Regressive Taxation
Regressive taxation is a tax system where the tax rate decreases as the taxable amount increases, resulting in lower-income individuals paying a higher percentage of their income compared to wealthier taxpayers. This often occurs due to the structure of certain taxes, notably consumption taxes like sales taxes and excise taxes, which disproportionately burden those with lower incomes. For example, while a flat sales tax applies uniformly to all purchases, lower-income households spend a larger share of their income on consumable goods, making the effective tax rate feel more steep for them.
Regressive taxation is commonly seen in local and state tax systems, where substantial revenue is generated from consumption taxes, leading to significant disparities in tax burdens among different income groups. Defenders of such tax structures argue they are fair because every consumer pays the same rate, but critics highlight that they place a heavier load on those least able to afford it. Additionally, variations exist among states in how they tax necessities like groceries, further complicating the fairness of the system.
Overall, regressive taxes are often linked to broader discussions about economic equity and the implications of tax policies on different socioeconomic classes. Understanding regressive taxation is essential for anyone interested in the dynamics of tax systems and their effects on income distribution.
Regressive Taxation
Abstract
Regressive taxation is a tax or tax structure in which the highest tax rate is applied to the lowest tier of taxpayer, and vice versa. In most cases, regressive taxes are not explicitly regressive, or are regressive only with respect to the highest or lowest tiers because of caps or deductions that alter the taxpayer's effective tax rate. Where regressivity is seen most is in consumption taxes and in the tax structures of state and local governments. Regressivity is rarely championed, as it unevenly distributes the tax burden to those least able to shoulder it.
Overview
A regressive tax is one that is applied such that the tax rate decreases as the amount taxed increases, so that the taxpayers with the smallest amount to be taxed pay the largest percentage of that amount, and those with the largest amount to be taxed pay the smallest percentage. This is not, in practice, the opposite of progressive taxation because progressive and regressive taxes tend to be applied to different things. For instance, most of the world taxes income on a progressive basis, but the only regressive income tax systems are flat taxes with available deductions such that higher income brackets pay a lower effective tax rate than lower ones do.
Payroll tax, on the other hand, are effectively regressive if they have a cap. In the United States, Social Security consists of a 12.4 percent tax on wages, but unlike income tax, only the first $118,500 of wages are subject to the tax (as of 2016), for a maximum contribution of $14,694, which means wage-earners over that amount are paying a lower percentage: An executive making $1 million a year pays a Social Security tax rate of about 1.5 percent, or an eighth of what a middle manager pays. Defenders point out that this is balanced out by the fact that the ratio of lifetime Social Security benefits to lifetime income received by the lowest lifetime income earners is higher than it is for the highest income earners; of course, this is by design, since the highest income earners are not in need of additional post-retirement support.
The term regressive taxation is often used in a somewhat more figurative sense, to refer not to a specific decrease in tax rate as the amount being taxed increases, but a decrease in the tax paid as a percentage of the income or wealth of the taxpayer, as that income or wealth increases. A sales tax, for instance, is not regressive: A 6 percent sales tax takes 6 percent of the purchase price whether $100 is spent or $1,000. Because upper-income taxpayers spend a smaller percentage of their income on things subject to that tax, while lower-income taxpayers spend the majority of their money after basic expenses on things subject to that tax, the burden of the tax is regressive, usually significantly so.
Further Insights
The most common regressive tax is a consumption tax. Consumption taxes are usually indirect taxes, levied on goods and services, of which the most common types in the United States are general sales tax (calculated ad valorem, meaning the tax is a specific percentage of the price of the sale) and excise taxes applied to specific categories of goods, like meals, tobacco, fuel, alcohol, and tourism-related expenses like hotels or transportation. Excise taxes can be either ad valorem or a flat dollar amount per unit. Cigarette and fuel taxes, for instance, are often applied as a specific dollar amount per pack of cigarettes or gallon of automotive fuel, and do not fluctuate with the sales price. Consumption tax was the main form of taxation in the early United States (income tax not being used until the Civil War, and not permanently adopted until fifty years later), and remains the main source of revenue for state and local governments, which leads to large differences between the federal tax structure and that of the states.
One of the most important issues in discussing the regressivity of consumption taxes is the handling of groceries. Poor households spend most of their income on necessities and food, while food is a trivial expense for wealthy households. States vary considerably in how groceries are taxed, while generally applying a meals tax to food from restaurants. Some states tax all groceries the same as other retail sales; others tax only certain items, such as prepared foods. Certain states have special rates for certain conditions that are applied independently from income considerations: South Carolina, for instance, has two separate sales tax rates, the lower of which is for customers over 85.
Because consumption taxes don't tax savings or investments, they tend to benefit those with enough wealth or income to invest a significant amount of it, while those who spend most of their income after basic expenses carry the greatest consumption tax burden. Excise taxes in particular are usually applied to goods the consumption of which is not elastic according to income: wealthy people do not generally use more gasoline, drink more alcohol, or smoke more cigarettes, and so the dollar amount of tax paid on those items does not vary greatly by income, but the percentage of income does.
State excise taxes collect about 1.6 percent of income from poor families nationwide, and less than 0.1 percent of wealthy incomes. Furthermore, while the income tax system lends itself to a robust system of deductions and exemptions—which historically have been tailored to benefit every income level to varying degrees—no such system exists for consumption taxes. This is particularly a concern when evaluating proposals to replace some or all of a progressive income tax with an across-the-board consumption tax, meaning a tax on every transaction. The effect of such a tax system would be disproportionately felt by people who rent their homes, for example. A homeowner's mortgage payment is not "consumption"; it is a payment on a debt owed to the bank that holds the mortgage. A renter's payment to a landlord, however, is a consumption and would be taxed. Defenders of these proposals point out that homeowners pay property taxes to which renters are not subject. However, renters do essentially pay these taxes, insofar as the cost is passed on to them by the landlord and built into their rent payment.
Property tax is typically somewhat regressive. Even though wealthier households tend to live in wealthier homes, the difference in housing cost among income tiers is not proportional to the difference in incomes. Though there are outlying exceptions, in the main poor homeowners pay a higher proportion of their income as property tax than the middle class does, and wealthy homeowners pay a smaller proportion; this is true for renters as well when you factor in the impact of property tax on rents.
While no one outright endorses regressivity, regressive tax structures are supported for a number of reasons. While no tax is per se popular, consumption taxes have general public support because of a veneer of fairness: if every customer pays a 6 percent sales tax regardless of their income, then everyone is presumed to be paying a fair tax, particularly when the goods being purchased are seen as optional, compared to rent, utilities, and other necessities. With excise taxes in particular, proponents argue that taxes can be avoided by not purchasing the cigarettes, alcohol, or other optional good. The problem with this is that it puts the burden of that buying decision on only the lowest income earners; the wealthy are not asked to apply any such calculus, and are not made to feel that their purchase of a six-pack of beer indicates that they are putting an unreasonable priority on alcohol. Further, consumption taxes have no real financial effect on the wealthy, but they definitely impact the poor and middle-class.
Where regressive taxes find their support is among fiscal conservatives, who since the 1970s have been increasingly hostile to taxation in any form. Most associated with Alan Greenspan in the 1970s and 1980s and the Reagan and George W. Bush presidencies, the phrase "starve the beast" has been used to refer to the deliberate cutting of tax revenue in an effort to "starve" the federal government. The end goal is putatively to force the government to reduce its spending, though in practice it has resulted instead in deficit spending and reductions to programs like health care and veteran services that created new increased costs in other areas years later. Because Social Security and Medicare, two programs funded through regressive taxation, account for so much of the federal budget, most failed proposals to significantly cut tax revenue have also required significant reductions to the benefits of those programs. The flat tax proposals popular in the 1990s, for instance, universally resulted in greatly increased deficits, part of which would have to be paid for by significant Social Security and Medicare cuts.
Regressivity came up in the periodic discussions of the Fair Tax Act or FairTax, first proposed in Congress in 1999 and subsequently a point of discussion in the 2008 elections. The FairTax would eliminate federal income taxes (and capital gains and corporate income taxes), payroll taxes, gift taxes, and estate taxes, adopting a national consumption tax, beginning at 23 percent, on all retail sales. The FairTax is designed to be revenue-neutral, meaning the amount of tax revenue remains the same, it is simply collected through different means. There has been great debate about the impact it would have; while the FairTax's advocates insist that it would meet the demands made by some liberal and progressive tax reformers to more fairly tax wealth, many economists have argued that a national consumption tax (even with the "allowance" given to family households as part of the plan) would be deeply regressive, with the lower and middle income earners paying significantly more than upper income earners.
Issues
There are several ways to look at taxation. You can consider a specific tax, and whether it is regressive, progressive, or something else. You can also look at the total tax burden of a person living in a given jurisdiction—the total amount or proportion of taxes they pay through all the taxes they are subject to, including income, sales, property, fuel taxes, excise taxes, capital gains taxes, and so on. While there are only a handful of specific regressive taxes in the United States, the overall tax burden of its citizens is regressive: The number of flat taxes on goods and services, the relatively low maximum rate of capital gains tax, and the number and character of income tax deductions mean that the wealthy, overall, pay a lower proportion of their total wealth in taxes than do lower income households.
The tax structure of nearly every state is regressive. Local and state taxes are not just regressive: In the conclusions of a 2015 study by the Institute on Taxation and Economic Policy, they are "fundamentally unfair." The ten most regressive in that study—the "Terrible Ten"—were Washington State, Florida, Texas, South Dakota, Illinois, Pennsylvania, Tennessee, Arizona, Kansas, and Indiana. While these states represent different regions, demographics, and population sizes, one thing they had in common was that most of them derived as much as two thirds of their revenue from sales and excise taxes, or twice the national average. Further, four of them levy no personal income tax, and a fifth taxes only interest and dividends, not wages. Poor families in these states paid almost eight times more of their income in taxes than wealthy families, and middle-class families five times more.
State consumption tax structures are significantly more regressive than income tax or even property tax, which is broadly regressive. Nationally, the poor pay about 7 percent of their income in consumption taxes, compared with 0.8 percent for the wealthy and 4.7 percent for the middle-class. Property tax can be made less regressive by capping the amount of property tax paid based on personal income, which also helps encourage home ownership in the lower and middle class.
States praised as "low tax" are usually regressive; those low taxes refer to the rates paid by the wealthy. Seven of the Terrible Ten had both the highest taxes on the poor and among the lowest taxes for the wealthy. Nationwide, in the ITEP study the bottom 20 percent of income-earners paid an effective state and local tax rate of 10.9 percent; the middle 20 percent paid 9.4 percent; and the top 1 percent paid 5.4 percent. There was a direct correlation in types of taxes states relied on: States relying mainly on sales tax and other consumption taxes were the most regressive, and those relying on income taxes the least regressive. In Alabama, even personal income tax—typically the most progressive form of taxation—is regressive, because the top tax rate is applied to the overwhelming majority of the state and taxpayers are allowed to deduct the full amount of their federal income tax bill, which results in a disproportionately higher deduction for the wealthy, such that the top 1 percent in Alabama pay a smaller proportion of state income tax than the middle-income tier. In other states, breaks on capital gains taxes contribute to regressivity.
The least regressive tax structures are found in Vermont, Oregon, Montana, Minnesota, the District of Columbia, Delaware, and California. All but Montana use highly progressive income taxes. California is home to several industries with a heavy concentration of wealthy executives, and so has tailored its progressive income tax such that the top tax rate of 13.3 percent is called the "millionaire's tax," and is much higher than what is paid by even most wealthy Californians.
Montana and Oregon do not impose sales taxes, which reduces the role played by consumption taxes. Montana is also one of several states that is able to reduce its overall reliance on taxes in general for revenue, because of a heavy reliance on natural resource rights. Other states like Nevada reduce the use of taxes through gambling revenues. New Hampshire is one of several states in which the state controls the trade in liquor; in New Hampshire's case, state-run liquor stores are the exclusive retailer for hard liquor, and the state is the exclusive wholesaler for wine.
Other states and local governments raise revenue through fees, fines, and charges, which are not always trivial sources; investigative reporting in the twenty-first century has shed a light on the number of towns and counties in the United States that receive the majority of their revenue from asset forfeiture. Vermont, the least regressive, offers an Earned Income Tax Credit as the federal government does, which serves the same purpose: to reduce the burden of income tax on the lowest income earners and thus reduce regressivity. Note that both Vermont and Montana, while less regressive overall, are also two of the states with substantial capital gains tax breaks, which is what keeps them from being flat or progressive.
One of the factors that contributes to the regressivity of state and local taxes is outside of state and local control: The federal income tax deduction. For filers claiming itemized deductions, state and local income and property taxes can be deducted from their income for federal tax purposes. This is an advantage disproportionately taken by higher income earners and the wealthy, who effectively have a third of their state and local income and property tax paid for by the federal government. Lower income earners are significantly less likely to claim itemized deductions, and because tax preparation is a specialized field, the average tax payer does not have the ability to take full advantage of the deductions available to them (and may have little awareness of this) without hiring a service to do it for them. Needless to say, wealthier people are able to afford better tax preparation.
Terms & Concepts
Consumption Tax: A tax levied on consumption of goods and services; in the United States, sales tax and excise taxes are the most common form.
Flat Tax: A flat tax is a tax system with a static marginal rate; a true flat tax is a proportional tax, with a fixed rate, usually discussed in reference to income taxes. "Flat" here can be considered the midpoint between progressive and regressive.
Income Tax: Income tax is a tax on wages paid by the individual.
Payroll Tax: Payroll tax is a tax paid on the money a business pays out to employees; usually, as with Social Security, the employee and employer each pay a portion of it.
Progressive Tax: A tax the rate of which increases as the amount being taxed increases, especially associated with income and capital gains taxes.
Regressive Tax: A tax the rate of which decreases as the amount being taxed increases; in some contexts, a tax under which the highest-income taxpayers pay the smallest percentage of their income.
Tax Rate: A tax rate is the ratio of the tax being paid to the value of the thing being taxed; a sales tax of 6 percent means the tax is 6 percent of the purchase price.
Tax Structure: The tax structure of an economy consists of the tax rates and tax base of that economy, rather than a single type of tax in that economy; for example, the tax structure of a state in the United States consists of any income, sales, property, business, meals, transportation, hotel, and other taxes that are collected.
Bibliography
Bogenschneider, B. N. (2015). Critical legal studies and regressive taxation in the United States. Harvard Unbound, 10, 98–100.
Chernick, H., & Reschovsky, A. (2000). Yes! Consumption taxes are regressive. Challenge, 43(5), 60. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=3566443&site=ehost-live
Guo, J., & Harrison, S. G. (2015). Indeterminacy with progressive taxation and sector-specific externalities. Pacific Economic Review, 20(2), 268–281. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=102482437&site=ehost-live
Krueger, D., & Ludwig, A. (2013). Optimal progressive labor income taxation and education subsidies when education decisions and intergenerational transfers are endogenous. American Economic Review, 103(3), 496–501. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=87662432&site=ehost-live
Nichols, D., & Wempe, W. (2010). Regressive tax rates and the unethical taxation of salaried income. Journal of Business Ethics, 91(4), 553–566. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=47728847&site=ehost-live
Vandenberg, B., & Sharma, A. (2016). Are alcohol taxation and pricing policies regressive? Product-level effects of a specific tax and a minimum unit price for alcohol. Alcohol & Alcoholism, 51(4), 493–502.
Westin, R. A. (2014). The historical origins of progressive taxation. Journal Jurisprudence, 23, 203–241.
Suggested Reading
Chen, J. (2012). Progressive taxation: An aesthetic and moral defense. University of Louisville Law Review, 50(4), 659–681.
Doerrenberg, P., & Peichl, A. (2013). Progressive taxation and tax morale. Public Choice, 155(3/4), 293–316. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=87391279&site=ehost-live
Eiji, Y. (2017). Effect of historical educational level on perceived inequality, preference for redistribution and progressive taxation. International Economic Journal, 31(3), 355–369. Retrieved January 20, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=124771620&site=ehost-live
Green-Armytage, J. (2017). Progressive and regressive equilibria in a tax competition game. Public Finance Review, 45(3), 307–333. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=122523049&site=ehost-live
Jang-Ting, G., & Krause, A. (2018). Changing social preferences and optimal redistributive taxation. Oxford Economic Papers, 70(1), 73–92. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=126936930&site=ehost-live
Teixidó, J. J., & Verde, S. F. (2017). Is the gasoline tax regressive in the twenty-first century? Taking wealth into account. Ecological Economics, 138, 109–125. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=122947228&site=ehost-live