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Taxes are differentiated by the effect they have on the placement of income and wealth. A proportional tax is the kind that places the same relative burden on all the taxpayers—i.e., where tax liability and income increase in equal levels. A progressive tax is characterized by a greater than proportional growth in the tax liability relative to the increase in income, and a regressive tax is recognisable by a less than proportional growth in the comparable liability. Therefore, progressive taxes are viewed as taking away inequity in income distribution, while regressive taxes may increase these inequalities.

The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, could become less so in the upper-income group—in particular if a taxpayer is permitted to lower his tax base by declaring deductions or by leaving out certain income components from his taxable income. Proportional tax rates that are applied to lower-income classes would also be more progressive if such personal exemptions are claimed.

Income measured over the course of a given year may not definitely come up with the best measure of taxpaying status. For example, transitory increases in income might be saved, and in temporary declines in income a taxpayer might select to finance consumption by reducing savings. Thus, if taxation is regarded with “permanent income,” it should be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (except those on luxuries) tend to be regressive, because the share of one’s income consumed or spent on a specific good declines as the rate of personal income increases. Poll taxes (aka head taxes), levied as a fixed amount per capita, obviously are regressive.

It is difficult to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to a lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden is dependant for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.

In assessing the economic effect of taxation, it is essential to differentiate between various ideas of tax rates. The statutory rates will include those specified in law; often these are marginal rates, but for some cases they are median rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income increases by one dollar. So, if tax liability increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws generally contain graduated marginal rates—i.e., rates that rise as income rises. Structured analysis of marginal tax rates need to regard provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points higher 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 relevant ones for considering incentive effects of taxation. It is even more difficult to know the marginal effective tax rate applicable to income from business and capital, as 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 shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates indicate the fraction of total income that is paid in taxation. The pattern of average rates is the one that is necessary for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally increase with income, both because personal allowances are provided for the taxpayer and dependents and due to that marginal tax rates are graduated; conversely, preferential treatment of income received fundamentally by high-income households might dwarf these effects, allowing regressivity, as indicated by average tax rates that lessen as income increases.

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