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Taxes can be differentiated by the impact they have on the distribution of income and wealth. A proportional tax is the kind of tax that applies the same relative requirement on each taxpayer—i.e., where tax liability and income grow in relative scale. A progressive tax is characterized by a greater than proportional rise in the tax burden in relation to the increase in income, and a regressive tax is recognised by a less than proportional increase in the relative onus. So, progressive taxes are seen as removing inequalities in income distribution, but regressive taxes might have the result of increasing these inequalities.

The taxes that are generally believed to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, may become less so in the upper-income group—particularly if a taxpayer is allowed to reduce his tax base by nominating deductions or by taking some income components from his taxable income. Proportional tax rates when applied to lower-income categories can also be more progressive if such exemptions of a personal nature are claimed.

Income measured over a given period does not necessarily offer the best measure of taxpaying status. For example, transitory rises in income may be saved, and within temporary declines in income a taxpayer may elect to finance consumption by taking from savings. Therefore, if taxation is made comparable with “permanent income,” it can be less regressive (or more progressive) than when compared with annual income.

Sales taxes and excises (save luxuries) are mostly regressive, because the share of individual income consumed or spent for specific goods declines as the amount of personal income increases. Poll taxes (also called head taxes), calculated as a set amount per capita, clearly are regressive.

It is difficult to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being considered.

In analysing the economic effects of taxation, it is important to distinguish between differing ideas of tax rates. The statutory rates are those dictated in legislature; often these are marginal rates, but occasionally they are average rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income is increased by one dollar. Ergo, if tax liability rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes usually contain graduated marginal rates—i.e., rates that grow as income grows. Careful analysis of marginal tax rates need to review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points more than indicated by the statutory rates. Since marginal rates indicate how after-tax income is changed in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applied to income from business and capital, since it may depend on considerations such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem holds that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates display the portion of total income that is required in taxation. The pattern of average rates is the one that is relevant for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates usually rise with income, both because personal allowances are allowed for the taxpayer and dependents and due to that marginal tax rates are graduated; on the other side of things, preferential treatment of income received fundamentally by high-income households may dwarf these effects, forcing regressivity, as displayed by average tax rates that decline as income increases.

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