Taxes can be distinguished by the impact they have on the distribution of income and wealth. A proportional tax is the kind that applies the same relative onus on all the taxpayers—i.e., where tax liability and income move in the same scale. A progressive tax is characterizable by a greater than proportional growth in the tax burden in regard to the growth in income, and a regressive tax is recognised by a less than proportional growth in the relative burden. Hence, progressive taxes are regarded as reducing inequity in income distribution, while regressive taxes can result in an increase these inequalities.

The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so in the upper-income group—particularly if a taxpayer is able to lower his tax base by declaring deductions or by taking some particular income parts from his taxable income. Proportional tax rates that are applied to lower-income categories will also be more progressive if exemptions of a personal nature are made.

Income measured over the course of a given period might not definitely give the best measure of taxpaying ability. For example, transitory growth in income may be saved, and during temporary declines in income a taxpayer may elect to finance consumption by decreasing savings. So, if taxation is regarded with “permanent income,” it can be less regressive (or more progressive) than when it is made comparable with annual income.

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

It is not easy to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining 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 considered.

In considering the economic purposes of taxation, it is essential to differentiate between varied ideas of tax rates. The statutory rates will be dictated in the legislation; commonly these are marginal rates, but for some cases they are average rates. Marginal income tax rates note the fraction of incremental income that is taken by taxation when income is increased by one dollar. Thus, if tax liability grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that increase as income grows. Heavy analysis of marginal tax rates are required to review provisions as well as 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 greater than specified by the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the appropriate ones for considering incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applicable to income from business and capital, because 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 indicate the portion of total income that is required in taxation. The pattern of average rates is the one that is in consideration for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally rise 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 for the most part by high-income households can swamp these effects, forcing regressivity, as indicated by average tax rates that lessen as income rises.

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