Economics
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Boundless Economics
Taxes and Public Finance
Progressive, Proportional, and Regressive Taxes
Economics Textbooks Boundless Economics Taxes and Public Finance Progressive, Proportional, and Regressive Taxes
Economics Textbooks Boundless Economics Taxes and Public Finance
Economics Textbooks Boundless Economics
Economics Textbooks
Economics
Concept Version 5
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Comparing Marginal and Average Tax Rates

Taxes can be evaluated based on an average impact or a marginal impact and can be categorized as progressive, regressive, or proportional.

Learning Objective

  • Calculate the average tax rate and marginal tax rate


Key Points

    • An average tax rate is the ratio of the total amount of taxes paid, T, to the total tax base, P, whereas the marginal tax rate equals the change in taxes, divided by the change in tax base.
    • A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or decreases. The average tax rate equals the marginal tax rate.
    • A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. The average tax rate is higher than the marginal tax rate.
    • A progressive tax is a tax in which the tax rate increases as the taxable base amount increases. The average tax rate is lower than the marginal tax rate.

Terms

  • average tax rate

    The ratio of the amount of taxes paid to the tax base (taxable income or spending).

  • marginal tax rate

    The tax rate that applies to the last unit of currency of the tax base (taxable income or spending), and is often applied to the change in one's tax obligation as income rises.


Full Text

Computing taxes

Average and marginal tax rate

An average tax rate is the ratio of the total amount of taxes paid, T, to the total tax base, P, (taxable income or spending), expressed as a percentage. If a company pays different rates on the first $100,000 in earning than the next $100,000, it will sum up the total tax paid and divide it by $200,000 to calculate the average tax rate.

T/P = average tax rate

The marginal tax rate is sometimes defined as the tax rate that applies to the last (or next) unit of the tax base (taxable income or spending), it is in effect, the tax percentage on the highest dollar earned. For example, if a company pays 5% tax on its first $100,000 earned, and 10% on the next $100,000, the marginal tax rate of earning the $101,000th dollar is 10%.

Broadly, the marginal tax rate equals the change in taxes, divided by the change in tax base, expressed as a percentage.

change in T/change in P = marginal tax rate

Types of taxes

Progressive tax

A progressive tax is a tax in which the tax rate increases as the taxable base amount increases . The term "progressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual's ability to pay it decreases.

Progressive taxation

Graph demonstrates a progressive tax distribution on income that becomes regressive for top earners.

Regressive tax

A regressive tax is a tax imposed in such a manner that the average tax rate decreases as the amount subject to taxation increases . "Regressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from high to low, where the average tax rate exceeds the marginal tax rate. In terms of individual income and wealth, a regressive tax imposes a greater burden (relative to resources) on the poor than on the rich — there is an inverse relationship between the tax rate and the taxpayer's ability to pay as measured by assets, consumption, or income.

Proportional tax

A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or decreases. The amount of the tax is in proportion to the amount subject to taxation. "Proportional" describes a distribution effect on income or expenditure, referring to the way the rate remains consistent (does not progress from "low to high" or "high to low" as income or consumption changes), where the marginal tax rate is equal to the average tax rate.

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