Progressive Tax

Understanding progressive tax

A progressive tax is designed so that the tax rate increases with the level of taxable income. This means lower-income individuals pay a smaller percentage of their income tax, while higher-income individuals pay a higher percentage. Typically, this is achieved through tax brackets that segment taxpayers based on their income levels.

Despite some recent flattening, the U.S. income tax system remains progressive. For 2022 and 2023, there are 7 tax brackets with rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Back in 1985, there were 16 tax rates. 

Why progressive tax?

The main idea behind a progressive tax is fairness. A flat tax rate would disproportionately impact those with lower incomes, as they would lose a larger share of their purchasing power. A progressive tax aims to ease this burden.

A tax system's progressiveness depends on how much of the tax load is placed on higher earners. For example, a tax system with rates ranging from 10% to 80% is more progressive than one with rates from 10% to 30%.

Related reading: What you need to know about U.S. tax code?

Benefits of a progressive tax

  1. Supports Low-Income Earners: By reducing their tax burden, low-income individuals have more money to spend on essentials, which can stimulate the economy.
  2. Generates More Revenue: Progressive taxes often raise more funds than flat or regressive systems because higher earners pay more.
  3. Funds Public Services: Wealthier individuals contribute a larger share to public services like safety and infrastructure, benefiting everyone.

Purpose of a progressive tax

The goal is to prevent low-income individuals from bearing an unfairly large share of the cost of public services and infrastructure. By taxing higher incomes at higher rates, the system reduces the tax burden on lower earners and increases overall tax revenue.

Drawbacks of a progressive tax

Critics argue that progressive taxes may discourage success and are seen as a form of economic redistribution that unfairly penalises the wealthy and sometimes the middle class. Opponents usually favour lower taxes and reduced government services.

Real example of benefits of a progressive tax 

Country: Sweden

Progressive Tax System: Sweden employs a progressive tax system where tax rates increase with higher income brackets.

Example:

  1. Income Brackets and Tax Rates (simplified for this example):some text
    • Up to SEK 20,000: 10%
    • SEK 20,001 to SEK 40,000: 20%
    • Above SEK 40,000: 30%
  2. Individual Incomes:some text
    • Person A: Annual income of SEK 18,000
    • Person B: Annual income of SEK 35,000
    • Person C: Annual income of SEK 50,000
  3. Tax Calculations:some text
    • Person A:some text
      • Income: SEK 18,000
      • Tax: 10% of SEK 18,000 = SEK 1,800
    • Person B:some text
      • Income: SEK 35,000
      • Tax: 10% of SEK 20,000 + 20% of SEK 15,000 = SEK 2,000 + SEK 3,000 = SEK 5,000
    • Person C:some text
      • Income: SEK 50,000
      • Tax: 10% of SEK 20,000 + 20% of SEK 20,000 + 30% of SEK 10,000 = SEK 2,000 + SEK 4,000 + SEK 3,000 = SEK 9,000

Benefits:

  1. Reduced Income Inequality:some text
    • The progressive tax system helps reduce income inequality by ensuring that those with higher incomes pay a specific share of their earnings in taxes.
    • In this example, Person C, with the highest income, pays a significantly higher amount in taxes compared to Persons A and B.
  2. Increased Revenue for Public Services:some text
    • Higher tax rates on higher incomes generate more revenue for the government, which can be utilised to fund public services like healthcare, education, and more.
    • Sweden is known for its extensive welfare state, funded by progressive taxes, and providing high-quality public services to its citizens.
  3. Social Equity and Fairness:some text
    • Progressive taxes are designed to distribute the tax burden more fairly based on individuals’ ability to pay.
    • In this system, Person A, who earns the least, pays the lowest tax rate, ensuring that those with limited means are not overburdened by taxes.
  4. Economic Stability:some text
    • By taxing higher incomes more, the government can stabilise the economy by redistributing wealth and providing social safety nets.
    • This helps maintain social stability and supports those in lower income brackets, reducing poverty and boosting economic security.

Sweden’s progressive tax system exemplifies how such a structure can reduce income inequality, fund essential public services, promote social equity, and contribute to economic stability.

Check out Inkle Tax. 

Conclusion

  • Progressive Tax: Higher incomes are taxed at higher rates.
  • Regressive Tax: Lower-income people pay a higher percentage (%) of their income.
  • Flat Tax: A single tax rate applied to all incomes, regardless of size.
  • Sales Tax: An example of a regressive tax.
  • Social Security Payroll Tax: Considered a flat tax in the U.S. (with an income cap).

Understanding these different tax structures helps clarify their impact on various income groups and the overall economy.

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