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Taxes can be categorized by the effect they have on the placement of income and wealth. A proportional tax is one that impinges the same relative liability on each taxpayer—i.e., in the case where tax liability and income increase in relative proportion. A progressive tax is characterized by a more than proportional rise in the tax liability in regard to the rise in income, and a regressive tax is recognised by a less than proportional rise in the comparable liability. Hence, progressive taxes are regarded as reducing a lack of equality in income distribution, but regressive taxes are found to have the result of an increase in these inequalities.

The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, could become less so within the upper-income group—especially if a taxpayer is allowed to lower his tax base by declaring deductions or by excluding particular income aspects from his taxable income. Proportional tax rates when applied to lower-income classes can also be more progressive if such exemptions of a personal nature are declared.

Income measured over the course of a given period might not definitely offer the most suitable measure of taxpaying status. For example, transitory rises in income can be saved, and during temporary declines in income a taxpayer may opt to finance consumption by taking from savings. Ergo, if taxation is held in comparison along with “permanent income,” it can be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (save those on luxuries) are mostly regressive, because the dissemination of own income consumed or spent for a specific good lessens as the level of personal income rises. Poll taxes (also known as head taxes), levied as a flat amount per capita, obviously are regressive.

It is hard to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden rests essentially 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 important to differentiate between several ideas of tax rates. The statutory rates are specified in legislation; commonly these are marginal rates, but occasionally they are average rates. Marginal income tax rates indicate the fraction of incremental income taken by taxation when income is increased by one dollar. Therefore, if tax onus increases by 45 cents when income grows 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 rises. Careful analysis of marginal tax rates should review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than indicated within the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for assessing 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 depend on factors 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 determine the fraction of total income that is paid in taxation. The pattern of average rates is the one that is in consideration for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are provided for the taxpayer and dependents and also because marginal tax rates are graduated; conversely, preferential treatment of income received mostly 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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