The 3 types of taxes
In the world of taxation, three types of taxes exist. The main difference between them is how the tax rate changes in relation to the income of the taxpayer.
The three types of taxes we have are:
- The Proportional Tax
- The Progressive Tax
- The Regressive Tax
The Proportional tax is fixed and has no terms. A Proportional tax is imposed so that the tax rate is fixed with no change as the taxable base amount increases or decreases. The amount of the tax is in proportion to the amount subject to taxation. This is also known as the flat tax. So if three different citizens earn $50,000, $100,000, and $200,000 a year, in a proportional tax system, the three of them will all be taxed at the same rate. Let’s say the tax is 20%. In that case, they will have to pay taxes of $10,000, $20,000, and $40,000 respectively.
As illustrated above, the burden of your tax liability increases as your income increases in this taxation system because the tax rate is fixed.
Progressive taxes take a larger percentage of income from high-income groups than low-income groups.
For example, it taxes low-income taxpayers at 10 percent, middle-income taxpayers at 15 percent, and high-income taxpayers at 30 percent.
This tax system requires high-income taxpayers to pay a greater fraction of their income than taxpayers with a lower income. This means that as the income grows, so does the tax rate. The idea behind this is that wealthy people spend relatively less on the basic necessities in life, so they can afford to pay more taxes and still maintain their standard of living.
For instance, under a Progressive Tax system: Individuals who earn up to $75,000 pay a 5% income tax, while individuals who earn between $75,000 and $150,000 pay 10% income tax, and lastly individuals who make more than $150,000 pay a 20% income tax.
This means that three different citizens who earn $50,000, $100,000, and $200,000 a year are taxed under 3 different tax brackets.
The first only has to pay a 5% income tax, which adds up to $2,500 in his case. While the second has to pay 10% taxes on his income, which is $10,000. Finally, the last individual’s income is taxed at 20%, which means he or she has to pay $40,000.
Note that despite the higher tax rate, the last person still has more money after paying the tax than the other two, and the second still has more than the first. Therefore, the higher tax burden doesn’t affect them as much because they can afford to pay what is required for their income tax bracket.
A regressive tax system is the reverse of a progressive tax system. It is a type of tax that takes a greater percentage of income from those who earn less than those with a higher income. It requires high-income earners to pay a smaller fraction of their income than those with a lower income. This automatically means that as your income grows, the tax rate decreases. One common example of a regressive tax is a sales tax, this is a tax placed on the sale of a good or service. Because the amount of that tax is the same for all buyers, the fraction of income devoted to paying it decreases as the income of the taxpayer increases.
Another example is on property taxes which are set at a flat percentage regardless of the status of the purchaser or owner.
Using three different citizens who earn $50,000, $100,000, and $200,000 a year, we will assume they all bought a new vehicle worth $50,000 with a sales tax of exactly 10%. This simply means that they all have to pay $5,000 in additional taxes. Now, if we calculate the tax rate in relation to their income, we can see that the first person who earns $50,000 has to spend 10% of his annual income to pay the sales tax. While the second person; $100,000 earner has to devote 5% of his income and the last person who earns $200,000 only spends 2.5% of his annual income to pay the exact same tax. So relatively speaking, in the Regressive tax system, the burden of the tax reduces as the income of the taxpayer grows.
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