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Taxes are distinguished by the impact they have on the allocation of income and wealth. A proportional tax is a kind that places the same relative requirement on every taxpayer—i.e., when tax liability and income grow in relative levels. A progressive tax is recognised by a more than proportional rise in the tax burden in relation to the rise in income, and a regressive tax is characterizable by a less than proportional growth in the relative burden. Ergo, progressive taxes are regarded as removing a lack of equality in income distribution, while regressive taxes are found to have the result of increasing these inequalities.

The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so for the upper-income class—particularly if a taxpayer is able to lower his tax base by nominating deductions or by taking certain income components from his taxable income. Proportional tax rates if applied to lower-income groups could also be more progressive if exemptions of a personal nature are claimed.

Income measured over a given period might not definitely offer the most accurate measure of taxpaying requirement. For example, transitory increases in income can be saved, and in temporary declines in income a taxpayer might choose to finance consumption by taking from savings. So, if taxation is made comparable alongside “permanent income,” it should be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (excepting luxuries) are generally regressive, because the share of personal income consumed or spent on a specific good declines as the level of personal income grows. Poll taxes (also called head taxes), levied as a standard amount per capita, obviously are regressive.

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

In assessing the economic effects of taxation, it is important to distinguish between varied concepts of tax rates. The statutory rates are those dictated in the legislation; commonly these are marginal rates, but occasionally they are median rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income increases by one dollar. Hence, if tax burden increases by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislation generally contain graduated marginal rates—i.e., rates that rise as income grows. Careful analysis of marginal tax rates must consider provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than specified within the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the necessary ones for appraising incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applied to income from business and capital, as it may depend on considerations including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates indicate the portion of total income that is required in taxation. The pattern of average rates is the one that is important for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates generally increase with income, both because personal allowances are permitted for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received fundamentally by high-income households can swamp these effects, producing regressivity, as signified by average tax rates that decrease as income increases.

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