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A progressive tax is a tax in which the tax rate increases as the taxable base amount increases. The term "progressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual's ability to pay it decreases.

The term is frequently applied in reference to personal income taxes, where people with more income pay a higher percentage of that income in tax than do those with less income. It can also apply to adjustment of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects. For example, a sales tax on luxury goods or the exemption of basic necessities may be described as having progressive effects as it increases a tax burden on high end consumption or decreases a tax burden on low end consumption respectively.

History

The earliest known application of progressive taxation took place in England in the 14th century. In the United States, the first progressive income tax was established by the Revenue Act of 1862, which was signed into law by President Abraham Lincoln and repealed the short-lived flat tax contained in the Revenue Act of 1861.

Overview

In the preface of the book, Tax Progressivity and Income Inequality, Professor of Economics Joel Slemrod writes,

The question of tax progressivity – who should bear the tax burden – has fascinated tax philosophers for over a century, and remains highly controversial... The ultimate answer to this question depends on ethical judgments into which the field of economics offers no insight, but it also depends on some of the bread-and-butter preoccupations of economics, such as the extent and nature of income inequality and the behavioral response of taxpayers to alternative tax systems.

Measuring progressivity

Indices such as the Suits index, Gini coefficient, Theil index, Atkinson index, and Robin Hood index are sometimes used to factor progressivity through measures of inequality of income distribution or inequality of wealth distribution.

Effective progression

An effective progression can be computed from inequality measures. The following example uses the Gini coefficient:

${\displaystyle r_{Gini}={\frac {1-G_{net}}{1-G_{gross}}}}$

Marginal and effective tax rates

The rate of tax can be expressed in two different ways; the marginal rate expressed as the rate on each additional unit of income or expenditure (or last dollar spent) and the effective (average) rate expressed as the total tax paid divided by total income or expenditure. In most progressive tax systems, both rates will rise as amount subject to taxation rises, though there may be ranges where the marginal rate will be constant. With a system of negative income tax, refundable tax credits, or income-tested welfare benefits, it is possible for marginal rates to fall as the amount subject to taxation rises.

Inflation and tax brackets

Many tax laws are not accurately indexed to inflation. Either they ignore inflation completely, or they are indexed to the Consumer Price Index (CPI), which tends to understate real inflation. In a progressive tax system, failure to index the brackets to inflation will eventually result in effective tax increases (if inflation is sustained), as inflation in wages will increase individual income and move individuals into higher tax brackets with higher percentage rate. This phenomenon is known as bracket creep and can cause fiscal drag.

Economic effects

Income equality

Progressive taxation reduces absolute income inequality when the higher rates on higher-income individuals are paid and not evaded, and transfer payments and social safety nets result in progressive government spending. When income inequality is low, aggregate demand will be relatively high, because more people who want ordinary consumer goods and services will be able to afford them, while the labor force will not be as relatively monopolized by the wealthy. High levels of income inequality can have negative effects on long term economic growth, employment, and class conflict. The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation.

There is debate between politicians and economists over the role of tax policy in mitigating or exacerbating wealth inequality and the effects on economic growth. For example, economists Thomas Piketty and Emmanuel Saez wrote that U.S. tax policy in the post World War II era has increased income inequality by enabling the wealthy greater access to capital. Conversely, a report published by the OECD in 2008 presented empirical research showing a negative relationship between the progressivity of taxes and economic growth. Tax Foundation economist William McBride states that progressivity can undermine investment, risk-taking, entrepreneurship, and productivity because high-income earners tend to do much of the saving, investing, risk-taking, and high-productivity labor.

Effects on educational choices

A potentially adverse effect of progressive tax schedules is their distorting effect on educational choices. By reducing the after-tax income of highly educated workers, progressive taxes reduce the incentives for citizens to attain education and can thereby lower the overall level of human capital in an economy. A related notion is the Davis-Moore hypothesis, which argues that inequality serves social stability. However, public subsidy of college tuition can increase the net present value of income tax receipts because college educated taxpayers earn much more than those without college education.

Psychological effects

In a study published in 2011, which included the use of data from 54 countries, the authors stated, "our results showed that progressive taxation was positively associated with the subjective well-being of nations," later adding, "we found that the association between more-progressive taxation and higher levels of subjective well-being was mediated by citizens’ satisfaction with public goods, such as education and public transportation."

Examples

Most systems around the world contain progressive aspects. When taxable income falls within a particular tax bracket, the individual pays the listed percentage of tax on each dollar that falls within that monetary range. For example, a person in the U.S. who earned $10,000 US of taxable income (income after adjustments, deductions, and exemptions) would be liable for 10% of each dollar earned from the 1st dollar to the 7,550th dollar, and then for 15% of each dollar earned from the 7,551st dollar to the 10,000th dollar, for a total of $1,122.50. In the United States, there are five tax brackets ranging from 10% to 35%.

New Zealand has the following income tax brackets (for the 2012–2013 financial year): 10.5% up to NZ$14,000; 17.5% from $14,001 to $48,000; 30% from $48,001 to $70,000; 33% over $70,001; and 45% when the employee does not complete a declaration form. All values are in New Zealand dollars and exclude the earner levy.

Australia has the following progressive income tax rates (for the 2012–2013 financial year): 0% effective up to A$18,200; 19% from $18,201 to $37,000; 32.5% from $37,001 to $80,000; 37% from $80,001 to $180,000; and 45% for any amount over $180,000.

Progressive taxation often must be considered as part of an overall system since tax codes have many interdependent variables. For example, when refundable tax credits and other tax incentives are included across the entire income spectrum, the United States has the most progressive income tax code among its peer nations; although its overall income tax rates are below the OECD average.

See also

• Laffer curve
• Proportional tax
• Regressive tax
• Robin Hood effect
• Suits index
• Tax incidence

References

1. Webster (4b): increasing in rate as the base increases (a progressive tax)
2. American Heritage (6). Increasing in rate as the taxable amount increases.
3. Britannica Concise Encyclopedia: Tax levied at a rate that increases as the quantity subject to taxation increases.
4. Princeton University WordNet: (n) progressive tax (any tax in which the rate increases as the amount subject to taxation increases)
5. ^ Sommerfeld, Ray M., Silvia A. Madeo, Kenneth E. Anderson, Betty R. Jackson (1992), Concepts of Taxation, Dryden Press: Fort Worth, TX
6. Hyman, David M. (1990) Public Finance: A Contemporary Application of Theory to Policy, 3rd, Dryden Press: Chicago, IL
7. James, Simon (1998) A Dictionary of Taxation, Edgar Elgar Publishing Limited: Northampton, MA
8. Internal Revenue Service: The luxury tax is a progressive tax – it takes more from the wealthy than from the poor.
9. Luxury tax – Britannica Online Encyclopedia: Excise levy on goods or services considered to be luxuries rather than necessities. Modern examples are taxes on jewelry and perfume. Luxury taxes may be levied with the intent of taxing the rich...
10. Clothing Exemptions and Sales Tax Regressivity, By Jeffrey M. Schaefer, The American Economic Review, Vol. 59, No. 4, Part 1 (Sep., 1969), pp. 596–599
11. http://www.taxworld.org/History/TaxHistory.htm
12. Slemrod, Joel. Tax Progressivity and Income Inequality. "The question of tax progressivity – who should bear the tax burden – has fascinated tax philosophers for over a century, and remains highly controversial... The ultimate answer to this question depends on ethical judgments into which the field of economics offers no insight, but it also depends on some of the bread-and-butter preoccupations of economics, such as the extent and nature of income inequality and the behavioral response of taxpayers to alternative tax systems." 1996. p. vii. ISBN 978-0521587761.
13. Philip B. Coulter: Measuring Inequality, 1989, ISBN 0-8133-7726-9 (This book describes about 50 different inequality measures.)
14. Eckhard Janeba (Mannheim University, Germany): Teil II, Theorie und Politik der öffentlichen Einnahmen, section: Umverteilungseffekte der Besteuerung
15. Moyes, P. A note on minimally progressive taxation and absolute income inequality Social Choice and Welfare, Volume 5, Numbers 2-3 (1988), 227–234, DOI: 10.1007/BF00735763. Accessed: 19 May 2012.
16. Pickett and Wilkinson, The Spirit Level: Why More Equal Societies Almost Always Do Better, 2011
17. Duncan, Denvil, Klara Sabirianova Peter (October 2012). "Unequal Inequalities: Do Progressive Taxes Reduce Income Inequality?" (PDF). Institute for the Study of Labor.{{cite web}}: CS1 maint: multiple names: authors list (link)
18. Moyes, P. A note on minimally progressive taxation and absolute income inequality Social Choice and Welfare, Volume 5, Numbers 2-3 (1988), 227–234, DOI: 10.1007/BF00735763. Accessed: 19 May 2012.
19. The Economics of Welfare| Arthur Cecil Pigou
20. Andrew Berg and Jonathan D. Ostry, 2011, "Inequality and Unsustainable Growth: Two Sides of the Same Coin?" IMF Staff Discussion Note SDN/11/08, International Monetary Fund
21. Alesina, Alberto (1994). "Distributive Politics and Economic Growth" (PDF). Quarterly Journal of Economics. 109 (2): 465–90. doi:10.2307/2118470. Retrieved 17 October 2013. {{cite journal}}: Unknown parameter |coauthors= ignored (|author= suggested) (help); Unknown parameter |month= ignored (help)
22. Castells-Quintana, David (2012). "Unemployment and long-run economic growth: The role of income inequality and urbanisation" (PDF). Investigaciones Regionales. 12 (24): 153–173. Retrieved 17 October 2013. {{cite journal}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
23. Shlomo Yitzhaki (1998). "More than a Dozen Alternative Ways of Spelling Gini" (PDF). Economic Inequality. 8: 13–30.
24. Study covers years between 1950 and 2006. Berg, Andrew G.; Ostry, Jonathan D. (2011). "Equality and Efficiency". Finance and Development. 48 (3). International Monetary Fund. Retrieved September 10, 2012.
25. Piketty, Thomas, and Emmanuel Saez. INCOME INEQUALITY IN THE UNITED STATES, 1913–1998. Tech. 1st ed. Vol. CXVIII. Quarterly Journal of Economics, 2003. Print.
26. Arnold, Jens (14 Oct 2008). "Do Tax Structures Affect Aggregate Economic Growth? Empirical Evidence From A Panel of OECD Countries". OECD. Retrieved 02 Jan 2014. {{cite web}}: Check date values in: |accessdate= (help)
27. McBride, William (December 18, 2012). "What Is the Evidence on Taxes and Growth?". Tax Foundation. Retrieved January 2, 2014.
28. McBride, William (February 20, 2013). "Comments on Who Pays? A Distributional Analysis of the Tax Systems in All 50 States". Tax Foundation. Retrieved January 2, 2014.
29. Heckman, J., L. Lochner and C. Tabner, Tax Policy and Human Capital Formation, American Economic Review, 88, 293–297. Accessed: 31 July 2012.
30. Davis, Kingsley and Wilbert E. Moore. (1970 ) "Some Principles of Stratification." American Sociological Review, 10 (2), 242–9.
31. Bosworth, Barry; Burtless, Gary; Steuerle, C. Eugene (December 1999). Lifetime Earnings Patterns, the Distribution of Future Social Security Benefits, and the Impact of Pension Reform (PDF) (report no. CRR WP 1999-06). Chestnut Hill, Massachusetts: Center for Retirement Research at Boston College. p. 43. Retrieved October 1, 2012.
32. Shigehiro Oishi, Ulrich Schimmack, and Ed Diener,. Progressive Taxation and the Subjective Well-Being of Nations. Psychological Science 23(1) 86–92. (Published online before print December 8, 2011).
33. "Income tax rates for individuals". ird.govt.nz. Inland Revenue Department (New Zealand). Retrieved 15 May 2013.
34. "Individual income tax rates". ato.gov.au. Australian Taxation Office. Retrieved 15 May 2013.
35. Growing Unequal?: Income Distribution and Poverty in OECD Countries, OECD Publishing, ISBN 978-92-64-04418-0, 2008, pp. 103, 104.

External links

• The Progressive Income Tax: Theoretical Foundations
• What's Wrong with the Progressive Income Tax
• Slemrod, Joel B. (2002). "Progressive Taxes". In David R. Henderson (ed.) (ed.). Concise Encyclopedia of Economics (1st ed.). Library of Economics and Liberty. {{cite encyclopedia}}: |editor= has generic name (help) OCLC 317650570, 50016270, 163149563

• Taxation and redistribution
• Tax incidence