There are three types of tax rate structures: (1) progressive rate, (2) proporti

Question

There are three types of tax rate structures: (1) progressive rate, (2) proportional rate, and (3) regressive rate. The US Federal income tax system currently applies the progressive tax rate structure. A common controversy is whether the progressive tax rate is the best application for the US. Many believe that the proportional tax rate would be a better system for the US Federal income tax rate system. Identify the differences between the three tax rate structures. In your opinion, what structure would be the best structure for the US? Be sure to support your answer with the advantages of the method you select and the disadvantages of the other tax rate structures.

Explanation / Answer

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 implementing a tax liability based on the individual or entity's ability to pay, 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 is assessed as a percentage of the item bought and is the same for every individual or entity. However, a sales tax of 7% has a greater burden on lower-income earners than it does on the wealthy because the ability to pay is not taken into consideration. Regressive taxes include real estate property taxes, state and local sales taxes as well as excise taxes on consumables such as cigarettes, gasoline, airfare or alcohol.

It will not be suitable for U.S or any economy as lower income people charged with higher taxes

Proportional Taxes

A proportional tax system, or a flat tax system, assesses the same tax rate to taxpayers regardless of income or wealth. It is meant to create equality between marginal tax rate and average tax rate paid. Under a proportional tax system, individual taxpayers pay a set percentage of their income regardless of total income earned.

For example, an income tax of 10% that does not increase or decrease as income rises or falls results in a proportional tax. In this example, an individual who earns $20,000 annually pays $2,000 under a proportional tax system, while someone who earns $200,000 each year pays $20,000 in taxes. Some specific examples of proportional taxes include per capita taxes, gross receipts taxes and occupational taxes.

It will not be suitable for U.S or any economy as flat rate of tax is charged on every one. Distinction between the low and higher income people was not been made

Progressive Taxes

The current federal income tax is a progressive tax system, in that the proportion of tax liability rises as an individual or entity's income increases. Tax burdens are meant to be more of an imposition to wealthy, high-income earners than they are to low- or middle-class individuals.

Under a progressive tax system, taxes assessed on income and business profits are based on a progressive or increasing tax rate schedule. Marginal tax rates under a progressive tax system are often higher than the average tax rates that are paid. Estate taxes are another example of progressive taxes, as a greater burden is placed on wealthy individuals.

The main advantages of progressive taxation are:

(i) Progressive tax is based on ‘ability to pay’ principle. Since the ability to pay increases indirect proportion to the increase in income, the rate of tax goes on increasing with every increase in the size of income.

(ii) Progressive tax promotes equality of incomes and wealth because under it the richer persons are required to pay the tax at higher rate than the poorer persons. This tax system is more productive, economical and elastic.

The main disadvantages of progressive taxation are:

(i) It reduces capital formation because it is the rich who can save and, therefore, if they are taxed more heavily than the poor, the saving potential will either be lost completely or reduced substantially. Consequently, the process of capital formation is adversely affected as a result of progressive taxation.

(ii) A progressive tax offers great temptation and there is scope for tax evasion and tax avoidance. The tax-payers invariably try to evade the payment of the tax by presenting false statements of accounts before the taxing authorities and also avoid payment of taxes by finding legal loopholes in the tax provisions.

It will be best suitable for U.S economy as people with higher income charged with taxes and based on ability to pay. Equality of income distribution exists.

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