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Taxes are categorized by the impact they have on the allocation of income and wealth. A proportional tax is a tax that impinges the same relative burden on every taxpayer—i.e., where tax liability and income grow in relative levels. A progressive tax is characterized by a higher than proportional rise in the tax onus in regard to the growth in income, and a regressive tax is characterizable by a less than proportional rise in the relative burden. Thus, progressive taxes are regarded as fighting inequalities in income distribution, but regressive taxes are found to result in increasing 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, can become less so for the upper-income group—in particular if a taxpayer is permitted to lower his tax base by claiming deductions or by excluding some income aspects from his taxable income. Proportional tax rates if applied to lower-income categories would also be more progressive if such personal exemptions are made.

Income measured over the course of a given period might not necessarily come up with the most accurate measure of taxpaying requirement. For example, transitory growth in income could be saved, and within temporary declines in income a taxpayer may elect to provide for consumption by taking from savings. So, if taxation is compared along with “permanent income,” it should be less regressive (or more progressive) than if it is held in comparison with annual income.

Sales taxes and excises (save luxuries) are mostly regressive, because the portion of personal income consumed or spent on specific goods declines as the amount of personal income grows. Poll taxes (also called head taxes), levied as a set amount per capita, patently are regressive.

It is difficult to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally 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 depends essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.

In analysing the economic effect of taxation, it is important to distinguish between several concepts of tax rates. The statutory rates include those specified in the law; commonly these are marginal rates, but for some cases they are median rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income increases by one dollar. Thus, if tax burden rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature commonly contain graduated marginal rates—i.e., rates that increase as income increases. Structured analysis of marginal tax rates are required to review 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 rise in income, the marginal rate is 20 percentage points more than nominated within 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 important ones for appraising incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applied to income from business and capital, because it may be reliant on such factors as 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 determine the portion of total income that is demanded 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 grows with income. Average income tax rates generally increase with income, both because personal allowances are permitted 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 could dwarf these effects, allowing regressivity, as shown by average tax rates that lessen as income rises.

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