What is a progressive tax system and how does it work?
A progressive tax is a system of taxation imposed on the payers in such a way that the effective tax rate applied increases as the amount to which that particular rate is applied increases. Simply put: The bigger the amount to be taxed, the bigger the rate to be applied. The concept “progressive tax” actually describes a distribution effect. This can be applied to any kinds of tax system (be it on income or any kind of consumption that meets the definition). However, it is usually being used in reference to income taxes, where in taxpayers who have more disposable income will pay a higher percentage of that income as compared to those who have less income. The term “progressive” refers to the how the rate progresses from a low rate to a high one. It can also be used to adjustments of the tax base by using selective taxation, tax credits, or tax exemptions that would make progressive distributional effects.
A good example of the application of the progressive tax, other than the personal income, is the case of tax being applied on luxury goods vis-à-vis the exemption on consumption of basic necessities. In this particular case, tax applied may be aptly described as exhibiting progressive effects as the setup or system increases a tax burden, so to speak, on high end consumption (luxury goods) and decreases it on low end consumption (basic necessities).
The opposite of this system of progressive tax is the regressive tax system. This is a setup where the tax rate being applied decreases as the amount to which the tax rate is applied increases. There is also the proportional tax system in the middle ground of the previous two systems. This is a system of taxation where the tax rate being applied is fixed and will never change regardless of the amount where the rate is being applied, i.e., the tax rate will not change whether the amount to be taxed increases or decreases.
It is said that progressive tax system is an attempt to reduce the tax incidence of consumers and citizens with smaller incomes.
The progressive income tax system has garnered much support from very influential economists and political scientists in spite of the differences in their ideologies (from Adam Smith, a liberalist–capitalist economist, to Karl Marx, the founder of communism). In Adam Smith’s The Wealth of Nations, he argued:
The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess.
A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be anything very unreasonable. It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion [emphasis supplied by the writer].
Karl Marx argued a century later in support for a progressive income tax in his work The Communist Manifesto that the most advanced countries and economies should apply a heavy progressive or graduated income tax system.
Reasons for implementation
There are many reasons why the progressive tax system is being espoused and used by almost all advanced countries or economies
- It is a reality that as income levels increases, the levels of consumption tend to decrease or fall. Modern opinions argued that economic demand, and thus activity, can be stimulated by decreasing tax burden on lower income brackets while increasing the tax burden on higher incomes.
- Since people with higher income actually can be assumed to have a higher percentage of that income as a “disposable one,” economists argued of that they afford a greater tax burden. This is more technically known as the “vertical equity” argument. These economists claim that a person with a salary just enough to pay for housing and food cannot afford to pay any taxes, regardless the rate applied to them, without these people experiencing a significant material damage. Those who are making twice or more of the same income can afford to pay even up to half of their income in government taxes.
- There are also those who argues that those in the upper income bracket have a disproportionally greater or more interest in ensuring that societal goods that are typically supported by taxation (e.g., defense and infrastructure) is maintained because they have greater risk if these goods fail than do the poor.
- A progressive tax system is viewed as an automatic stabilizer. This is particularly true in the case of a person who is exposed to a decrease in wages, for instance, due to a recession. In this case, the money regained by being in a lower tax bracket, hence lower tax rate, lessens this blow (the lower wage).
There are of course some opposition on this system. Some argues that this system may lessen the incentive to work harder because increased income simply translates to higher taxes, or that this system presents injustice in representation considering that everyone has the same weight of vote in spite of significant differences in tax being paid. Whether the pros or against have more weight in reason is second only to the importance of having the tax system work. This is simply to say that as long as taxes go to where they should go, and the citizens are enjoying their rights and privileges, then, the system of tax to be used is of lesser importance.
Slemrod, J.B. 2007. “Progressive Taxes.” The Concise Encyclopedia of Economics. The Library of Economics and Liberty (http://www.econlib.org/LIBRARY/Enc/ProgressiveTaxes.html). Date accessed: December 2, 2007.
“Progressive tax.” Investopedia.com (http://www.investopedia.com/terms/p/progressivetax.asp). Date accessed: December 2, 2007.