A progressive tax system increases rates for taxpayers as their taxable revenue increases. The system requires determining specific brackets with rates that gradually increase.
An example of a progressive system is when rates move from 0% to 45%, so from the lowest to the highest bracket depending on the taxable income. According to this system, a taxpayer’s marginal rate is always higher than the actual average tax rate.
Apart from progressive, countries may use other tax systems, such as regressive, digressive, or proportional. The progressive system recognizes instances when individuals earn less than the accepted taxable minimum. In that case, these earnings are not liable.
A progressive system is supposed to improve the ability of low-income individuals to afford personal everyday items in increasing economic demand.
What Makes a System Progressive?
A progressive tax system applies higher rates to people with higher income and lower rates to people with lower income. In the US, rates range from 10% to 37%. For example, individuals earning $523,600 or more belong to the 37% bracket.
However, it doesn’t mean that they have to pay 37% on all of their gross income. Instead, taxpayers must determine under how many brackets they fall. For instance, a taxpayer with gross income $75,000 falls under 3 brackets: 10%, 12% and 22%.
They have to pay 10% on their first 9,950 if single (or $14,200 and $19,900 when head of household and married, respectively), then 12% on revenue between $9,951 to $40,525, and 22% on revenue between $40,526 to $75,000.
It’s also worth mentioning that according to the progressive taxing system, higher-income taxpayers contribute a larger share of taxes when compared to lower-income taxpayers. For instance, in 2015, the top 1% of earners paid an average federal tax rate of 33.3%, and the lowest fifth of taxpayers paid just 1.5 percent on average.
The US also applies state tax rates that depend on how much a taxpayer earns, so they belong to the progressive tax system.
Types of Progressive Taxes
Types of progressive taxes include:
- Tax on interest earned. Taxpayers earn interest from their savings or investments. Such a type of revenue is called passive income.
- Investment income tax. This category includes taxes on investment revenue-generating operations. This tax impacts individuals and businesses that have excess money they invest into ventures that generate profit.
- Tax credit. Some US taxpayers receive help from the government in the form of benefits and perks. This is also taxable income, and it includes such credits as child tax, elderly and disabled, retirement savings contributions, etc. This taxable income is also taxed according to the progressive system.
- Affordable Care Act taxes, or Obamacare taxes. The 3.8% Net Investment Income Tax only applies to individuals generating over $200,000 annually, or $250,000 for married individuals or filing jointly, including dividends and capital gains.
- Estate tax. The government typically collects estate tax against the property of deceased people. It only applies when the value of the property is above a set amount by the government.
- Rental revenue. It also belongs to a progressive system and targets those who invest in property to get revenue.
When taxpayers earn revenue from the mentioned sources, the more they earn, the more they pay.
Progressive vs. Regressive Systems
You now know more about the progressive system from our article, but what about the regressive system? It’s the opposite of a progressive system. According to the regressive tax policy, it takes a larger amount of income from a low-income taxpayer in comparison to a high-income taxpayer.
The simplest example is a sales tax. According to this tax, buyers of goods have to pay the same sales tax when purchasing products.
For example, when rich and poorer taxpayers go to the same grocery store and buy the same product, they pay the same price. But the price includes a tax that a seller must apply to the product. As a result, the poorer person has to use a larger percentage of their income to get the product.
Progressive vs. Flat Systems
A flat tax system applies the same rate to everyone regardless of the data about their income. In the US, the tax on a payroll that funds Medicare and Social Security is a flat tax since it deducts the same percentage from payrolls of all wage earners.
The tax has a cap. In 2021, the payroll tax shouldn’t be applied to your revenue if it goes over $142,800. In 2021, it shouldn’t be applied if your revenue goes over $147,000.
In these two cases, taxpayers pay a lower percentage when compared to those who earn less than $142,800 (and $147,000 in 2022). It means that a flat tax becomes a regressive tax since poorer people have to contribute more of their revenue.