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Taxes are distinguished by the impact they have on the placement of income and wealth. A proportional tax is one that puts the same relative burden on all the taxpayers—i.e., where tax liability and income increase in the same proportion. A progressive tax is recognisable by a larger than proportional growth in the tax liability in regard to the increase in income, and a regressive tax is characterized by a less than proportional rise in the comparable burden. Hence, progressive taxes are regarded as removing a lack of equality in income distribution, but regressive taxes might cause an increase in these inequalities.

The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, may become less so within the upper-income demographic—especially if a taxpayer is permitted to reduce his tax base by declaring deductions or by removing particular income elements from his taxable income. Proportional tax rates when applied to lower-income demographics can also be more progressive if such personal exemptions are made.

Income measured over the period of a year does not absolutely give the most appropriate measure of taxpaying ability. For example, transitory rises in income can be saved, and in temporary declines in income a taxpayer might choose to provide for consumption by taking from savings. Therefore, if taxation is made comparable with “permanent income,” it would be less regressive (or more progressive) than when it is held in comparison with annual income.

Sales taxes and excises (with the exception of luxuries) are usually regressive, because the share of personal income consumed or spent for specific goods lowers as the level of personal income grows. Poll taxes (also known as head taxes), calculated as a set amount per capita, patently are regressive.

It is not simple to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden lays crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In assessing the economic effects of taxation, it is necessary to differentiate between varied points of tax rates. The statutory rates will include those specified in law; generally speaking these are marginal rates, but in some cases they are mean rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income is increased by one dollar. Therefore, if tax onus rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws commonly contain graduated marginal rates—i.e., rates that increase as income rises. Heavy analysis of marginal tax rates must regard provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than nominated in the statutory rates. Since marginal rates signify how after-tax income increases or decreases in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, because it may rely on considerations including 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 percentage of total income that is taken in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly increase with income, both because personal allowances are provided for the taxpayer and dependents and also because marginal tax rates are graduated; on the other side of things, preferential treatment of income received mostly by high-income households can dwarf these effects, producing regressivity, as displayed by average tax rates that lower as income rises.

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