Taxes are differentiated by the impact they have on the distribution of income and wealth. A proportional tax is a tax that impinges the same relative onus on all the taxpayers—i.e., in the case where tax liability and income grow in the same levels. A progressive tax is recognisable by a larger than proportional rise in the tax liability in regard to the rise in income, and a regressive tax is characterizable by a less than proportional growth in the comparative burden. Thus, progressive taxes are viewed as fighting the lack of equality in income distribution, whereas regressive taxes are seen to have the result of increasing these inequalities.

The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so in the upper-income categories—especially if a taxpayer is able to lessen his tax base by declaring deductions or by excluding some particular income elements from his taxable income. Proportional tax rates when applied to lower-income groups will also be more progressive if such exemptions of a personal nature are claimed.

Income measured over the course of a given year may not necessarily come up with the best measure of taxpaying requirements. For example, transitory growth in income may be saved, and in temporary declines in income a taxpayer may elect to finance consumption by reducing savings. Ergo, if taxation is compared along with “permanent income,” it will be less regressive (or more progressive) than if it is held in comparison with annual income.

Sales taxes and excises (excepting luxuries) are mostly regressive, because the portion of individual income consumed or spent for a specific good declines as the amount of personal income rises. Poll taxes (also called head taxes), calculated as a flat amount per capita, clearly are regressive.

It is difficult to dictate 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 deciding who bears the tax burden is dependant for the most part on whether a national or a subnational (that is, provincial or state) tax is being debated.

In assessing the economic purpose of taxation, it is necessary to distinguish between varied ideas of tax rates. The statutory rates are those nominated in legislature; often these are marginal rates, but occasionally they are median rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income rises by one dollar. Hence, if tax burden grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that rise as income increases. Careful analysis of marginal tax rates should consider provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated within the statutory rates. Since marginal rates signify how after-tax income moves in response to changes in before-tax income, they are the important ones for assessing incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate to apply to income from business and capital, as it may be reliant on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates determine the part of total income that is demanded in taxation. The pattern of average rates is the one that is important for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally grow with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received fundamentally by high-income households may dampen these effects, producing regressivity, as displayed by average tax rates that decline as income rises.

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