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The opposite of a progressive tax is a regressive tax. In this case, the amount of the tax is smaller as a percentage of income for people with larger incomes. Many taxes other than the income tax tend to be regressive in practice: e.g. most sales taxes (since lower income people spend a larger portion of their income), social security taxes (because they exclude interest, rent, and other kinds of income common for the affluent), excise taxes, and so on. (A flat tax, also called a proportional or poll tax, is one where the tax amount is fixed as a function of income, and is a term mainly used only in the context of income taxes.)
There are two main arguments for a progressive tax system. First, if the utility gained from income exhibits diminishing marginal returns, as many psychologists assert (see Weber-Fechner law), then for the tax burden to be vertically equitable , those with higher incomes must be taxed at a higher rate.
Second, it is argued that people with higher income tend to have a higher percentage of that in disposable income, and can thus afford a greater tax burden. A person making exactly enough money to pay for food and housing cannot afford to pay any taxes without it causing material damage, while someone making twice as much can afford to pay up to half their income to taxes. The converse argument is that too progressive a tax rate acts as a disincentive to work; in the previous (extreme) example, there would be no monetary incentive at all for the first person to try to double his or her income. In practice, however, no advocates of a progressive tax go as far as that extreme example, so they often argue that the taxes they propose have very little effect (or even no effect at all) on incentives.
For example, in the United States as of 2004 there are six "tax brackets" that are used to calculate the percentage of income that must be paid as income tax to the federal government. These percentages in 2003 and 2004 are:
If an individual's yearly income falls within a particular tax bracket, they pay the listed percentage of their income on each dollar that falls within that monetary range. For example, a person who earned $10,000 in 2003 would be liable for 10% of each dollar earned from the 2,651st dollar to the 9,700th dollar, and then for 15% of each dollar earned from the 9,701st dollar to the 10,000th dollar, for a total of $749.75. This ensures that every rise in a persons salary results in an increase of after-tax salary.
The tax bracket system has a few problems, however. Bracket creepBracket creep describes the process by which inflation pushes wages and salaries into higher tax brackets. Most progressive tax systems are not adjusted for inflation. As wages and salaries rise in nominal terms under the influence of inflation they becom occurs when the amounts are not tied to the cost of living, due to inflationFor alternative meanings see inflation (disambiguation). In economics, inflation is a fall in the market value or purchasing power of money. This is equivalent to a rise in the general level of prices. Inflation is the opposite of deflation. Zero or very tax rates would thus slowly rise.
An alternate system of having taxes with an increasing relative rate is a negative income taxA negative income tax is a method of tax reform that is popular among economists, but has never been fully implemented. It was developed by United States economist Milton Friedman in 1962. It is commonly used as a method of implementing a guaranteed minim, which eliminates the step problem.
Tax progressivity or regressivity should not be confused with two similar concepts: tax neutrality and tax incidence . Tax neutrality refers to the effect a change in taxation policy will have on government revenues. If the change has no net impact to government income, it is said to be neutral. Tax incidence refers what group ultimately bears the burden of a tax (for example, sales taxes, which are nominally applied to businesses, are passed through to consumers as higher prices (although the degree to which a sales tax is passed on to the consumer depends on elasticityIn economics, elasticity is the ratio of the incremental percentage change in one variable with respect to an incremental percentage change in another variable. Elasticity is usually expressed as a (positive) absolute value when the sign is already clear), and can measure the effective progressivity of a tax by income group as well as breaking the impact down by geographic area or other factors.
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