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Taxes can be distinguished by the effect they have on the allocation of income and wealth. A proportional tax is the kind that puts the same relative liability on all taxpayers—i.e., in the case where tax liability and income move in relative proportion. A progressive tax is recognisable by a higher than proportional growth in the tax burden relative to the rise in income, and a regressive tax is characterized by a less than proportional rise in the comparative liability. Hence, progressive taxes are thought of as removing a lack of equality in income distribution, whereas regressive taxes are found to have the effect of an increase in these inequalities.

The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, could become less so within the upper-income demographic—especially if a taxpayer is permitted to reduce his tax base by claiming deductions or by taking some particular income aspects from his taxable income. Proportional tax rates which are applied to lower-income demographics could also be more progressive if personal exemptions are made.

Income measured over the course of a given year might not necessarily give the best measure of taxpaying requirement. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer might decide to finance consumption by taking from savings. Thus, if taxation is made comparable along with “permanent income,” it will be less regressive (or more progressive) than when it is compared with annual income.

Sales taxes and excises (except those on luxuries) tend to be regressive, because the dissemination of own income consumed or spent for a specific good lessens as the amount of personal income grows. Poll taxes (aka head taxes), levied as a flat amount per capita, clearly are regressive.

It is complicated to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being determined.

In considering the economic effects of taxation, it is necessary to distinguish between several concepts of tax rates. The statutory rates will include those nominated in legislature; commonly these are marginal rates, but occasionally they are average rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income increases by one dollar. Thus, if tax onus increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation generally contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates must review provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than specified by the statutory rates. Since marginal rates display how after-tax income changes in response to changes in before-tax income, they are the relevant ones for considering incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate to apply to income from business and capital, as it may depend 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 zero under a consumption-based tax.

Average income tax rates display the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally increase with income, both because personal allowances are granted for the taxpayer and dependents and due to that 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, forcing regressivity, as signified by average tax rates that lower as income rises.

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