Taxes are distinguished by the effect they have on the distribution of income and wealth. A proportional tax is the kind of tax that applies the same relative onus on each taxpayer—i.e., where tax liability and income move in the same levels. A progressive tax is characterized by a more than proportional increase in the tax onus in relation to the increase in income, and a regressive tax is recognisable by a less than proportional rise in the related onus. Ergo, progressive taxes are viewed as reducing inequalities in income distribution, but regressive taxes are found to have the effect of an increase in these inequalities.

The taxes that are normally regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, could become less so in the upper-income categories—particularly if a taxpayer is able to reduce his tax base by declaring deductions or by leaving out particular income elements from his taxable income. Proportional tax rates which are applied to lower-income groups can also be more progressive if personal exemptions are made.

Income measured over a given year might not absolutely offer the most accurate measure of taxpaying requirements. For example, transitory increases in income may be saved, and in temporary declines in income a taxpayer could opt to finance consumption by reducing savings. So, if taxation is regarded along with “permanent income,” it should be less regressive (or more progressive) than when it is made comparable with annual income.

Sales taxes and excises (save luxuries) tend to be regressive, because the portion of own income consumed or spent for specific goods decreases as the level of personal income is raised. Poll taxes (also known as head taxes), nominated as a set amount per capita, obviously are regressive.

It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests for the most part on whether a national or a subnational (that is, provincial or state) tax is being debated.

In assessing the economic effects of taxation, it is necessary to distinguish between varied ideas of tax rates. The statutory rates are nominated in legislation; commonly these are marginal rates, but sometimes they are average rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income is increased by one dollar. Ergo, if tax liability rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax statutes often contain graduated marginal rates—i.e., rates that rise as income increases. Structured analysis of marginal tax rates need to review provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated by the statutory rates. Since marginal rates signify how after-tax income moves 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 realise the marginal effective tax rate to apply to income from business and capital, because it may be reliant 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 nothing under a consumption-based tax.

Average income tax rates signify the fraction of total income that is demanded in taxation. The pattern of average rates is the one that is important for assessing 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 flip side, preferential treatment of income received mostly by high-income households can swamp these effects, producing regressivity, as indicated by average tax rates that lower as income grows.

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