Regressive Tax, Regressive Tax System
A tax or tax system is regressive when the percentage of income that goes to pay the tax decreases as income increases. General sales taxes are usually regressive since lower-income taxpayers spend a greater percentage of their income on items subject to the tax.
Progressive Tax, Progressive Tax System
A tax or tax system is progressive when the percentage of income that goes to pay the tax increases as income increases. The U.S. Federal income tax is an example of a progressive tax since lower incomes are taxed at a lower rate than higher incomes.
Personal Exemption indexation, "inflationary tax hikes"
When the personal exemption is not indexed to inflation, there is an implicit tax hike since more income will be subject to taxation than otherwise would be the case. For example, if the personal exemption was $1000 and the tax rate were 10%, a taxpayer earning 1000 in income would pay no taxes in the base year. If the taxpayers earnings the next year grew only enough to keep up with inflation (say, .03), the taxpayer would owe $3.00 in taxes the next year (income would be 1030 with a 3% inflation rate; the taxable income would be $30.00 so 10% of $30.00 is $3.00) even though real income has not increased. By indexing the personal exemption, this taxpayer would not be unfairly taxed. This is analagous to “bracket creep” in the income bracket cutoffs of the income tax.
Flat Income Tax Rate vs. Graduated Income Tax Rate
A flat rate tax or proportional tax appies the same rate to all income brackets while a graduated income tax applies progressively higher rates as income rises. While many mistakenly state that a flat rate is the fairest tax system, they are wrong because taking an equal share of income from all taxpayers will lower the quality of life of lower income taxpayers (who need to spend a high percentage of their income to make ends meet) while not significantly affecting higher income taxpayers.
Sales Tax Base: Narrow-based, Broad-based
The base of a sales tax are all of the goods and services that are subject to the tax. A broad based sales tax has few exemptions while the narrow-based sales tax are targeted on certain products. The broader the base, the more revenue will be generated from the tax. By narrowing the base, certain objectives like tax equity can be achieved. For example, even though exempting food from the base for a sales tax lowers overall revenue, it would make the overall tax system less regressive since a higher percentage of lower income taxpayers’ budget goes towards food.
Interaction Between Federal and State Taxes
A state can export, or pass on part of, the cost of income and property taxes to the federal government since higher income taxpayers are more likely to itemize their federal tax deductions. When a taxpayer itemizes, s(he) can deduct state and local income and property taxes from income. An example is if IL raises the upper income bracket, the state receives all of the additional revenue, but taxpayers in the affected bracket only have to pay part of the tax since they recoup some of the additional tax when they fill out their US tax form.
Revenue-raising, Revenue-reducing, Revenue-neutral Options
When proposing changes to the tax structure, the goals are important. Is the proposal intended to raise revenue, return tax money or address the equity of the structure? Any additional tax can raise revenue but that may not always be the intent of the proposal. For example, an increase in the sales tax or a broadening of the base for a sales tax (see above for discussion on Sales Tax Base) can raise revenues quickly but has the consequence of making the overall system more regressive. Lowering higher income brackets or collapsing brackets will return money to taxpayers but more of the money will go to higher income taxpayers while decreasing the progressivity of the tax structure. Lowering the rate of the higher income brackets or collapsing brackets will return money to taxpayers but more of the money will go to higher income taxpayers while decreasing the progressivity of the tax structure.
Refundable vs Non-refundable
Whether a credit is refundable or not depends on whether it merely lowers tax liability or can result in a refund check. The distinction is important since a non-refundable tax credit offers no benefit to taxpayers whose income is not high enough to generate income tax liability.
EITC
The state Earned Income Tax Credit is a credit modeled on the federal EITC which allows working low income taxpayers tax relief. If a taxpayer has earned income (either wage income or self-employment income) and is below the threshold for the number of claimed exemptions, s(he) can apply for the credit which increases with the taxpayer’s income up to a maximum amount. As a low income wage subsidy, it is politically popular as a “making work pay” tool. A successful component of the federal EITC is that it is refundable so for very low income taxpayers, the credit generates a refund check if it is larger than the tax liability.
Dependent Care Credit
This credit offers relief to taxpayers who must pay to provide dependent care to a qualified dependent and is usually a percentage of the costs of the care up to a certain maximum per dependent. The credit is typically non-refundable. The federal credit is non-refundable and defines “qualified dependent” as a member of the household who is a child under age 13 or anyone who needs constant care due to physical or mental incapacity. Important features of the tax are what costs are allowed and whether the credit is indexed.