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Taxes are distinguished by the effect they have on the allocation of income and wealth. A proportional tax is the kind that places the same relative liability on each taxpayer—i.e., where tax liability and income move in equal proportion. A progressive tax is recognised by a higher than proportional growth in the tax onus relative to the growth in income, and a regressive tax is characterized by a less than proportional rise in the related onus. Thus, progressive taxes are thought of as removing a lack of equality in income distribution, while regressive taxes may result in an increase these inequalities.

The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so within the upper-income demographic—especially if a taxpayer is able to lower his tax base by declaring deductions or by excluding particular income aspects from his taxable income. Proportional tax rates when applied to lower-income classes will also be more progressive if such exemptions of a personal nature are claimed.

Income measured over the period of a year may not definitely provide the most accurate measure of taxpaying requirements. For example, transitory rises in income can be saved, and within temporary declines in income a taxpayer could decide to provide for consumption by taking from savings. Ergo, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than if compared with annual income.

Sales taxes and excises (with the exception of luxuries) are generally regressive, because the share of own income consumed or spent on specific goods lowers as the amount of personal income rises. Poll taxes (aka head taxes), calculated as a set amount per capita, clearly are regressive.

It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden lays crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic effect of taxation, it is important to distinguish between varied concepts of tax rates. The statutory rates are dictated in the law; generally speaking these are marginal rates, but occasionally they are mean rates. Marginal income tax rates signify the fraction of incremental income that is taken by taxation when income rises by one dollar. So, if tax onus grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax statutes commonly contain graduated marginal rates—i.e., rates that increase as income rises. Heavy analysis of marginal tax rates are required to consider provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than indicated within the statutory rates. Since marginal rates signify 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 complicated to know the marginal effective tax rate applicable to income from business and capital, since it may rely on factors 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 nothing under a consumption-based tax.

Average income tax rates signify the portion of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually grow with income, both because personal allowances are granted for the taxpayer and dependents and due to that marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households could dampen these effects, forcing regressivity, as shown by average tax rates that decline as income grows.

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