Definition: A regressive tax is a taxation system where rates remain the same regardless of income level; thus, taking a greater percentage of low-income earners’ income than high-income earners’ income. In other words, the tax rate or total tax does not change as an individual’s income increases.
What Does Regressive Tax Mean?
This type of taxation typically places a larger burden on the low-income earners in the economy. Even though they are paying the same rate as high-income earners, they are less able to pay it because it makes up a bigger percentage of their total and discretionary income. Some common examples include sales tax, property taxes, and roadway tolls. A $5 toll is the same for the individual making $100 per day and the person making $1,000 per day, but it’s a greater burden the on person only making $100 per day.
This is because as an individual’s income increases certain tax liabilities consume less of their budget. Generally taxes that charge the same percent regardless of income amount become regressive because as income builds the actual tax percent becomes smaller in comparison to one’s wealth.
Taxing items or activities that low income individuals predominantly consume is also said to be a regressive system.
Let’s look at some examples.
Example
Richard and Pete are both on a trip to South America. They buy the same food, take the same plane, and both paid for their passports. Each product cost the same. The only difference is the Richard is traveling for business and Pete for pleasure.
Pete is visiting family in South America and doesn’t earn very much at his current job. He paid the same amount for his trip as Richard; however, it made up a larger portion of his income. Richard is on his way to pitch a merging proposition to some businessmen and this trip made up a relatively small amount of his income. The taxes that existed on the food, ticket, and the passport were less percentage-wise to Richard when expressed as a percentage of his income than Pete. The larger the difference between the two travelers incomes, the more regressive the tax would become.
Sales tax is another good example. Assume two people purchase goods for the year and paid $1,000 in sales tax on the goods. One person has an annual salary of $100,000 and the other $50,000. The $1,000 of tax is only 1% of the first person’s salary, but it is 2% of the second person’s salary even though they paid the same sales tax rate.
On average, regressive tax rates are not favored and steps have been taken by government officials and policy makers to move toward progression tax systems. In some countries, they have taken general sales taxes off of items like food because poorer citizens spend more of their income on that than wealthier people. Also some countries even send out rebate checks on taxes poorer citizens have paid if they are below a certain income bracket.
Some changes have been suggested by economists and lobbyists to make regressive taxes less drastic, but the implementation can be complicated and confusing leaving citizens to simply re-evaluate budgets and governments to provide services that aid in budgetary restrictions.
