Taxes are distinguished by the impact they have on the distribution of income and wealth. A proportional tax is the kind of tax that imposes the same relative requirement on all taxpayers—i.e., in the case where tax liability and income move in equal scale. A progressive tax is recognisable by a higher than proportional increase in the tax liability relative to the growth in income, and a regressive tax is recognised by a less than proportional rise in the related burden. Ergo, progressive taxes are seen as removing the lack of equality in income distribution, whereas regressive taxes are believed to have the result of an increase in these inequalities.

The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, could become less so for the upper-income demographic—in particular if a taxpayer is able to lessen his tax base by declaring deductions or by taking some income elements from his taxable income. Proportional tax rates when applied to lower-income demographics can also be more progressive if exemptions of a personal nature are declared.

Income measured over the period of a year might not necessarily give the best measure of taxpaying requirements. For example, transitory increases in income can be saved, and within temporary declines in income a taxpayer could decide to provide for consumption by decreasing savings. Thus, if taxation is held in comparison alongside “permanent income,” it can be less regressive (or more progressive) than if made comparable with annual income.

Sales taxes and excises (excepting those on luxuries) tend to be regressive, because the portion of one’s income consumed or spent on specific goods lessens as the amount of personal income grows. Poll taxes (aka head taxes), calculated as a fixed amount per capita, clearly are regressive.

It is hard to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to a lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In assessing the economic effects of taxation, it is necessary to distinguish between several points of tax rates. The statutory rates include those specified in law; often these are marginal rates, but for some cases they are median rates. Marginal income tax rates note the fraction of incremental income taken by taxation when income increases by one dollar. Hence, if tax burden rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax laws often contain graduated marginal rates—i.e., rates that rise as income increases. Structured analysis of marginal tax rates are required to review provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points more than nominated in the statutory rates. Since marginal rates display how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for appraising incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, since it may depend on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem determines that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.

Average income tax rates indicate the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally grow with income, both because personal allowances are granted for the taxpayer and dependents and due to that marginal tax rates are graduated; conversely, preferential treatment of income received mostly by high-income households may swamp these effects, producing regressivity, as indicated by average tax rates that lessen as income rises.

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