Tax systems fall into three main categories within the tax code: regressive, proportional and progressive taxes. Regressive taxes are those that have a greater impact on low-income individuals than high-income earners. A proportional tax, also referred to as a flat tax, impacts low-, middle- and high-income earners relatively equally. A progressive tax has more of a financial impact on higher-income individuals and businesses, and less on low-income earners. The U.S. federal tax system and local and state tax systems use all three types to collect tax revenue.
Regressive Taxes
Under a regressive tax system, individuals and entities with low incomes pay a higher amount of that income in taxes compared to high-income earners. Rather than basing the tax on the individual or entity’s earnings or income level, the government assesses tax as a percentage of the asset that the taxpayer purchases or owns.
For example, a sales tax on the purchase of everyday products or services, such as food and clothing, is assessed as a percentage of the item bought, and is the same for every individual or entity. Shoppers pay, say, a 6% sales tax on their groceries, whether they earn $30,000 or $130,000 annually. Because the buyer’s wealth (and hence, ability to pay) is not taken into consideration, this sales tax – while nominally the same for all shoppers – effectively places a greater burden on lower-income earners than it does on the wealthy: The former end up paying a greater portion of total income than the latter. For instance, if a person makes $20,000 a year and pays $1,000 in sales taxes on clothing and other consumer goods, then 5% of his annual income goes to sales tax. If a person makes $100,000 a year and pays the same $1,000 in sales taxes, then only 1% of his income goes to sales tax.
Aside from state and local sales taxes, regressive taxes include real estate property taxes and excise taxes (a fixed tax included in the price of the product or service) on consumables such as gasoline or airfare. Sin taxes, a subset of excise taxes, are imposed on certain commodities or activities perceived to be unhealthy or have a negative effect on society, such as cigarettes, gambling and alcohol (in an effort to deter individuals from purchasing those products). Sin-tax critics argue that these disproportionately affect the less well-off not just because of economics, but because these lower-income groups tend to indulge more in these items or activities.
Many also consider Social Security a regressive tax. Social security tax obligations are capped at a certain level of income. This means that once an individual reaches that income threshold ($128,700 in 2018), any wages he earns above that are not subject to the 6.2% FICA bite. In other words, the annual maximum that one pays in Social Security tax is “capped” at $7,979 (in 2018) – whether one earns $128,701 or $300,00 or $1 million. Because of this cap, higher-income employees effectively pay a lower proportion of their overall income into the Social Security system than lower-income employees do.
Progressive Taxes
Under a progressive tax system, the taxes assessed – say, on income or business profits – are based on the taxable amount, and follow an accelerating schedule. High-income earners pay more than low-income earners, and the tax rate, along with tax liability, increases as an individual or entity’s wealth increases. The overall outcome is that higher earners pay a higher percentage of taxes and more money in taxes than do lower-income earners.This sort of system is meant to affect upper-class people more low- or middle-class individuals – to reflect the fact that they can afford to pay more.
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