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Taxes are categorized by the impact they have on the placement of income and wealth. A proportional tax is the kind of tax that applies the same relative liability on every taxpayer—i.e., when tax liability and income move in equal scale. A progressive tax is characterizable by a more than proportional increase in the tax liability relative to the rise in income, and a regressive tax is recognised by a less than proportional growth in the related onus. Thus, progressive taxes are thought of as taking away the lack of equality in income distribution, whereas regressive taxes are found to cause an increase in these inequalities.

The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so in the upper-income demographic—particularly if a taxpayer is permitted to reduce his tax base by nominating deductions or by taking some particular income elements from his taxable income. Proportional tax rates if applied to lower-income groups will also be more progressive if exemptions of a personal nature are made.

Income measured over a given period may not necessarily offer the best measure of taxpaying status. For example, transitory growth in income can be saved, and in temporary declines in income a taxpayer might decide to pay for consumption by taking from savings. Thus, if taxation is regarded with “permanent income,” it should be less regressive (or more progressive) than when held in comparison with annual income.

Sales taxes and excises (with the exception of those on luxuries) tend to be regressive, because the portion of own income consumed or spent for specific goods decreases as the level of personal income increases. Poll taxes (also called head taxes), nominated as a set amount per capita, patently are regressive.

It is complicated to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden lays crucially on whether a national or a subnational (that is, provincial or state) tax is being considered.

In considering the economic effect of taxation, it is essential to distinguish between several ideas of tax rates. The statutory rates are those nominated in legislation; usually these are marginal rates, but in some cases they are mean rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income is increased by one dollar. Ergo, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax regulations usually contain graduated marginal rates—i.e., rates that grow as income grows. Careful analysis of marginal tax rates must take into account provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated within the statutory rates. Since marginal rates signify how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for regarding incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applicable to income from business and capital, because it may depend on such considerations as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.

Average income tax rates signify the percentage of total income that is paid in taxation. The pattern of average rates is the one that is necessary for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates usually increase 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 for the most part by high-income households may dwarf these effects, forcing regressivity, as shown by average tax rates that lessen as income grows.

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