Taxes, Regressive

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Taxes, Regressive

A regressive tax is one that has a disproportionately more negative economic effect on the poorer members of society than the wealthier members. Regressive taxes usually have fixed rates, and are thus not sensitive to one’s ability to pay. Likewise, a tax is considered regressive if the wealthy are able to avoid compliance more readily than the poor.

Because of the limited capabilities of premodern political authorities to assess value and monitor transactions, the earliest forms of taxation tended to be regressive. The preference was for taxes that were relatively simple to compute and collect. The head tax, such as the British poll tax and the Russian soul tax, was a direct tax with regressive distributional consequences. It was a levy applied at a fixed rate on each individual, regardless of income and property status. Likewise, the French gabelle, or salt tax, was an indirect tax with regressive distributional consequences. This tax was set at a fixed rate and administered by royal agents in the sale of this consumption necessity, even though the cost was a significantly greater burden for poor households.

In the modern period, regressive tax schemes remained common in economies with narrow elites, wide income disparity, underdeveloped industrial bases, and authoritarian political regimes. In the advanced industrial democracies, however, regressive taxation eventually fell out of favor. This was a consequence of political reforms that expanded voting rights, leading to the enactment of more progressive forms of taxation. An additional factor was an increase in technological and bureaucratic capabilities that enabled modern governments to keep track of economic activities and income sources.

More recently, arguments have gained ground in favor of tax reforms with regressive tendencies in the industrial democracies. Fiscal arguments stress the complex and opaque nature of contemporary tax systems and contend that the simplification of tax policy would facilitate taxpayer compliance and state collection. Economic arguments stress that a more regressive tax code would create greater incentives for the investment and activity that would stimulate economic growth to the benefit of all. In the United States, however, the reduction of high progressive tax rates in the 1980s and the first decade of the twenty-first century did not result in a decline in tax-avoidance practices among wealthier taxpayers.

National sales taxes and flat rate income taxes are the most common types of tax reforms that have regressive distributional consequences. The European economies rely heavily on the value-added tax (VAT), which is a kind of national sales tax, where a fraction of the total tax is added at each stage of production and distribution, instead of all at once at the last stage. If the price of necessary goods and services is relatively constant, then a sales tax is regressive. To illustrate, Denmark has a 25% VAT without exception. Thus, if two persons buy an identical bag of groceries each week for 20 Danish krones (DK), they both pay DK5 in VAT. But if the first person’s weekly income was DK100 and the second’s was DK1000, then the first person paid a higher percentage of their weekly worth (5%) than the second person (0.5%). Most European governments, however, provide exemptions on the VAT for basic necessities. Support for a flat income tax has grown in Europe and United States with the enactment of flat tax rates in the transition economies of central and eastern Europe, including Estonia, Slovakia, and Russia. The flat tax was instituted in the transition economies largely because of the weakness of the state tax administration to monitor and extract revenue from the emerging private sector and households.