Tax Structure: Tax Base, Tax Rate, Proportional,

Regressive, and Progressive Taxation

The tax structure of an economy depends on its tax

base, tax rate, and how the tax rate varies. The tax
base is the amount to which a tax rate is applied.
The tax rate is the percentage of the tax base that
must be paid in taxes. To calculate most taxes, it is
necessary to know the tax base and the tax rate. So if
the tax base equals $100 and the tax rate is 9%, then
the tax will be $9 (=100 × 0.09). Proportional
taxes (aka flat-rate taxes) apply the same tax rate
to any income level, or for any size tax base. So if Bill
earns $50,000 and Jane earns $100,000, and the tax
rate is 10%, then Bill will owe $5,000 in taxes while
Jane will owe $10,000. Many state income taxes and
almost all sales taxes are proportional taxes. Social
Security and Medicare taxes are also proportional
since the same tax rate is applied to any earned
income up to the Social Security wage base limit,
which, for 2021, is $142,800. The Medicare tax is a
proportional tax that applies to all earned income, =
2.9%. Flat taxes are a fixed amount and do not
depend on income or transaction values, such as a $10
per capita tax.

A regressive tax is higher at lower incomes. The

most prominent regressive tax is the Social Security
tax, because the tax drops to 0, when earned income
exceeds the Social Security wage base limit.
Regressive taxes especially hurt the poor. The
inequitable effects of regressive or proportional taxes
are often mitigated by payments to the poor and by
exempting essential products and services, such as
food, from regressive and proportional taxes.

A tax can also be regressive if it places a greater

burden on poorer people. Flat taxes, for instance,
place a greater burden on poor people because, even
though the tax is the same for everyone, the tax is a
greater proportion of income for a poor person than
for a rich person. Even proportional taxes can be
regressive. For instance, if the tax rate was 10% for
everyone, that 10% of income represents a greater
burden for poor people because they need all their
money to live. Taking 10% from a rich person
probably would not lower their standard living at all
because they have so much more than what they need
to live well. The marginal utility of money declines
with increasing wealth, so much so that taking 10%
from someone who makes $10,000 annually is much
more burdensome than taking 10% from someone
who earns $1 million annually, even though the tax
revenue from the wealthy person is $100,000 while
the tax revenue from the poor person is only $1000.
This is why some rich people pay many millions of
dollars for a painting or other collectibles because
they cannot use it to improve their quality of life, so
they invest it.

A progressive tax applies a higher tax rate to higher

incomes. So if the tax rate on $50,000 is 10% and
20% for $100,000, then, continuing the above
example, Bill still owes $5,000 in taxes while Jane
must pay $20,000 in taxes. However, almost all
progressive taxes are structured as a marginal tax,
meaning that the progressive tax rate only applies to
that part of the income exceeding a certain amount.
The portion of the tax base subject to a particular tax
rate, known as a tax bracket, always has lower and
upper limits, except for the top tax bracket, which has
no upper limit. To see the current rates published by
the IRS, scroll down to the bottom of the current tax
table from the instructions for Form 1040.

Continuing the above example, if the 20% tax rate is

only applied to that portion of the income between
$50,000 and $100,000, then Jane would owe $5000
on the first $50,000 of income and $10,000 on the
2n d $50,000 of income, a total tax liability of $15,000.

Without marginal tax rates, a progressive tax would

skew economic decisions and would be viewed as
unfair. For instance, if the 20% tax rate was applied to
all earned income and Jane only earned $60,000,
then she must pay $12,000 in taxes, 2.4 times more
than Bill's taxes, even though she only made 1.2 times
more than Bill. A more extreme example, consider
what happens if Jane makes $50,001. Then she must
pay $10,000, $5000 more than what Bill must pay,
even though he earned only $1 less. Hence, without
marginal tax rates, a pay increase could actually result
in a decrease in disposable income. A person's tax
bracket is the highest tax bracket applicable to her
income level.
A progressive, marginal tax rate also makes economic
sense, since money, like everything else, has a
declining marginal utility. In other words, $1 is worth
a lot more to someone who earns $10,000 per year
than to someone who makes $10 million per year.
Poor people need the money to buy essentials,
whereas rich people spend their money for luxuries,
so the wealthy can pay higher taxes without seriously
lowering their standard of living.