Question

Margaret pays a local income tax of 2 percent, regardless of the size of her income. This tax is a. proportional. b. regressive. c. progressive. d. a mix of (a) and (b).

Short answer

The local income tax paid by Margaret is proportional.

Step-by-step solution

Determine if the tax is proportional

Since Margaret is paying the same percentage (2%) of her income regardless of the size of her income, this tax can be considered proportional.

Determine if the tax is regressive

As per the definition, a regressive tax rate would decrease as income increases. However, Margaret's tax rate remains constant at 2%, so it is not regressive.

Determine if the tax is progressive

A progressive tax rate would increase as income increases. Since Margaret is paying the same tax rate, regardless of her income, the tax is not progressive. Based on the comparison against the tax type definitions, the local income tax paid by Margaret is: a. proportional.

Key concepts

Proportional Tax

A proportional tax is a type of taxation where the tax rate remains the same regardless of the taxpayer's income level. This means everyone pays the same percentage of their income, making it straightforward and predictable.
For example, if the tax rate is set at 2%, someone earning $50,000 annually would pay $1,000 in taxes, while another person earning $200,000 would pay $4,000. Despite the difference in the amount paid, the rate (2%) stays constant.

• This tax system is also known as a flat tax because of its uniformity in how it applies to income.
• It simplifies the tax filing process as everyone calculates their tax liability using the same rate.
• Proponents argue that it treats all income equally and is simple to administer.

However, critics suggest it may not adequately account for the varying ability of individuals to pay, as a flat rate could cause proportionately more financial strain on lower-income individuals.

Regressive Tax

A regressive tax structure implies that the taxation rate effectively decreases as a person earns more. This happens because the tax levied takes a larger percentage of income from lower-income earners compared to higher-income earners.
Sales taxes and excise duties are typically regressive since they apply equally to all purchases regardless of the purchaser's income. This means:

• Everyone pays the same amount for the tax, which can represent a higher proportion of a lower-income earner’s total income.
• As income increases, the burden of such taxes decreases relative to the individual's income.

For example, if everyone pays $3 for a tax on essential goods, someone with a lower income spends a greater share of their income on this tax than a wealthier individual. Critics of regressive taxes argue that they can heighten economic inequality, making it more difficult for lower-income families to save and build wealth.

Progressive Tax

In a progressive tax system, the tax rate increases with the increase in an individual’s income. This means higher earners pay a larger percentage of their income compared to lower earners, which aims to reduce income inequality.
This approach intends to distribute the tax burden more equitably based on one's ability to pay. Examples include most income tax systems where people might owe:

• 10% of their income for earnings under $10,000
• 20% for those between $10,000 and $50,000
• 30% for earnings above $50,000

Advantages of a progressive tax are that it can potentially reduce inequality, provide government revenue for social programs, and adjust automatically with changes in individuals’ financial situations.
As income increases, taxpayers contribute a higher rate, reflecting a principle of wealth redistribution. However, some criticize it for potentially discouraging high earners from working harder due to diminishing returns.