Taxes can be distinguished by the impact they have on the placement of income and wealth. A proportional tax is one that imposes the same relative requirement on every taxpayer—i.e., when tax liability and income grow in equal levels. A progressive tax is characterized by a larger than proportional increase in the tax liability in relation to the increase in income, and a regressive tax is recognised by a less than proportional rise in the related liability. Thus, progressive taxes are regarded as fighting inequalities in income distribution, but regressive taxes may have the effect of an increase in these inequalities.

The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so for the upper-income class—particularly if a taxpayer is allowed to reduce his tax base by nominating deductions or by taking some income components from his taxable income. Proportional tax rates when applied to lower-income groups would also be more progressive if such personal exemptions are claimed.

Income measured over a given period does not absolutely provide the most suitable measure of taxpaying status. For example, transitory growth in income could be saved, and in temporary declines in income a taxpayer might select to provide for consumption by taking from savings. Therefore, if taxation is compared with “permanent income,” it can be less regressive (or more progressive) than when made comparable with annual income.

Sales taxes and excises (save luxuries) are usually regressive, because the dissemination of individual income consumed or spent on a specific good lessens as the rate of personal income is raised. Poll taxes (also called head taxes), nominated as a fixed amount per capita, clearly are regressive.

It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating 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 analysing the economic effects of taxation, it is essential to differentiate between several ideas of tax rates. The statutory rates will be specified in the law; generally speaking these are marginal rates, but sometimes they are median rates. Marginal income tax rates note the fraction of incremental income demanded by taxation when income grows by one dollar. Ergo, if tax burden rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations commonly contain graduated marginal rates—i.e., rates that rise as income increases. Structured analysis of marginal tax rates need to regard provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher 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 important ones for considering incentive effects of taxation. It is even more difficult to know the marginal effective tax rate to apply to income from business and capital, since it may be reliant 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 nothing under a consumption-based tax.

Average income tax rates signify the portion of total income that is taken 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 grows with income. Average income tax rates commonly grow with income, both because personal allowances are granted for the taxpayer and dependents and due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households might swamp these effects, producing regressivity, as signified by average tax rates that fall as income rises.

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