Regressive Tax
Regressive taxes are taxes that are applied uniformly to all taxpayers.
Regressive taxes are taxes that are applied uniformly to all taxpayers. This tax does not take their income level into account. This means poorer families pay the same amount or tax rate as wealthier families.
The structure results in a higher tax burden for the former. Regressive taxes are often considered unfair and inefficient. This may be because they do not follow the ability-to-pay principle and may increase income inequality.
The United States uses a range of regressive taxes. Consider sales taxes, for example. They are levied on goods and services purchased by people. This tax is the same for all incomes.
Excise taxes are fixed taxes imposed on specific products, such as gasoline, alcohol, and tobacco. Property taxes are a tax imposed on people's properties. Payroll taxes are deducted from wages to fund government programs.
Regressive taxes have some advantages and disadvantages. They are easy to administer and collect. This is because they do not require complex calculations or reporting.
They also provide a stable source of revenue for the government since they do not depend on economic fluctuations or tax evasion. However, they reduce the disposable income and purchasing power of poorer families.
This may affect their living standards and consumption patterns. They also create disincentives for saving and investing because they lower the after-tax return on capital. They may also negatively affect social welfare and economic growth because they increase wealth disparity.
Regressive taxes are often contrasted with progressive taxes and proportional taxes. Progressive taxes are taxes that increase with the increase in income. Wealthier families pay a greater tax rate than their poorer counterparts in this format.
Proportional taxes apply the same percentage of tax to all income levels. In this structure, everyone pays the same proportion of their income in tax.
Both progressive and proportional taxes are more aligned with the ability to pay principle than regressive taxes, as they consider the differences in income among taxpayers.
Key Takeaways
- A regressive tax system taxes the poor people more than the rich.
- Administering and collecting this requires no complex calculations or income reporting, making it a cinch.
- Harmful products or activities, such as pollution, tobacco, or alcohol, can be deterred from being consumed.
- A less susceptible revenue stream to economic shifts creates stability and predictability for the government's generating methods.
- Purchasing power and disposable income of low-income earners are greatly reduced, which ultimately contributes to rising levels of poverty and inequality.
- As one earns more income, the marginal benefit is reduced, serving as a disincentive to save or work.
- Market inefficiencies can arise due to distortions in resource allocation. The relative prices of goods and services are impacted by this phenomenon.
- National defense, public health, and infrastructure are examples of public goods and services. Funding for this can be provided by the government.
- Since it unfairly places a greater load on the financially struggling, regressive taxation erodes the values of just and equal tax distribution.
Types of Regressive Taxes
Regressive taxes take a larger percentage of income from poorer families than from wealthier families. They are applied uniformly to all people. Regressive taxes are often criticized for being unfair and burdening the poor more.
Some common examples of regressive taxes are:
1. Consumption taxes
These taxes are imposed on our purchases. Consumption taxes are regressive. While every household may consume the same amount, consumption takes up a greater percentage of poorer families' income.
For example, consider an item that costs a hundred dollars. It would incur a ten-dollar tax if the tax rate was ten percent. However, the same ten dollars is worth more to someone who is poor. This is because it takes up more of their income.
2. Gasoline tax
This is a type of excise tax that is imposed on fuel purchases. The gasoline tax is regressive because poorer families tend to drive older and less fuel-efficient vehicles than wealthier families.
For example, if people drive the same distance and purchase gasoline with the same per gallon gas tax, they both pay the same dollar amount in tax. However, money is valued more by people who have less wealth.
NOTE
People value wealth differently according to how much they have. Someone who makes a living earning millions of dollars would value it less than someone who is living on seven hundred dollars a week.
3. Payroll tax
This type of tax is deducted from employees' wages to fund government programs. Payroll tax is regressive because it has a cap on taxable income. This implies that wealthier families may end up paying the same amount in tax as poorer individuals.
However, this will affect them differently because the same amount is more valuable to poorer individuals. As a result, this is also regressive.
Different Types of Tax Systems
The payment of a regressive tax can be traced back to every time you've made a purchase at a retail store or have fueled up your automobile. A regressive tax lacks consideration for income and is collected at an equal dollar amount or rate for people in different earning brackets.
The impact of this tax is much more profound and troublesome for those who earn less money because it constitutes a greater percentage of their total income compared to the affluent, who can spare the same dollar amount or rate without breaking a sweat.
Progressive, proportional, and regressive categorize tax systems.
1. Regressive Taxes
Low earners can find it more challenging to pay the same percentage of their income as higher earners when purchasing goods or products because of a regressive tax system. This type of tax is known for disproportionately affecting those with less income.
2. Proportional Taxes
Regardless of whether you are making $700 or $5 million a week, the proportional tax system means all individuals are taxed equally. Consider a flat income tax of 20%. This means that the government collects 20% of everyone's income.
NOTE
The taxpayers' social welfare and ability to pay go unnoticed by this tax system, even though it is considered unbiased and uncomplicated.
3. Progressive Taxes
Operating on the theory that higher earners can bear more, a progressive tax system levies a larger percentage of taxation on them. Consider the following graduated income tax system. It may apply a 10% tax to incomes up to $50,000.
This goes up to 15% for incomes falling between $50,000 and $100,000. And finally, it rises to 20% for incomes that surpass $100,000. Despite being considered fair and redistributive, this tax system could foster disincentives for investment and work.
What is a progressive tax system?
Tax rates increase as income increases in a progressive tax system. Those with more resources must contribute more to public services that benefit all. This is due to the principle of ability to pay.
On the plus side, a progressive taxation approach presents benefits and drawbacks. One of the advantages is easing the tax liability for those with smaller incomes, who might find it challenging to afford basic necessities.
Conversely, a progressive tax system yields higher revenue from individuals with higher salaries, allowing them to contribute more without negatively impacting their standard of living. This extra income can contribute to public goods and services.
This may benefit amenities that enhance citizens' quality of life. The increased taxation will yield benefits for all citizens, not just those who pay those specific taxes.
Punishing those who earn a lot can discourage their drive to succeed and stifle economic progress. Tax evasion may become a viable option for those hit hard by a progressive tax system.
NOTE
The ability-to-pay principle argues that those with the means to pay should bear the greatest tax burden.
The richest population will do whatever it takes to protect their wealth from taxation. They may try to reduce their taxable income to do so. Ultimately, the system may disincentivize good practices. This can include investing, saving, or starting new businesses.
This directly contrasts with their ambitions, which require them to work hard and achieve greatness.
Throughout the globe, different types of taxation systems exist beyond the traditional progressive tax system. Less commonly used are regressive taxes, which lower tax rates for high earners.
Then there's a flat tax, which uncaringly charges everyone the same tax rate regardless of their income bracket. Meanwhile, proportional tax considers each taxpayer's earnings and requires everyone to pay the same tax percentage.
Countries That Use Regressive Tax Structures
Public services and programs in different countries are funded through various tax methods. The usage of regressive taxes varies among countries. Below are some illustrations:
1. United States
The United States has a tax system that aims to achieve equality by being progressive. However, disparities exist in imposing taxes at the state and local levels, as many regressive taxes are still imposed.
A recent study in America showed that the poorest 20% faced an average rate of 20.9%. Meanwhile, the top 1% paid less than half at 7.4%. Additionally, nearly forty-five states have a slightly regressive tax structure.
2. Japan
In Japan, consumers face one of the world's highest consumption taxes. The tax rate was raised recently despite concerns about economic growth and inequality.
The consumption tax currently provides approximately 40% of Japan's overall tax revenue, compared to income taxes which account for roughly 30%.
NOTE
To address tax inequality, Japan employs a progressive income tax system which, although it has its own exemptions and deductions to reduce progressivity, aims to balance the tax burden.
3. Saudi Arabia
Not collecting income tax has set Saudi Arabia apart from other countries. Saudi Arabia utilizes oil revenues and other non-tax revenue streams for its government spending.
However, a value-added tax of 5% was recently integrated in 2022, which functions as a regression tax toward goods and services sold in the country.
To decrease reliance on oil and expand the economy, Saudi Arabia's fiscal reform plan included implementing a value-added tax. This tax is so significant that its effects are visible in the country's GDP.
At times, seemingly impartial treatment of regressive taxes may appeal since they're indifferent to income. But they also possess adverse effects that could hurt you:
Regressive taxes especially hard hit poorer families compared to wealthier families. This is because their disposable income is reduced more. This can result in less money for basic necessities or savings after paying taxes.
Regressive taxes may widen the gap between the rich and the poor. This can ultimately result in increased income inequality. This, in turn, causes various social problems. Poverty, crime, and political instability are only some of the potential consequences.
Regressive taxes can reduce the purchasing power of consumers. This may reduce economic activity and consumption. Consequently, businesses, growth, and employment may be negatively impacted.
Pros and Cons of a Regressive Tax System
Regressive taxes have both advantages and disadvantages for the economy and society. Some of the advantages are:
1. Easy to administer and collect
They do not require complex calculations or reporting by the taxpayers or the tax authorities. They also reduce tax evasion and avoidance opportunities, as they are levied at the point of sale or consumption.
2. Encourages economic growth and efficiency
They do not distort the incentives to work, save, invest, or consume, as they do not vary with income levels. They also do not create deadweight losses, which are the losses in economic surplus due to taxation.
3. Used to correct externalities and promote social goals
Externalities are the costs or benefits that affect third parties who are not involved in economic activity. For example, tobacco taxes can be used to deter smoking.
This can improve public health and preserve the environment. Similarly, gasoline taxes can reduce pollution and congestion caused by driving.
Some of the disadvantages of regressive taxes are:
1. Unfair and inequitable
They hurt the poor more than the rich. This violates the principle of vertical equity. Vertical equity states that taxpayers with more ability to pay should pay more taxes than those without.
Regressive taxes also violate the principle of horizontal equity, which states that taxpayers with a similar ability to pay should pay similar amounts of taxes. Regressive taxes create disparities among taxpayers with different consumption patterns or preferences.
2. Can increase poverty and inequality
They reduce the disposable income and purchasing power of poorer families, affecting their living standards and well-being. They also increase income inequality. This can have negative social and political consequences.
3. Can reduce government revenue and fiscal stability
They depend on the level of economic activity and consumption. Because these values can fluctuate with business cycles and consumer confidence, this is an unstable source of income for the government.
They also tend to be less elastic than progressive taxes. This means that they do not respond proportionally to changes in income levels.
Researched and authored by Haimeng Yang | LinkedIn
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