Crawford School of Public Policy
TTPI Tax and Transfer Policy Institute
What are progressive and regressive taxes?
TTPI – Policy Brief 3/2016 February 2016
Peter Varela Research Fellow, Tax and Transfer Policy Institute, Crawford School of Public Policy, Australian National University
Tax and Transfer Policy Institute Crawford School of Public Policy College of Asia and the Pacific +61 2 6125 9318 [email protected]
The Australian National University Canberra ACT 0200 Australia www.anu.edu.au
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THE AUSTRALIAN NATIONAL UNIVERSITY Brief: Progressive and Regressive Taxes Taxes have a wide range of rates, A regressive tax is the opposite, thresholds and burdens for different where the average tax rate, or amount kinds of taxpayers. In general, we of tax paid as a percentage of income, describe a tax decreases as income increases. An as progressive or regressive by example of a regressive tax is a head comparing the tax paid by an individual tax, or lump sum tax, which requires with the income of that individual. each taxpayer to pay an identical amount of tax. While a head tax is A progressive tax is a tax where the equal in the sense that each taxpayer average tax rate, or the total amount of pays exactly the same amount, it is a tax paid as a percentage of income, regressive tax because the amount of increases as the taxpayer’s income tax paid as a percentage of income increases. A tax may be progressive if decreases as income increases. people with higher incomes pay a higher tax rate (e.g. the personal A proportional tax lies between a income tax). Alternatively, taxes can progressive and a regressive tax, and be progressive if the tax is levied on an collects a constant percentage of action or purchase that is more income in tax for all taxpayers. common amongst wealthier people (e.g. the luxury car tax, or an inheritance tax).
Figure 1: Progressive, proportional and regressive taxes
Source: TTPI, Stocktake Report, Chart 1.2
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The Australian income tax is a progressive tax
The most common example of a of each dollar earned in tax. This is progressive tax is the personal income shown in the chart below, which tax. As an individual’s taxable income displays the marginal and average tax increases, they enter higher tax rates for the Australian income tax in brackets, and pay a higher percentage 2014-15.
Figure 2: Marginal and average tax rates
Note: These are the statutory marginal tax rates excluding the phase out of the Medicare Levy and low income tax offset that cause the tax schedule to become regressive over some ranges.
The GST and other Australian taxes designed in a progressive way, so that a greater burden applies for offenders While the income tax is progressive, with higher incomes. many of Australia’s other taxes are regressive. So-called “sin taxes”, such The GST is an interesting and as taxes on gambling, alcohol and important case. When the GST is tobacco tend to be regressive because examined as a proportion of income, they disproportionately affect those on the GST is found to be a regressive low incomes. Many government tax, even though the GST is applied at charges and fines such as motor a constant rate of 10 per cent. This is vehicle registration, are highly because people with higher incomes regressive. A recent report suggests tend to spend less (and save more) of that traffic fines and penalties could be their income than people with lower
2 incomes, which results in less GST inheritances), or as a measure of being paid as a percentage of the ability to pay in its own right. As shown income of higher income earners. in Figure 3, the GST is close to a proportional tax when compared to an However, progressivity can also be expenditure benchmark. This is also measured against household shown in a 2014 OECD study on expenditure rather than income. This distributional effects of consumption could be justified as a proxy for lifetime taxes. income (ignoring bequests or
Figure 3: The distributional incidence of the GST
Source: 2009 Household Expenditure Survey: Authors calculation based on the ABS Fiscal Incidence Study. Note: This figure is based on the existing GST, rather than an ideal broad based GST with no exemptions.
Overall, the Australian tax-transfer individuals or households, combined system is progressive with the payment of cash transfers and withdrawal of benefits over time. Progressivity can be measured across the whole tax and transfer (welfare) The figure below uses data from the system. Such an overall measure Australian Bureau of Statistics and takes into account the effects of all includes all taxes (except the taxes in the system on different corporate income tax). It shows that
3 the Australian tax system is only very tax. However, when combined with slightly progressive; those in the transfer payments, the overall tax and lowest income quintile pay around 22 transfer system is highly progressive per cent of their income in tax, while (represented by the black line on the those in the highest quintile pay chart). around 27 per cent of their income in
Figure 4: The incidence of the Australian Tax and Transfer System (per cent of income)
Source: Government benefits, taxes and household income. ABS Cat. No 6537.0
This chart also provides an important of the transfer system (discussed insight into the nature of redistribution further on p. 35 of this Productivity using the tax system. While the Commission report). income tax is more progressive than the rest of the tax system (the red Different measures of progressivity versus the green areas), the transfer There isn’t a single measure of system is much more progressive than progressivity. In fact, there are a the income tax. As a result, a key variety of options that need to be determinant of the progressivity of a considered in order to estimate how tax/transfer system is the absolute size progressive or regressive a tax is.
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Economic incidence of a tax to consider progressivity over a longer time period (in Australia such long- First, ideally progressivity is term data is not available, and determined based on the economic so estimates of lifetime progressivity incidence (as opposed to the legal must be modelled, such as in chapter incidence) of a tax. Those who are 6 of this Productivity Commission legally obliged to pay a tax will often report). try to pass that tax on to another party. For instance, taxes placed on Unit for comparison producers, or on vendors, may be passed on to customers, either in part Third, it is necessary to decide the or in full, through increased prices. In appropriate unit for comparison. practice, it may be difficult to Progressivity is generally estimated at determine exactly who bears the either the household level or the economic burden of a tax, as this individual level. This choice has depends on how wages, prices and important implications when looking at behavior changes in our economy. the impact of the tax and transfer system, as the tax system is largely As a result, simplifying rules of thumb based on the individual, while the are often used. For example, it is transfer system is largely based on the usually assumed that all GST is borne household. by the final consumer, and all income and payroll tax on wages, paid or To see why this might be important, withheld by the employer, is borne by consider the example of an increase in the employee. (On the potential the minimum wage. By definition, this problems with this assumption about will be a progressive policy change payroll tax, see Mathias Sinning’s when using individuals as the base article on the blog). because people earning minimum wage are at the low end of the income Benchmark of income or distribution. However, if those low expenditure income individuals are earning income Second, it is necessary to decide in a high income household that has which definition of income (or other sources of income (for instance if expenditure) is to be used as the they are children living with their benchmark for defining progressivity. parents), then the same policy may be This is usually annual disposable regressive when measured using the income after all taxes and transfers are household as a base. This issue was taken into account. However, if the considered by Andrew Leigh in 2007, data is available it is may be possible who found that ‘given that the typical
5 minimum wage worker lives in a Retired people or students may middle-income household, it appears have very little income on an unlikely that raising the minimum wage annual basis but may have will significantly lower family income considerable wealth, expected inequality’. future earnings or future wealth and therefore may be Where an analysis focuses on data at considered reasonably well off the household level, it is common to overall. make an adjustment for the number of Families in which individuals – people residing in a household. The especially women - are taking reasoning is that a family of six living time out of the labour force to on $100,000 a year is less ‘well off’ care for young children, than a family of two with the same providing valuable “imputed income. An example of this is the income” in the household but Australian Bureau of Statistics not earning income measured in measure of Equivalised Household the data. Income, which is calculated as follows: Unemployed people, particularly where people are unemployed Taking the first adult in the household for short periods of time, may as having a weight of 1 point, each report low income in one additional person who is 15 years or particular year, but over a older is allocated 0.5 points, and each longer time period may be child under the age of 15 is allocated reasonably well off. 0.3 points. Equivalised household income is derived by dividing total Progressivity and inequality household income by a factor equal to the sum of the equivalence points Progressivity of taxes and transfers allocated to the household members. can also be estimated by comparing the impact of a tax with more general In many cases, the choice of individual measures or indexes of income or household as the base for inequality. An example is the Gini comparison and the choice of income coefficient which measures how definition will only have a minor effect unequal the distribution of income is on the results. However, particular among individuals and households. It care needs to be taken when is possible to estimate the Gini analyzing progressivity for individuals coefficient before taxes and transfers, or households in some particular and compare it with the Gini coefficient circumstances. after taxes and transfers. This also gives us information about
6 progressivity of the tax and transfer it is possible to show the incidence of system. This summarises the taxes and transfers over the age progressivity of a tax system into a distribution of a population. The single number, and as a result it can following chart shows that Australia’s be used to make comparisons government spending is highly between tax systems over time or concentrated towards older Australians across countries. (and suggests why population ageing will put pressure on the federal Incidence of taxes by age budget).
Using the same framework used to estimate progressivity and regressivity,
Figure 5: Australian Government spending by age group ($‘000 per person, 2011-12)
Source: Chart 5.1, An Ageing Australia, Preparing for the Future. Productivity Commission.
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Progressivity or regressivity of tax the difficulties in this context can be concessions or ‘tax expenditures’ found here and here).
It is possible to estimate the Putting aside difficulties in exact progressivity or distributional impact of measurement, it is clear that a number tax concessions in the system, such as of Australia’s tax expenditures are exemptions or low tax rates, as well as regressive. For example, Figure 7 the progressivity of the overall tax rate below shows the proportion of structure. Such analyses follow the superannuation tax concession same basic structure as the examples received by people in different parts of given above. However, to estimate the income distribution, and shows that whether or not a tax concession is they are highly skewed towards high progressive or regressive, it is income individuals. In fact, individuals necessary to accurately identify the in the lowest income decile are incidence of the tax expenditure. This actually worse off as a result of our tax is difficult for a number of Australia’s rules for superannuation. large tax expenditures (a discussion of Figure 6: Distribution of superannuation tax concessions is regressive
Source: A Stocktake of the tax system and directions for reform, Chart 4.12, the Tax and Transfer Policy Institute.
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Further Research
How should progressivity be measured? By the Tax Policy Centre
The Distributional Effects of Consumption Taxes in OECD Countries
Tax and Transfer Incidence in Australia, by the Productivity Commission
Who Pays? A report on the progressivity of taxation in the 50 US States by the Institute on Taxation and Economic Policy
Measurement of Progressivity, from the Treasury document: International Comparison of Australia’s Taxes
Tackling income inequality - The role of taxes and transfers. From the OECD Journal Economic Studies
What nation has the most progressive tax system, by Greg Mankiw
ABS Household Expenditure Survey
The Distributional Impact of State Taxes for South Australian Households, by Ben Phillips
Analysis of the 2015-16 Federal Budget, By Ben Phillips
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