Question

Determine whether each of the following taxes is proportional, regressive, or progressive. [LO 20.4] a. An income tax of 25 percent on income from all sources. b. An income tax with three brackets and corresponding marginal tax rates: 10 percent for income up to \(\$ 50,000 ; 20\) percent for income up to \(\$ 100,000\); and 30 percent for income over \(\$ 100,000\). c. A fee of \(\$ 500\) per year for municipal services, charged to everyone who lives within the city limits. d. A capital gains tax that charges a flat rate of 40 percent, but only on capital gains over \(\$ 1\) million. e. A payroll tax of 10 percent on income under \(\$ 200,000\)

Short answer

a. Proportional; b. Progressive; c. Regressive; d. Progressive; e. Proportional

Step-by-step solution

Understand the Types of Tax Systems

Before solving the problem, we must understand the types of tax systems: Proportional taxes require everyone to pay the same percentage of their income; regressive taxes impose a greater burden (relative to resources) on poor individuals than on rich ones; progressive taxes place a higher burden on higher-income earners.

Evaluate Tax Type for Part A

The tax is a flat rate of 25 percent on all income sources, meaning every taxpayer, irrespective of income size, pays the same percentage. Therefore, this is a proportional tax.

Evaluate Tax Type for Part B

The tax has increasing rates: 10 percent for income up to $50,000, 20 percent for income between $50,000 and $100,000, and 30 percent for income over $100,000. As income increases, the tax rate increases, making it a progressive tax.

Evaluate Tax Type for Part C

A flat fee of $500 irrespective of income implies that lower-income individuals pay a larger percentage of their income compared to higher-income individuals. Thus, this is a regressive tax.

Evaluate Tax Type for Part D

The tax is a flat 40 percent on capital gains exceeding $1 million. As it only taxes amounts over this limit, it affects higher-income earners differently, appearing progressive since only larger gains are taxed.

Evaluate Tax Type for Part E

This tax is a flat 10 percent on income less than $200,000, meaning everyone pays the same rate on eligible income. It resembles a proportional tax on income within the specified bracket.

Key concepts

Proportional Tax

Proportional taxes, also known as flat taxes, apply a constant percentage rate to all income levels. This means that every taxpayer pays the same proportion of their income, regardless of how much they earn. For example, if there is a 25% tax on all income, a person earning \( \\(40,000 \) and another earning \( \\)100,000 \) both pay exactly 25% of their income in taxes.

• Simple to calculate because the rate does not change based on income level.
• Considered equitable in that everyone pays the same rate, but sometimes critiqued for not considering ability to pay.

Understanding proportional taxes is straightforward because the tax rate is fixed, leading to predictable tax liabilities for different levels of income.

Regressive Tax

Regressive taxes are those that take a larger percentage of income from low-income individuals compared to high-income individuals. This means that as income decreases, the effective tax rate increases. Common examples include sales taxes and certain fixed fees, like a \( \$500 \) yearly fee for municipal services.

• Tends to place more financial strain on those less able to afford it.
• Disproportionately impacts lower-income individuals as they spend a larger portion of their income on taxable goods or fees.

Regressive taxes often provoke debate as they can exacerbate income inequality by leaving less disposable income for lower-income earners.

Progressive Tax

Progressive taxes are designed to take a larger percentage of income from high-income earners compared to low-income earners. This system increases the tax rate as income levels rise. For instance, a tax rate might be 10% for incomes up to \( \\(50,000 \), 20% for incomes between \( \\)50,000 \) and \( \\(100,000 \), and 30% on income over \( \\)100,000 \).

• Reflects a principle of "ability to pay," reducing tax burdens on those with lower incomes.
• Helps to redistribute wealth and reduce income disparities in society.

Progressive taxation aims to bolster economic equity by adjusting the tax rate based on how much an individual earns, ensuring those who earn more contribute more to state revenues.

Marginal Tax Rates

Marginal tax rates refer to the amount of tax paid on an additional dollar of income. In a system where low incomes are taxed at a lower rate than higher incomes, the marginal tax rate increases as one earns more.
For example, in a bracketed tax system:

• An individual might pay 10% on the first \( \\(50,000 \) of income, 20% on the next \( \\)50,000 \) (i.e., up to \( \\(100,000 \)), and 30% on income exceeding \( \\)100,000 \).
• This means that each \"extra dollar\" moves into the next tax bracket, potentially subjected to a higher tax rate.

Marginal tax rates offer insight into the progressive nature of certain tax systems, showing how tax obligations increase with income. This concept is integral to understanding how tax brackets function and how they impact individuals as they earn more.