Proportional Tax

What is a 'Proportional Tax'

A proportional tax is an income tax system where the same percentage of tax is levied from all taxpayers, regardless of their income. A proportional tax applies the same tax rate across low-, middle- and high-income taxpayers. The proportional tax is in contrast to a progressive tax, where taxpayers with higher incomes pay higher tax rates than taxpayers with lower incomes. A proportional tax is also frequently called a flat tax.

BREAKING DOWN 'Proportional Tax'

In a proportional tax system, all taxpayers are required to pay the same percentage of their income in taxes. For example, if the rate is set at 20%, a taxpayer earning $10,000 pays $2,000 and a taxpayer earning $50,000 pays $10,000. Similarly, a person earning $1 million would pay the exact same rate, or $200,000.

In some instances, a sales tax can also be considered a type of proportional tax since all consumers, regardless of earnings, are required to pay the same fixed rate. However, because sales tax applies to particular goods and services, it is nearly impossible to vary the rate; the income of the purchaser is not a part of the equation.

Regressive Nature of Proportional Taxes

Proportional taxes are a type of regressive tax because the tax rate does not increase as the amount of income subject to taxation rises, placing a greater financial burden on low-income individuals. Using the same example as before, the taxpayer earning $10,000 has $8,000 left after taxes while the taxpayer earning $50,000 keeps $40,000 and the million-dollar earner keeps $800,000. While the percentage of tax is the same, which can be regarded as fair, the after-tax effect on low-income earners is more burdensome than for high-income earners. Opponents of the flat tax usually claim that higher income earners should pay a higher percentage than poorer taxpayers.

Proponents of proportional taxes argue that they are beneficial because they encourage individuals to seek higher earnings without penalizing high-income earners with higher tax rates, as would be the case in a progressive tax system. They claim that treating everyone exactly the same is the very definition of fairness. Additionally, a proportional tax system is easy to understand and apply in practice, since there is no issue as to the rate of tax.

To understand a proportional tax system, it is important to also look at how it defines income. If a system has generous deductions, then low-income earners may be exempt from tax, thus eliminating (at least in part) the regressive aspects of the tax.