What it is:
A regressive tax is a tax that increases as a percentage of income as the amount of income declines.
How it works (Example):
The United States has the opposite of a regressive tax system. That is, it has a income are taxed at increasing rates (that’s why the rates are often referred to as marginal rates).system, which means that different portions of a person’s or company’s
For example, under a regressive tax system, the IRS might tax a single filer’s $100,000 income as follows:
The first $8,025 is taxed at 28% = $2,247
The next $24,525 is taxed at 25% = $6,131.25
The next $49,100 is taxed at 15% = $7,365
The final $18,350 is taxed at 10% = $1,835
Total tax owed: $17,578.25
But under a progressive tax system, the IRS might tax a single filer’s $100,000 income as follows:
The first $8,025 is taxed at 10% = $802.50
The next $24,525 is taxed at 15% = $3,678.75
The next $49,100 is taxed at 25% = $12,275.00
The final $18,350 is taxed at 28% = $5,138
Total tax owed: $21,894.25
As you can see, a regressive tax system requires a higher tax burden from lower income earners. A progressive tax system transfers that higher tax burden to higher income earners by taxing only the higher portions of income at a greater rate.
Why it Matters:
In general discourse, it is important to know the difference between tax brackets and tax rates. Many people assume that when they’re in the 28% tax bracket, for example, that all of their income is being taxed at 28%, which is not the case. As our example shows, you can be in the 28% tax bracket but have a 21.89% effective tax rate on your income under a system (or something higher than 21.89% under a regressive tax system).