Articles
  1. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
  2. Taxes

    How the GOP Tax Bill Affects You

    Here's how the new tax bill changes the taxes you file in 2018.
  3. Taxes

    Countries with the Highest Income Taxes

    Before you move to one of these countries with the highest income taxes, think through the overall tax situation - and what you get for your money.
  4. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  5. Taxes

    How Much Tax Do You Really Pay?

    When you add direct and indirect taxes together, your real tax rate is much more than you expected.
  6. Insights

    A Concise History Of Changes In U.S. Tax Law

    We look at how U.S. taxes have changed since their inception.
  7. Taxes

    How Getting A Raise Affects Your Taxes

    Many people think they may actually make less overall because they are paying more taxes.
  8. Taxes

    5 State Tax Issues For When You Leave the Military

    When you're budgeting for post-military life, certain state tax issues need to be considered.
  9. Taxes

    Who Does The Current Tax Code Benefit?

    Are the non-workers benefiting from the current tax code in any way or is it the wealthy who are still getting the big breaks?
  10. Taxes

    Use Tax Vs. Internet Sales Tax: How Are They Different?

    Learn about the differences between a use tax and an Internet sales tax. Find out about transactions in which the taxes apply, and to whom they apply.
  1. Progressive Tax

    A tax that takes a larger percentage from the income of high-income ...
  2. Proportional Tax

    A tax system that requires the same percentage of income from ...
  3. Tax Rate

    A tax rate is the percentage at which an individual or corporation ...
  4. Flat Tax

    A system that applies the same tax rate to every taxpayer regardless ...
  5. Tax Liability

    The total amount of tax that an entity is legally obligated to ...
  6. Future Income Tax

    Income tax that is deferred because of discrepancies between ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  4. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  5. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  6. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
Trading Center