What is regressive tax?
The United States uses the progressive tax system with tax brackets, and the tax burden increases as income increases. However, there are other tax systems, such as the regressive tax system, in which all taxpayers pay the same dollar amount. This tax takes a larger percentage of income from low-income earners than high-income groups.
The regressive tax system is common in developing countries where most taxpayers are in the same income class.
Here, we’ll explore regressive tax and how it affects the economy and taxpayers.
A regressive tax is a type of tax in which taxpayers pay the same dollar amount regardless of their income level.
Jump to insightIn a regressive tax system, the tax burden reduces as the income increases.
Jump to insightThe U.S. government takes a progressive tax approach on income, but other taxes are levied uniformly.
Jump to insightUnderstanding regressive tax
A regressive tax levies the same dollar amount to its taxpayers regardless of income level. It takes a higher percentage of income from low-earners than the middle and high-earner groups. As a result, the tax burden decreases as income increases.
“In theory, a flat tax rate might seem fair, providing a straightforward approach to taxation. However, regressive taxes disproportionately burden lower-income households, as they spend a larger share of their income on taxes compared to wealthier individuals, leading to reduced consumer spending, which is the backbone of the economy,” said Andy Chang, founder & CEO of The Credit Review.
“Since lower-income households may have to allocate a significant portion of their limited income to taxes, this reduces their purchasing power for essential goods and services, thus slowing down economic growth, as consumer expenditure drives demand and business expansion,” Chang said.
For example, under a regressive tax system, a government could decide that taxpayers must pay $20,000 annually, regardless of their income level.
This differs from progressive tax, where taxpayers pay based on their income. For example, under the progressive tax system, those earning $11,000 and filing singly for 2023 will pay 10% of their income. Meanwhile, any taxpayer earning over $ 578,126 is required to pay 37% of their tax. However, the tax rate can change if taxpayers apply for a tax relief program to lessen their tax burden.
Regressive tax can be easily confused with proportional tax since the system also supports equality by having a single rate. However, the proportional tax system levies taxpayers with the same income percent. While a regressive tax system might tax its residents $20,000, a proportional tax system would tax all taxpayers 20% of their income.
Although the U.S. uses a progressive income tax system, some taxes, such as sales, tariffs, property, payroll and excise taxes, are still regressive.
» MORE: What is tax relief?
How regressive tax works
Let's use the sales tax as an example to understand regressive tax. The U.S. government taxes all customers uniformly when purchasing goods, but low-income customers are more affected than high-income taxpayers. For example, even though a sales tax is $10, the aftermath differs for every income earner.
Imagine two individuals (A and B) buy $200 groceries per week, and they both pay a sales tax of $10 on their purchase:
- If Individual A earns $3000 per week, the sales tax rate on the purchase will be 0.33% of their income.
- If Individual B earns $300 per week, the sales rate on the purchase makes up 3.33% of their income.
Although the tax imposed is the same percentage, Individual A, with a higher income, spends a lower percentage than Individual B, who has a low income. As a result, regressive tax tends to take a higher percentage of low-income earners compared to high- and middle-class earners.
Pros and cons of regressive tax
Like any other tax system, the regressive tax system has advantages and disadvantages. A regressive tax system might be easier to enforce and manage, but since taxation is relative to each person’s income, lower-income individuals pay a higher percentage of their income in taxes compared to higher-income individuals. The hallmark of regressive taxation is that it places a heavier burden on lower-income earners relative to their income.
Consider the full list of pros and cons:
Pros
- Simple and low administrative costs
- Easy to enforce and manage
- Less paperwork and low cost
Cons
- Disproportional tax burden
- Slow economic growth
» MORE: Tax credits
FAQ
What is an example of regressive tax?
Sales tax, a levy imposed on goods and services, is an example because it's the same for everyone regardless of income level.
How do regressive taxes compare to progressive and proportional taxes?
Regressive taxes impose the same dollar amount on everyone despite their income level. On the other hand, progressive tax increases as income increases, while proportional taxes impose the same tax rate percent on all taxpayers.
Who is most affected by regressive taxes?
Low-income households are more affected because they spend a higher percentage of their income on taxes than high-income earners.
Bottom line
A regressive tax system has its benefits, such as simplicity and low administration costs. However, it can have a negative impact on society by causing purchasing power disparity, which could impact economic growth.
Supporters of regressive taxes focus on the need for equality. Understanding the implications of a taxing system helps policymakers devise a system that works for the economy.
Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- IRS, “Federal income tax rates and brackets.” Accessed March 11, 2024.
