Tax

Definition

A tax is a mandatory payment that needs to be made to a government or regulatory body, which typically varies in quantity based on some other quantity of money involved that is being taxed. Some main taxes include:

• income taxes, which are taxes levied on individuals and households based on the income earned. This may include capital gains taxes.
• consumption taxes, which could take the form of sales taxes and value-added taxes, which are taxes levied for consumption or purchase, either at the final point of purchase or at intermediate stages of the production process on the value added at each stage.
• corporate taxes, which are taxes levied on firms based on their net profits.
• wealth taxes, which are taxes levied on the total wealth that an individual or household possesses.

Most taxes are increasing (or at least non-decreasing functions) of the quantity being taxed.

Classification of taxes

The average tax rate for a given tax is the ratio of the quantity of the tax to the quantity being taxed, and the marginal tax rate is the rate of change in the quantity of the tax relative to the quantity being taxed. A tax is called a:

• Progressive tax if the marginal tax rate is an increasing (or non-decreasing) function of the quantity being taxed. The average tax rate in this case is also an increasing (or non-decreasing) function of the quantity being taxed.
• Flat tax if the marginal tax rate is constant, or equivalently, the average tax rate is constant.
• Regressive tax if the marginal tax rate is decreasing. Thus, the average tax rate is also decreasing.

Sometimes, the terms progressive and regressive are used more loosely for taxes based on disparate impact, i.e., a tax may be labeled progressive if it impacts rich people more than poor people (for instance, a high sales tax on yachts or private jets), and regressive if it impacts poor people more than rich people (for instance, a high sales tax on tobacco, which is used disproportionately by poor people). This is not a precise use of the terms progressive and regressive.