What is regressive tax? Definition and meaning

The definition and meaning of regressive tax refers to a tax which takes a greater proportion of low-wage individuals’ income than from wealthier people. In a regressive tax system, as your income rises, the proportion of that income that you pay in tax declines. It is the opposite of progressive tax, which takes a higher percentage of rich people’s income compared to that of low earners’ incomes.

In most cases, regressive taxes are applied evenly in all situations, regardless of the individual’s income or ability to pay.

Regressive tax – fair or unfair?

People on low incomes are more severely affected – compared to high-income individuals – by a regressive tax than a progressive one. In some cases, taxing everybody uniformly is fair, but in others it may be deemed as unjust.

Regressive tax - sales tax on smartphoneWhen the three people in this image buy a new smartphone, how much they are taxed – as a proportion of monthly income – varies considerably. Hence, sales tax is an example of a regressive tax – rich people are charged a much smaller percentage of their income than their poorer counterparts.

For example, if income tax were regressive – with poor people paying a higher percentage of their income in taxes than rich individuals – it would be seen as extremely unfair.

However, sales tax, which is applied uniformly, is seen as fair. The sales tax on a pint of beer is the same, regardless of who buys it.

A rich person does not pay more sales tax on that pint of beer than a low-income individual, even though the tax on that beer represents a higher percentage of the poorer person’s income than that of his or her richer counterpart.

According to the Financial Times’ glossary of terms, to define regressive tax is:

“A taxation system that imposes lower rates of tax for those on higher incomes — or more realistically, that results in poorer people paying a larger proportion of their income in tax than richer people (for instance in the case of a flat sales tax).”

Regressive tax system in US statesBesides complaints within these ten US states that taxes are too high, the other is that a regressive flat tax costs each state revenues as income inequality expands. (Image data source: media.chicagomag.com)

Sales tax – a regressive tax

Tom, who earns $2,000 per month, is friends with Bernadette, who earns $10,000 per month.

Imagine they both go to the supermarket and spend $100 on identical groceries. Sales tax represented $8 (8%) of the $100 they spent.

– $8 is 0.4% – or 1/250 – of Tom’s monthly income.

– $7 is 0.08% – or 1/1250 – of Bernadette’s income.

Sales tax (UK/Ireland: VAT, value-added-tax)  represented a much smaller proportion of Bernadette’s income than Tom’s.

Are property taxes regressive? Yes & no

Not regressive:

In most countries, expensive properties are taxed at a higher rate than cheaper ones – the property tax on a $50 million home is usually higher than the tax on a $70,000 house.

So, in that sense, property taxes are not regressive; they are progressive. As only very rich people can afford the $50 million home, that higher tax rate will only affect them, and not individuals on lower incomes.

Most $70,000 properties will be sold to people at the lower end of the socioeconomic ladder – very few billionaires will be among the customer list for $70,000 homes.

Regressive tax vs Progressive taxPeople on lower incomes prefer a progressive tax system, while those on higher incomes prefer a regressive tax system.

Yes, regressive:

However, it could also be argued that property taxes are regressive. If the world’s richest person – Bill Gates – buys a $70,000 home, he or she pays the same amount in property tax as Mary Smith the office cleaner.

However, the property tax on that home represents a considerably greater percentage of Ms. Smith’s financial resources than Mr. Gates’.

User fees – regressive tax

User fees are generally considered regressive because people at the bottom of the socioeconomic ladder pay a higher percentage of their income in tax than those in the higher-income groups.

Examples include the fees we pay for parking, admissions to public parks and museums, tolls for tunnels, bridges & roads, and licenses.

Patrick is a successful cosmetic surgeon in New York, he earns approximately $50,000 per month, while his cousin John, a part-time car-park attendant, earns $1,000 per month.

Bernie Sanders tax quoteBernard ‘Bernie’ Sanders has been a junior US Senator from Vermont since 2007. He has served longer than anybody else in the US Congress. (Image: twitter.com/BernieSanders)

When Patrick drives across a specific bridge, he has to pay a $5 toll. John also has to pay $5 to cross that bridge in his car. Five dollars represents a much larger proportion – fifty times larger – of John’s monthly income than Patrick’s.

Regarding regressive taxes, the IRS (Internal Revenue Service) – the revenue service of the United States federal government – says:

“A regressive tax may at first appear to be a fair way of taxing citizens because everyone, regardless of income level, pays the same dollar amount.”

“By taking a closer look, it is easy to see that such a tax causes lower-income people to pay a larger share of their income than wealthier people pay. Though true regressive taxes are not used as income taxes, they are used as taxes on tobacco, alcohol, gasoline, jewelry, perfume, and travel.”

Video – Different Tax Structures – Definition and Meaning

This Kramer Academy video explains what the three different tax structures are: 1. Proportional Tax. 2. Regressive Tax. 3. Progressive tax.