Progressive Taxation, Regressive Taxation and Flat Tax
A progressive tax increases as a person’s income rises. The next example uses the following salary and tax information:
- There is no tax assessed on salaries below $2,000 per month, so the tax rate is 0%.
- The tax rate on salaries between $2,000 and $3,000 a month is 10%.
- The tax rate on salaries between $3,000 and $4,000 is 20%.
Every income segment, with its related tax rate, is called a tax bracket.
If Mr. Longfellow earns $3,500 a month, then he will pay $200 in tax as the following calculation shows:
Segment of income
According to tax bracket
|0% (first bracket)|
10% (second bracket)
20% (third bracket)
|Total income: $3,500||Total tax: $200|
In most countries of the world, income tax is progressive.
A progressive income tax system decreases income inequality, and lowers the country’s Gini index.
A regressive tax decreases as a person’s income increases (in other words, people in higher tax brackets pay a lower tax rate).
A flat tax levies the same rate upon everyone regardless of income level (i.e., there is only one tax bracket).
A head tax is a fixed tax imposed equally upon all citizens of a country. Even those earning no income whatsoever must pay this tax. This type of tax was common in ancient times.
The disposable income of a household is the amount of money left over after paying income taxes.
Disposable income is used for two purposes:
consumption and savings. As disposable income increases, the proportion of income directed towards consumption usually falls, and the proportion invested as savings increases.
The Peterson family uses its disposable income as follows:
- The first dollar of income is used entirely for consumption, while nothing is set aside for savings.
- The 1,000th dollar is divided as follows: $0.70 for consumption, and $0.30 for savings.
- The 2,000th dollar is divided as follows: $0.60 for consumption, and $0.40 cents for savings.
- The 3,000th dollar is divided as follows: $0.50 cents for consumption, and $0.50 for savings.
- The 15,000th dollar is divided as follows: $0.20 cents for consumption, and $0.80 cents for savings.
The 20,000th dollar is deposited as savings.