Tax systems can be categorized based on how they impact different income groups. The main types of tax structures are progressive, regressive, and proportional. Each has distinct effects on income distribution and equity.
1. Progressive Taxes
Definition: Progressive taxes are those where the tax rate increases as the taxable income increases. In other words, higher income individuals or entities pay a higher percentage of their income in taxes compared to lower income individuals. The aim is to ensure that those with greater financial resources contribute a larger share of their income towards public finances.
Characteristics:
- Higher Rates for Higher Incomes: Tax rates increase with income levels.
- Equity: Designed to reduce income inequality by imposing a greater burden on those who can afford to pay more.
Example in India:
- Income Tax: India’s income tax system is progressive. For the financial year 2024-25, the income tax slabs for individuals below 60 years are as follows:
- Income up to ₹2.5 lakhs: No tax
- Income from ₹2.5 lakhs to ₹5 lakhs: 5% tax
- Income from ₹5 lakhs to ₹10 lakhs: 10% tax
- Income above ₹10 lakhs: 30% tax (plus applicable cess and surcharge)
This means that individuals with higher incomes pay a higher percentage of their income in taxes compared to those with lower incomes.
2. Regressive Taxes
Definition: Regressive taxes are those where the tax rate decreases as the taxable amount increases. In other words, lower income individuals or entities pay a higher percentage of their income in taxes compared to higher income individuals. These taxes tend to disproportionately affect those with lower incomes.
Characteristics:
- Higher Burden on Lower Incomes: The effective tax rate decreases as income increases.
- Equity: Considered less equitable as they place a greater relative burden on lower-income individuals.
Example in India:
- Goods and Services Tax (GST): GST is often considered regressive because it is a consumption tax. Everyone pays the same GST rate on goods and services, regardless of their income. As a result, lower-income individuals, who spend a larger proportion of their income on consumption, bear a relatively higher burden of the tax compared to higher-income individuals.
3. Proportional Taxes
Definition: Proportional taxes, also known as flat taxes, are those where the tax rate remains constant regardless of the amount of taxable income or wealth. In other words, everyone pays the same percentage of their income or wealth in taxes, irrespective of how much they earn.
Characteristics:
- Constant Rate: The tax rate is the same for all income levels.
- Simplicity: Often simpler to administer and understand compared to progressive or regressive systems.
- Equity: Can be seen as fair in terms of equal rates but may not address income inequality effectively.
Example in India:
- Corporate Tax: Corporate tax rates in India are generally proportional. For instance, as of the financial year 2024-25, the corporate tax rate for domestic companies with a turnover of up to ₹400 crores is 25%, while companies with a higher turnover are taxed at 30%. This rate is consistent for all levels of corporate income within the applicable turnover brackets, making it a proportional tax.
Comparative Summary
- Progressive Taxes:
- Impact: Higher income earners pay a higher percentage of their income.
- Objective: To address income inequality and ensure those who can afford to contribute more do so.
- Example: Progressive income tax in India.
- Regressive Taxes:
- Impact: Lower income earners pay a higher percentage of their income.
- Objective: Can be problematic as it disproportionately affects those with less income.
- Example: GST on essential goods and services.
- Proportional Taxes:
- Impact: Everyone pays the same percentage of their income or wealth.
- Objective: Simplifies tax administration but does not address income inequality.
- Example: Corporate tax rates.
Conclusion
Understanding the distinctions between progressive, regressive, and proportional taxes helps in evaluating their impacts on different income groups and designing fair and effective tax policies. India’s tax system incorporates elements of each type, aiming to balance equity, simplicity, and efficiency. Progressive taxes like income tax strive to reduce inequality, regressive taxes like GST raise concerns about fairness, and proportional taxes like corporate tax offer simplicity in administration.
