Progressive Tax

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on February 06, 2024

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What Is Progressive Tax?

A progressive tax is a system of taxation where the tax rate increases as the taxpayer's income increases. A progressive tax reduces income inequality by redistributing wealth from high-income to low-income earners.

Progressive tax systems are used by many countries around the world, including the United States, Canada, and many European countries.

It is designed to ensure that those who earn more pay a higher percentage of their income in taxes than those who earn less. This is based on the principle of distributive justice, which holds that those who have more should contribute more to society.

The Evolution of Progressive Taxation

The idea of progressive taxation has a long history, dating back to the 18th century.

The French economist Jean-Baptiste Say first proposed the idea of a progressive tax, arguing that it would help to reduce inequality and promote economic growth. Economists such as John Stuart Mill and Karl Marx later developed the concept of a progressive tax.

Historical Overview of the Concept of Progressive Taxation

The concept of progressive taxation is rooted in the idea of distributive justice, which holds that society has a moral obligation to distribute its resources fairly.

In the context of taxation, this means that those with more should pay more taxes than those with less. Progressive taxation is seen as a way to achieve distributive justice by redistributing wealth from the rich to the poor.

The concept of progressive taxation gained popularity in the late 19th and early 20th centuries, as the industrial revolution created a growing income gap between the rich and poor.

Many economists and social reformers argued that progressive taxation was necessary to reduce inequality and promote social welfare.

Development of Progressive Tax Systems in Different Countries

The first modern progressive tax system was implemented in Germany in 1891 under the leadership of Chancellor Otto von Bismarck.

The German tax system was based on the principle of "ability to pay," with higher tax rates for those with higher incomes. Other European countries, including France, Italy, and the United Kingdom, later adopted this system.

In the United States, the idea of a progressive tax system was first implemented in 1913 with the passage of the 16th Amendment to the Constitution. This amendment gave Congress the power to levy an income tax designed to be a progressive tax.

Major Milestones in the Evolution of Progressive Taxation

Since the introduction of the first progressive tax system, there have been several significant milestones in the evolution of progressive taxation. One of the most important milestones was the introduction of the concept of marginal tax rates, first proposed by the British economist Arthur Pigou in 1920.

Marginal tax rates refer to the tax rate applied to each additional dollar of income earned. In a progressive tax system, marginal tax rates are higher for those with higher incomes. This means that high-income earners pay a higher tax rate on each additional dollar they earn, which helps to reduce income inequality.

Another major milestone in progressive taxation's evolution was the introduction of the welfare state concept in the mid-20th century. The welfare state refers to government programs and initiatives designed to provide for citizens' basic needs, such as healthcare, education, and housing.

Many countries introduced higher tax rates for high-income earners to fund the welfare state. These tax rates were often used to fund social programs and initiatives that benefited low-income earners.

How Progressive Tax Works

Progressive tax works by dividing income into different brackets and assigning a tax rate to each bracket. The tax rate increases as the income of the taxpayer increases.

For example, a progressive tax system may have tax rates of 10%, 15%, and 20% for the first, second, and third income brackets, respectively. If a taxpayer has an income that falls into the second bracket, they will pay a 15% tax on that portion of their income.

Progressive tax systems are different from flat tax systems, where everyone pays the same tax rate, regardless of their income.

Flat tax systems are often criticized for being regressive, as they burden low-income earners more. Progressive tax systems are designed to be fairer by placing a higher burden on high-income earners.

Benefits of Progressive Tax

A progressive tax system offers several benefits, including reducing income inequality, funding government programs, and promoting economic stability.

Reduces Income Inequality

When the tax burden is placed more heavily on high-income earners, the government can use that revenue to fund social programs and initiatives that benefit low-income earners.

For example, the revenue from a progressive tax system can be used to fund education, healthcare, and affordable housing initiatives.

Funds Government Programs

Another benefit of a progressive tax system is that it can provide the government with the revenue it needs to fund important programs and initiatives.

When tax revenue is spread more evenly across the population, the government can use that revenue to fund public goods and services that benefit everyone. These public goods and services can include infrastructure projects, environmental protection initiatives, and national defense.

Promotes Economic Stability

The tax burden spread more evenly across the population can reduce economic volatility and prevent economic downturns.

For example, during an economic recession, a progressive tax system can provide the government with the revenue it needs to fund stimulus packages and other initiatives that can help to boost the economy.

Criticisms of Progressive Tax

While a progressive tax system has several benefits, it also faces criticism for potentially disincentivizing high-income earners, encouraging tax evasion, and being complex and challenging to administer.

Disincentivizes High-Income Earners

One of the criticisms of a progressive tax system is that it can disincentivize high-income earners from working hard and pursuing success.

When tax rates are higher for those who earn more, it can make it less appealing for high-income earners to work harder or take risks. This can lead to a reduction in economic growth and innovation.

Encourages Tax Evasion

High-income earners may seek to hide their income or engage in other forms of tax evasion to avoid paying higher tax rates. This can lead to a reduction in tax revenue and can undermine the effectiveness of the progressive tax system.

Complexity of Tax System

Another criticism of a progressive tax system is that it can be complex and difficult to administer.

Progressive tax systems often have many income brackets and tax rates, making it challenging for taxpayers to understand and comply with the tax code. This complexity can also make it more difficult for the government to collect tax revenue effectively.

Benefits and Criticisms of Progressive Tax System

Progressive Tax in the Real World

Progressive tax systems are used in many countries worldwide. Their impact on income distribution, economic growth, and social welfare can be observed in various real-world examples.

Countries That Use Progressive Tax

Many countries worldwide use progressive tax systems. The federal income tax is progressive in the United States, with tax rates ranging from 10% to 37% depending on income. Canada, the United Kingdom, and many European countries also use progressive tax systems.

Current Debates About Progressive Tax

There are ongoing debates about the merits of progressive tax systems. Some argue they are necessary to promote economic fairness, while others say they stifle economic growth and innovation.

In recent years, there has been a growing interest in wealth taxes, a form of progressive tax that targets the assets of the wealthy rather than their income.

In the United States, there have been proposals to increase the tax rates on high-income earners and to implement a wealth tax.

Some argue that these measures are necessary to reduce income inequality and fund critical social programs. Others say that they would discourage economic growth and lead to tax evasion.

Conclusion

A progressive tax system effectively reduces income inequality, funds government programs, and promotes economic stability.

While it has some drawbacks, such as disincentivizing high-income earners and encouraging tax evasion, the benefits of a progressive tax system outweigh its limitations.

The ongoing debates about the merits of progressive tax highlight the importance of balancing promoting economic growth and ensuring economic fairness.

To navigate the complex tax system and ensure compliance with tax laws, it is crucial to seek the services of a tax professional. Tax services professionals can help individuals and businesses understand the tax code's intricacies, minimize tax liability, and avoid costly penalties.

Progressive Tax FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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