The taxes you pay on your income and purchases can take several forms, including progressive tax, regressive tax, and flat taxes. But what is a progressive tax? And how does it compare to a regressive or flat tax?
What is a progressive tax?
A progressive tax is when the tax rate you pay increases as your income rises.
In the U.S., the federal income tax is progressive. There are graduated tax brackets, with rates ranging from 10% to 37%.
For the 2021 tax year (tax returns filed in 2022), those tax brackets are:
In 2021, if you’re single and have $15,000 of taxable income, you’re in the 12% tax bracket, while if you’re single and have taxable income of $600,000, you’re in the 37% tax bracket.
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But this doesn't mean that all your income is taxed at that rate, as there's a difference between a marginal tax rate and an effective tax rate. If you have $15,000 of taxable income, you have a 12% marginal tax rate, but your effective tax rate is lower. That's because when your income enters a higher tax bracket, only the income that falls into that higher bracket is taxed at the higher rate.
In 2021, you would calculate your tax bill as follows:
- 10% on the first $9,950 of income = $995
- 12% on the next $5,050 of income = $606
Your total tax bill comes to $1,601. While there are a few ways to calculate an effective tax rate, the simplest way is to divide your total tax by your taxable income. TurboTax calculates effective tax rates in a more sophisticated way by adjusting for various recaptured taxes and tax credits.
- Let’s say you have an adjusted gross income of $27,400 and no non-refundable credits.
- That would make your effective tax rate 5.8% (=$1,601/$27,400).
Progressive tax pros and cons
Progressive taxes are popular because they shift the burden of paying taxes to those who are likely most able to pay.
Like federal income tax, progressive tax systems typically allow several deductions and credits. These tax breaks provide additional relief for low-income taxpayers, as is the case with the Earned Income Tax Credit. They can also encourage certain behaviors. For example, the mortgage interest deduction encourages homeownership, and the American Opportunity Tax Credit encourages people to pursue higher education.
But some tax breaks can also make it possible for high-income taxpayers to pay less tax than lower-income people. For example, preferential rates on long-term capital gains sometimes result in wealthy taxpayers paying a lower rate overall than their middle-class counterparts.
Inflation can also cause "bracket creep." This is when taxpayers are pushed into a higher tax bracket, even though their higher income doesn't give them more buying power.
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What is a regressive tax?
A regressive tax is the opposite of a progressive tax because you pay a higher tax rate as your income decreases. There are two types of regressive taxes.
Proportional tax
Proportional taxes are when everyone pays the same tax rate, regardless of income.
Sales taxes are typically regressive proportional taxes because everyone pays the same rate, regardless of income.
- For example, say Darnell and Myra buy the same TV for $1,000 and each pay 7% in sales tax, which amounts to $70.
- But Darnell's monthly income is $2,000, while Myra's monthly income is $5,000.
- In this situation, the $70 sales tax makes up 3.5% of Darnell's monthly income but only 1.4% of Myra's monthly income.
Flat tax
Flat taxes are when everyone pays the same amount, regardless of income. Flat taxes are typically a flat rate rather than a flat dollar amount.
Some states add a flat excise tax to car registrations. For example, say Myra and Darnell are both registering their cars, and the state adds a flat fee of $100 to every car registration. That $100 flat tax makes up 5% of Darnell's monthly income but only 2% of Myra's monthly income.
Pros and cons of tax structures
Flat taxes are appealing because they're simple: You pay a flat rate, and your tax calculations are done. But as illustrated in the examples above, regressive taxes place more of the tax burden on people with lower incomes — many of whom currently pay little or no income tax at all.
For that reason, most "flat tax" proposals are modified proportional taxes. While the details vary from plan to plan, these proposals often:
- Establish a minimum income threshold under which no taxes are paid
- Keep some tax credits, such as the Child Tax Credit and Earned Income Tax Credit
- Allow a small number of deductions, such as those for donations to charity or home mortgage interest
For most of us, paying taxes is inevitable. But the impact they have depends on the tax system used and your income.
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