Taxes can be categorized by the impact they have on the allocation of income and wealth. A proportional tax is the kind that imposes the same relative burden on all taxpayers—i.e., where tax liability and income move in relative scale. A progressive tax is recognised by a greater than proportional growth in the tax liability relative to the growth in income, and a regressive tax is characterized by a less than proportional increase in the related onus. Therefore, progressive taxes are thought of as reducing inequity in income distribution, whereas regressive taxes can have the result of increasing these inequalities.

The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so within the upper-income class—in particular if a taxpayer is allowed to reduce his tax base by nominating deductions or by leaving out some particular income parts from his taxable income. Proportional tax rates if applied to lower-income categories could also be more progressive if such personal exemptions are declared.

Income measured over a given period may not necessarily offer the most appropriate measure of taxpaying requirement. For example, transitory increases in income can be saved, and during temporary declines in income a taxpayer may choose to provide for consumption by reducing savings. Ergo, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than when held in comparison with annual income.

Sales taxes and excises (except those on luxuries) are mostly regressive, because the spread of personal income consumed or spent for a specific good declines as the level of personal income rises. Poll taxes (also called head taxes), nominated as a set amount per capita, patently are regressive.

It is not simple to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the lack of certainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden is dependant essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic purpose of taxation, it is important to distinguish between several ideas of tax rates. The statutory rates include those specified in law; generally speaking these are marginal rates, but occasionally they are median rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income increases by one dollar. Thus, if tax burden increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax statutes often contain graduated marginal rates—i.e., rates that grow as income grows. Structured analysis of marginal tax rates should take into account provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than nominated within the statutory rates. Since marginal rates specify how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for regarding incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applicable to income from business and capital, since it may be reliant on such considerations as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates determine the fraction of total income that is paid in taxation. The pattern of average rates is the one that is in consideration for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are permitted for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households could dampen these effects, producing regressivity, as signified by average tax rates that decrease as income grows.

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