Progressive Tax

Progressive tax refers to the system in which the payable taxes are determined with respect to one's income level, which means the taxable amount is more for people with higher income and is low for those who earn less. Levying such taxes helps maintain a balance between the higher and lower-earning groups.

For the progressive tax system to work, taxpayers are segregated based on their income ranges. As per their income group, the applicable tax rates are imposed with the rich paying more taxes and the poor paying less. The applicable tax rates for a particular income group increase with their earnings.

• Progressive tax refers to the tax arrangement wherein the government imposes taxes with respect to the income levels of individuals. As a result, the higher-income group pays more tax than the lower-income group.
• There are seven tax brackets appliable in the United States, which include 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
• It is different from a regressive tax structure, where the taxes levied on individuals are the same irrespective of their income ranges.
• The progressive form of taxation increases with the increase in income level. Hence, it helps an economy bridge the rich and poor gap arising from income inequality.

A progressive tax arrangement attempts to eradicate the income inequality issues across an economy. Though the taxable amount is disproportionately distributed among the population with respect to their earnings, it helps lower-income groups to have a sufficient amount left in hand after paying their share of tax. As a result, people get an opportunity to serve their lifestyle needs without much struggle.

Such taxes are imposed based on the tax brackets segregating taxpayers into different income groups. The tax slabs divide the tax liability from 0% to 45% among the citizens. As of 2021, there are seven tax brackets in the United States – 10%, 12%, 22%, 24%, 32%, 35%, and 37%. With the increase in the level of income of individuals, their tax liability increases, and hence, the arrangement is termed progressive tax.

Some of the types of progressive taxes are as follows:

1. Investment income tax – This progressive income tax is imposed on income generated from people's savings and investments.
2. Estate tax – It is the form of tax imposed on the assets passed on to heirs. The taxes apply only if the cost of assets is above a specific amount set by the higher authorities.
3. Tax Credits – The progressive tax attempts to reward certain individuals for their tax contributions. These credits are some amounts deducted from the taxable amount of an individual and not the gross income earned. These include elderly and disabled tax credit, retirement savings contribution credit, etc.

Let us consider the following progressive tax examples to understand the concept better:

Example #1

Harriet, an IT professional, had an income worth $10,000, while a shopkeeper in the same nation earned $5,000. As per the government rules, the former fell under the tax bracket of 20%, while the latter was liable to pay 10% of the income. 

As a result, Harriet paid $2000 as tax while the shopkeeper had to pay only $500.

Example #2

Let us check out the single filer tax bracket for 2022:

The progressive tax system is so designed that it benefits both the citizens of an economy and the government.

This arrangement removes the economic barrier caused due to the wide gap between the income ranges. Moreover, with a different progressive tax rate, the amount payable as tax is distributed among the citizens, indicating the economy's elasticity. As a result, the highly paid individuals carry the heaviest tax loads and vice-versa.

The tax system lets eradicate the issues arising from income inequality, thereby making it easier for each individual in an economy to bear the cost of living. It also helps raise employment opportunities since the marginal propensity to consume increases as wealth gets distributed from the rich to the poor. 

Above everything else, when individuals find the tax rates lenient, they do not skip paying taxes. Thus, in such a progressive arrangement, the government generates more revenue in the form of timely and regular tax payments.

Even though such taxes bridge the gap between the rich and the poor classes of people in an economy, critics believe that the progressive tax structure stands unfair to the higher income group, including the middle-class families. As a result, many high-income groups opt for keeping their actual earnings a secret, thereby evading taxes. 

Different nations imply different tax rates as economic income distribution varies from one to another. As the taxes received from the richer class are redistributed from the poor class through various government programs, some may perceive this as socialism.

While progressive tax is imposed based on the income range one belongs to, the regressive tax is levied irrespective of the effect of any factor on one's taxable income.

In the progressive arrangement, higher-income groups are subject to paying higher taxes, and lower-income groups pay lower taxes, given the government's tax rates. On the contrary, the regressive tax structure levies the same tax on individuals no matter how much they earn. Whether individuals belong to higher income groups or lower-income groups, the tax to be paid is the same for all.

While income taxes fall under the progressive arrangement, sales taxes are regressive. The former is imposed as per the tax brackets in which individuals fall, while the latter remains the same for all when buying the same products with the same sales tax.

This article is a guide to Progressive Tax & its definition. Here we explain how the system works along with the benefits, limitations, examples and its differences from regressive tax. You may also have a look at these articles below to learn more about Accounting basics –

• Indirect Taxes | Top 4 Examples
• Tax Evasion vs. Tax Avoidance
• Top Differences Between Income Tax vs. Payroll Tax
• Tax Credits vs. Tax Deductions