Regressive Tax

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Regressive Tax Definition

A regressive tax refers to the taxation system where taxes are levied irrespective of the income level of individuals. This means that people with higher and lower income groups are liable to pay an equal amount as tax, thereby making the latter pay higher taxes despite having limited earnings.

Regressive Tax

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The regressive tax structure is not the type of taxation the United States follows. Though the taxation system in the nation is progressive, there are a few taxes that the government collects without considering how much individuals earn. Some such taxes include sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%).read more, tariff, excise taxExcise TaxExcise tax is the tax applied to the sale of particular goods and services like tobacco, fuel, and alcohol. It is not directly paid by an individual consumer, instead, the tax department levies the tax on producer or merchant of products.read more, property tax, etc.

Key Takeaways

  • Regressive tax refers to the taxation system under which the citizens are taxed at the same rate without their income level being considered. Here, a greater percentage of the income of the low-income group is charged as tax when compared with the high-income group in the same country.
  • It is called regressive because the higher income group pays less tax than the lower income group.
  • Sales tax, user fee, excise tax, property tax, sin tax, etc., are common forms of these taxes.
  • These increase the wealth gap between the rich and poor, with the latter being compelled to pay more tax than the former.

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Regressive Tax System Explained

The regressive tax definition specifies the regressivity of the taxes levied on US citizens. Regressivity, here, implies the decrease in the tax rate with the increase in income. In this type of tax, the tax rate remains the same for all, irrespective of their income range. As a result, the tax payable is higher for the lower-income group and lower for the higher-income group. In short, every citizen pays the same amount of tax.

As the income of the individuals increases, the tax payable decreases in proportion to their earnings. This tax structure is likely to increase the wealth gap in a nation by making the lower income group pay more as tax and letting those from a higher income group save on their taxes. As a result, the former runs short of funds and cannot meet its basic requirements. This, in turn, leads to economic imbalance.

Some of the commonly found forms of regressive taxes include:

Regressive Tax Forms

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#1 – Sales Tax

It is the tax on the goods and services levied on the purchase price or the product’s cost price. For example, if a person purchases a television, a predetermined percentage of tax will be levied on the cost of the television, irrespective of the person’s income. Here, the sales tax will be the same for all citizens, irrespective of their income.

#2 – Property Tax

It is the amount paid by the property holders. When two people with different incomes decide to stay in the same locality, they pay tax to the government for owning. This tax amount is the same for both of them and is independent of the individual’s income. This tax is levied based on the property’s location, dimension, size, and price.

#3 – Excise Tax

The excise tax is an indirect tax where the tax is not paid by the consumers directly. However, the tax passes indirectly from merchants or producers to wholesalers, from wholesalers to retailers, and from retailers to consumers.

#4 – Tariff

It is the tax on the imports and exports of goods levied on the goods that ultimately hit the consumers who purchase the products. Therefore, if a high tax rate is imposed on the necessary goods imported or exported, it will be a burden for the low-income group to purchase these goods. However, as they do not have any option other than purchasing them, they pay for the basic daily requirements.

Examples

Let us consider the following regressive tax examples to understand the concept better:

Example #1

Suppose person A earns $100,000 and pays $20,000 as tax, which is 20% of the income. On the other hand, if person B earns $200,000 and pays $20,000 as tax, the person utilizes only 10% of the income to meet the same amount. This shows how the regressive tax rate remains constant irrespective of the income level of the US citizens.

Example #2 

The United States levies a sales tax worth 7% on purchases. Mark’s income is worth $1,000, hence, the sales tax constitutes 0.7% of his income. On the other hand, for Stella, who earns $500, the sales tax becomes 1.4% of her income. Though the sales tax comprises an insignificant portion of the earnings of the former, the same for the latter is a considerable expense.

Pros & Cons

The regressive tax structure helps people with increasing income pay fewer taxes. On the other hand, they are a huge burden for any low-income group individual. In short, the taxation system has its own set of pros and cons, which one must be aware of:

AdvantagesDisadvantages
Reduced demand for tobacco and alcohol products as higher taxes are levied on their purchase priceIt is a huge burden for people belonging to a lower-income group.
It keeps people motivated and encourages them to earn more as the tax rates do not change.Consumption of goods is likely to decrease, affecting the revenue negatively.
Easy to calculateWealthier people earn more, and poor ones keep losing money on taxes.
The higher the income, the more insignificant this tax expense becomes.Tax evasion might become a common phenomenon

Regressive Tax vs Progressive Tax

While the United States follows a progressive taxProgressive TaxProgressive tax refers to the increase in the average rate of tax with the increase in the amount of taxable income so that the liability of paying heavy taxes passes to those who earn a higher income and those with lower income can have a relaxation from the heavy income tax obligations.read more system for collecting income tax, a few taxes are regressive and have the same rate for all citizens. Let us have a quick look at the differences between these two tax structures in a nutshell:

  • As the regressive tax rate is equal for all, it widens the gap between the wealthy and the poor by making the former pay less in proportion to their income while compelling the latter to pay more with respect to their lower earnings. 
  • On the other hand, a progressive tax is a tax that segments individuals into tax slabs depending on their income range. As a result, people with higher incomes pay more taxes than those with lower incomes.
  • Let us reconsider the first example of the Examples section. There, though person A and person B pay the same tax percentage, the amount paid as tax consists of a higher portion of A’s income, while the amount is lenient and not a major concern for B.
  • On the contrary, if person A earns $100,000 and pays $10,000 as tax, which is 10% of the income, and person B earns $200,000 and pays $30,000 as tax, which is 15% of the income, the latter pays more to meet the same amount of tax paid by A. This is how the progressive tax system works.

Frequently Asked Questions (FAQs)

Is GST a regressive tax?

Though the Goods and Service Tax (GST) is levied at the same rate for all individuals, it is not classified as a regressive tax. This is because it requires individuals and entities to pay taxes in proportion to what they earn. Hence, they are proportionate taxes and not regressive.

Why is sales tax a regressive tax?

The sales tax on the purchase or cost price of the goods and services one buys is the same for every buyer. Thus, no matter how much one earns, the sales tax rate will remain the same. As a result, the portion of income that individuals from the lower group pay as tax is more than what the higher-income people pay.

How to calculate regressive tax?

The taxable amount can be calculated based on the rate applicable for the regressive tax type. For example, A and B have an income of $100,000 to $200,000, respectively, and purchase 100 grams and 200 grams of gold. If a 10% tax is levied on the purchase, both must pay 10% of the market value per gram of gold.

This has been a guide to the Regressive Tax definition. Here we explain the forms in which it exists along with examples, pros, cons, and vs progressive tax. You may learn more about our articles below on accounting –

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