Question

Identify each of the following taxes as being either progressive or regressive. \(L 020.6\) a. Personal income tax. b. Sales taxes. c. Payroll taxes. d. Property taxes.

Short answer

Personal income tax is progressive; sales taxes and payroll taxes are regressive; property taxes are generally proportional or slightly progressive.

Step-by-step solution

Understand Progressive and Regressive Taxes

A progressive tax is one where the tax rate increases as the taxable amount increases, meaning higher-income individuals pay a larger percentage of their income compared to lower-income individuals. Conversely, a regressive tax imposes a higher percentage rate on lower-income individuals, as the tax rate decreases with an increase in the taxpayer's ability to pay.

Analyze Personal Income Tax

Personal income tax is progressive because the tax rate increases as income increases. Thus, individuals with higher incomes pay a larger percentage of their income compared to those with lower incomes.

Analyze Sales Taxes

Sales taxes are regressive because they take a larger percentage of income from low-income earners than from high-income earners. Everyone pays the same rate, so the tax represents a larger portion of a lower-income individual's earnings.

Analyze Payroll Taxes

Payroll taxes are regressive because they are typically imposed at a flat rate up to a certain income cap. Lower-income workers end up paying a higher portion of their earnings compared to higher-income workers.

Analyze Property Taxes

Property taxes can be considered slightly progressive or proportional. They are levied based on the value of the property owned. Those with more valuable properties pay more, but the tax rate doesn't increase with the value, so it's not strongly progressive or regressive.

Key concepts

Progressive Tax

Progressive taxes are designed to collect a higher percentage of income from those who can afford to pay more. The core idea is straightforward: as your income increases, so does the percentage of income you pay in taxes.
This is seen as a more equitable approach because it aligns the tax burden with the taxpayer's ability to pay. For example:

• An individual earning $30,000 might pay a tax rate of 10%.
• An individual earning $100,000 might pay a tax rate of 25%.

The progressive tax system helps to redistribute wealth in society and reduce income inequality. While it might seem complex, it's a fair method in the eyes of many because it takes into account the disparity in earning potential.

Regressive Tax

Regressive taxes work in the opposite way to progressive taxes. Here, the tax rate decreases as the taxable income increases, placing a heavier burden on lower-income earners. Everyone pays the same amount or rate regardless of income, which affects lower earners more substantially.

• If a regressive tax is 5% on all purchases, both a low-income earner and a high-income earner pay the same rate.
• This results in the low-income earner giving up a larger portion of their income than the high-income earner.

This type of tax is often criticized for being unfair to those with lower income because it can exacerbate financial inequality by consuming a more considerable portion of their earnings.

Income Tax

Income tax is a prime example of a progressive tax and is typically calculated based on the overall income of an individual or a business.
This progressive nature means that as one's income increases, they move into higher tax brackets which correspondingly increase the tax rate.
For instance:

• A person earning a modest income might pay 10%.
• A wealthier person could pay up to 30%.

This system is particularly beneficial for addressing economic disparities, ensuring that those with more income contribute a larger share to the state-funded services that benefit all citizens.

Sales Tax

Sales tax is a common regressive tax applied to goods and services. It does not change based on a person's income, meaning everyone pays the same rate irrespective of how much they earn.
This can disproportionately affect lower-income individuals.

• For example, if the sales tax is set at 7%, both a millionaire and someone earning minimum wage will pay the same rate.

Although simple to administer, sales taxes can widen the gap between different income groups by making everyday purchases a heavier burden for those less well-off.

Payroll Tax

Payroll taxes fund essential social services like Social Security and Medicare. Though they are often levied as a percentage of income, they are considered regressive because there is an income cap after which no additional tax is charged.
This means lower-income earners pay the tax on their entire wage while higher earners only pay up to a limit.

• If the cap is at $140,000, anyone earning above this pays the same as those at the cap.
• Therefore, as income increases beyond this cap, the proportion of income paid in payroll taxes actually decreases.

This regressive nature can challenge equity as lower earners feel the impact more intensely.

Property Tax

Property tax, levied on real estate owned, is a bit unique. It's considered somewhat progressive or proportional.
It is calculated based on the property's assessed value—higher-value properties face higher taxes, but the rate itself does not change with property value increase.
Some feel this can be a fair approach, as wealthier individuals typically own more valuable property. Still, it doesn't quite reach the full progressive nature of income tax since the rate remains constant.

• For example, owning a $200,000 home might incur a 1% tax rate.
• A $1,000,000 home would face the same rate, yet still results in higher tax due to the home's greater value.

Overall, it maintains a sense of balance but does not fully address income inequality through varying tax rates.