PROPORTIONAL TAX: Definition and Examples

proportional tax

The proportional tax is one of the tax systems in use in the US. Other forms of taxation include progressive and regressive taxes. Unlike the others, the proportional tax on a person’s income remains unchanged regardless of how much money he or she earns. An example of a proportional tax is an income tax of 10% imposed on every income earner, regardless of their income. We’ll elaborate more in this chapter.

Definition of Proportional Tax 

A proportional tax, sometimes known as a flat tax, is one in which the percentage of a person’s income that is taxed remains constant regardless of how much money he or she earns. It is the same for taxpayers with low, moderate, and high incomes.

Proportional Tax Explained

A proportional tax system requires everyone to pay the same percentage of their income in taxes. For example, if the tax rate is 10%, an individual earning $200,000 per year would pay $20,000 in taxes, leaving him with $180,000 in income.

In comparison, a taxpayer earning $10,000 per year pays $1,000 in taxes, leaving him or her with $9,000 per year to cover all of his or her expenditures. The 10% tax rate is paid equally regardless of how much money a taxpayer earns.

Proponents of the proportional tax claim that a uniform tax rate is the most equitable system. There are no exclusions, the rules are simple, and there should be no confusion regarding the rate because it is the same for all taxpayers.

Another argument in favor of a proportional tax system is that it encourages people to work harder. The objective is that by encouraging individuals to earn more money, the country and people’s standard of living will improve.

Opponents of proportional taxation claim that it unfairly burdens the poor and middle classes by eliminating deductions and broadening the tax base to include all income levels.

They argue that enacting such a tax shifts the tax burden from wealthy individuals to the poor — those most affected by taxation and least able to pay.

Example of a Proportional Tax

The sales tax is an example of a proportional tax today. Although sales taxes differ by area, every buyer pays the same sales tax. For example, if the sales tax is 10%, every buyer of a $1,000 laptop would pay $100 in sales tax, regardless of personal income.

Working residents in nations such as Russia pay a proportional tax to fund government activities. President Vladimir Putin implemented Russia’s 13 percent flat tax in 2001.

However, in the United States, the government does not impose a proportional tax on income. Rather, the government imposes a progressive tax in which high-income individuals are taxed at a greater rate than low-income individuals.

Advantages And Disadvantages of The Proportional Tax

Proportional taxes are a sort of regressive tax since the tax rate does not rise in proportion to the amount of income subject to taxation, putting a greater financial burden on low-income people. A tax is said to be regressive if it has an inverse relationship in which the average tax burdens higher-income persons or corporations less.

Proponents of the proportional tax argue that higher-income taxpayers should pay a higher percentage than lower-income taxpayers. They believe the system places a greater strain on middle-income individuals to bear a huge percentage of government spending. While the tax percentage is the same, which is fair, the after-tax effect on low-income earners is more burdensome than on high-income earners.

To comprehend a proportional tax system, one must first grasp how income is defined. If a system allows for generous deductions, low-income earners may be exempt from tax, removing the regressive aspects of the tax, at least in part. Allowing mortgage deductions and setting lower income levels are two variations of the proportional tax.

Overview of Regressive, Proportional, and Progressive Taxes

proportional tax

Tax systems in the United States are classified into three types: regressive, proportional, and progressive. Two of these schemes have differing effects on high- and low-income earners. Lower-income people are hit harder by regressive taxation than the wealthy.

Proportional tax, often known as a flat tax, impacts low-, middle-, and high-income earners fairly equally. Regardless of income, they all pay the same tax rate. A progressive tax has a greater financial impact on higher-income people than on lower-income people.

Regressive Taxation

Under a regressive tax system, low-income individuals pay more taxes than high-income ones. This is because the government levies tax as a proportion of the value of the asset purchased or owned by a taxpayer. This form of tax has no relation to a person’s wages or income level.

Property taxes, sales taxes on items, and excise taxes on consumables such as gasoline or flight are examples of regressive taxes. Excise taxes are fixed and are built into the cost of the product or service.

Sin taxes, a type of excise tax, are levied on goods or activities that are deemed to be unhealthy or harmful to society, such as cigarettes, gambling, and alcohol. They are imposed in order to discourage people from acquiring these things. Critics of the sin tax contend that it unfairly affects the poor.

Many people believe that Social Security is a regressive tax. Social Security tax obligations are capped at a specific level of income known as a wage base—$142,800 for the 2021 tax year and $147,000 in 2022. Earnings above this threshold are not subject to the 6.2 percent Social Security tax.

In 2022, the annual maximum Social Security tax you can pay is $9,114.00. This is regardless of whether you earn $147,001 or $1 million. Employers must pay an additional 6.2 percent on behalf of their employees. Self-employed persons must in turn pay half of their earnings up to the wage base.

Higher-income employees effectively pay a lower proportion of their overall earnings into the Social Security system than lower-income employees. This is because it is a fixed rate for everyone and there is a cap.

Social Security is a regressive tax. However, it is also a proportional tax because everyone pays the same rate, at least up to the salary base.

Progressive Tax

The taxable amount of an individual’s income is used to calculate taxes under a progressive system. They progress at a faster rate, so high-income people pay more than low-income earners. The tax rate, as well as the tax liability, rises in tandem with an individual’s wealth. Overall, higher-income earners pay a higher proportion of taxes and more money in taxes than lower-income ones.

This type of system is designed to disproportionately affect higher-income people over lower- and middle-income earners. Thus, reflecting the assumption that they can afford to pay more.

The federal income tax in the United States is a progressive tax system. Its marginal tax rate schedule applies a higher income tax rate to those with higher incomes and a lower income tax rate to those with lower incomes. The percentage rate rises in steps as taxable income rises. Each dollar earned places the individual in a tax bracket or category. Thus, resulting in a higher tax rate after the dollar amount reaches a new level.

The standard deduction is part of what makes the federal income tax in the United States progressive. It allows people to avoid paying taxes on the first portion of their income each year. The standard deduction amount varies from year to year in order to keep up with inflation. Taxpayers may choose to itemize deductions instead if doing so results in a larger overall deduction. Because of tax deductions, many low-income Americans pay no federal income tax at all.

Progressive tax rates, like every government policy, have detractors. Some argue that a progressive taxation is a form of inequality and a redistribution of wealth because higher-income people pay more to a country that supports more lower-income earners. Those who reject progressive taxation frequently appeal to a flat tax rate as the best alternative.

Examples of Progressive, Regressive, and Proportional Taxes In Practice

The examples of regressive, proportional, and progressive taxes below demonstrate how they work in practice:

Regressive tax

If buyers pay a 6% sales tax on their groceries whether they make $30,000 or $130,000 per year, individuals with lower incomes wind up paying a larger share of their overall income than those with higher incomes. If a person earns $20,000 per year and pays $1,000 in sales taxes on consumer products, sales tax consumes 5% of their annual income. However, if they earn $100,000 per year and pay the same $1,000 in sales taxes, this represents only 1% of their total income.

Proportional tax

Individual taxpayers pay a fixed percentage of their annual income under a proportional income-tax system, regardless of how much they earn. The fixed-rate does not change when income rises or falls. A person earning $25,000 per year would pay $1,250 at a 5% rate. On the other hand, someone earning $250,000 per year would pay $12,500 at the same rate.

Progressive tax

Income taxes in the United States are levied in a progressive manner. Federal progressive tax rates in 2022 will be 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The initial tax rate of 10% applies to incomes of less than $10,275 for singles and $20,550 for married couples filing jointly. Incomes over $539,900 for single taxpayers and $647,850 for joint married filers are subject to the maximum tax rate of 37%.

A single taxpayer with a taxable income of $50,000 in 2022, for example, would not be subject to the third rate of 22 percent. Instead, they would owe 10% on the first $10,275 of income, 12% on income between $10,276 and $41,775, and 22% on income beyond $41,776. This taxpayer would owe a total of $6,617: the 10% rate on the first $10,275 is $1,027, the 12% rate on the $10,276 to $41,775 is $3,780, and the 22 percent rate on all earnings between 41,775 and 50,000 is $1,809. This results in an effective tax rate of 13%.

Principles Of Taxation

#1. Clarity

Tax laws and regulations must be understandable to the taxpayer; they must be as basic as possible (given other tax policy aims), as well as straightforward and certain—both to the taxpayer and to the tax administrator. While the principle of certainty is more followed today than it was in Adam Smith’s time, and arbitrary tax administration has been decreased, every country has tax rules that are far from being understood by the public. This not only leads to significant inaccuracy, but also undermines honesty and respect for the law, and it tends to discriminate against the uninformed and poor, who are unable to take advantage of the myriad lawful tax-saving alternatives accessible to the educated and rich. Attempts to establish equity have sometimes produced complications, undermining reform goals.

#2. Stability

Tax rules should be modified infrequently. If and when they are changed, they should be done as part of general and systematic tax reform, with enough provisions for a fair and orderly transition. Frequent changes in tax legislation can lead to lower compliance or behavior that attempts to compensate for likely future changes in the tax system, such as hoarding liquor in anticipation of an increase in alcoholic beverage tariffs.

#3. Cost-effectiveness

The expenses of assessing, collecting, and regulating taxes should be maintained to a minimum consistent with other taxation aims. This idea is secondary in rich countries. However, it is critical in developing countries and countries transitioning from socialism, where resources for compliance and administration are limited. Clearly, equity and economic rationality should not be abandoned for cost reasons. The costs to be reduced include not only government expenses but also those of the taxpayer and private fiscal agents such as employers who collect taxes on behalf of the government through the withholding procedure.

#4. Convenience

Taxation should cause as little hardship to taxpayers as practicable, subject to the limits of higher-ranking tax principles. Governments frequently enable high tax liabilities to be paid in installments and provide broad time limits for completing returns.

In Conclusion,

A proportional tax is that in which the percentage tax levied on income is the same for all income earners. While this might favor the high-income earners, it doesn’t really go down well with the low-income earners. If you fall among the low-income earners, the best you can do is to increase your earnings.

Proportional Tax FAQs

What are the 3 types of taxes?

The 3 types of taxes are proportional, progressive, and regressive taxes

What is the difference between proportional and regressive taxes?

The proportional tax takes the same percentage of income from all income groups, while the regressive tax takes a larger percentage of income from low-income groups than from high-income groups.

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