Definition of Proportional Tax
Proportional tax, also sometimes referred to as flat tax, is a tax levied on the consumer or the taxpayer such that the tax rate is constant on the income earned irrespective of changes to the taxable income.
Explanation
The guiding principle behind the proportional tax is the notion of socio-economic equality across the income strata in the society by making a change in tax rates absent. This essentially means that all the income groups, from lower to higher and very high, pay the same amount in taxes.
Example of Proportional Tax
Proportional taxes find real-world application in few parts of the globe. Particularly, in the United States, proportional tax is imposed in Colorado, Pennsylvania, Michigan and Massachusetts. The United States has, in general, the progressive form of taxation, which has been opposed by many analysts and thinkers citing reasons of unjust and inequitable imposition of taxes.
Assume the following 3 tax systems and some cooked-up numbers for the illustration purposes
| Income Tax Rates Under | |||
| Regressive Tax | Proportional Tax | Progressive Tax | Income Interval (annual) |
| 20% | 20% | 10% | $80,000 – $100,000 |
| 20% | 20% | 20% | $100,001 – $120,000 |
| 18% | 20% | 25% | $120,001 – $140,000 |
| 15% | 20% | 30% | $140,001 – $160,000 |
Now just see the income taxes paid under these 3 systems,
| Income Taxes Paid Under | |||
| Regressive Tax | Proportional Tax | Progressive Tax | Income Interval (annual) |
| $16,000 – $20,000 | $16,000 – $20,000 | $8,000 – $10,000 | $80,000 – $100,000 |
| $20,000 – $24,000 | $16,000 – $20,000 | $20,000 – $24,000 | $100,001 – $120,000 |
| $21,600 – $25,200 | $16,000 – $20,000 | $30,000 – $35,000 | $120,001 – $140,000 |
| $21,000 – $24,000 | $16,000 – $20,000 | $42,000 – $48,000 | $140,001 – $160,000 |
Observe that the Proportional taxes charge the same amount while Regressive taxes charging lower taxes for higher incomes and Progressive taxes charging higher taxes for higher incomes.
Proportional Tax Rate
In simple words, a proportional tax is a flat tax where everyone pays the same amount in taxes to the tax collector. In contrast, there is 2 other taxation methods, majorly viz. progressive and regressive tax. In the former, the tax rate increases with the increase in taxable income. In the later, the tax rate decreases with the increase in taxable income.
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Considering the two extremes of tax classification, we can say that a proportional tax system can be said to have a regressive outlook. This is because a flat tax nature of the proportional tax system charges the poor and the rich equally, thus burdening the poor more.
Two important terms to note are the average tax rate and the marginal tax rate.
Average tax rate –It is the ratio of total taxes paid to the total income earned.
Average Tax Rate = Taxes Paid / Income
Marginal tax rate – It is measured as the incremental taxes paid on the incremental income.
Marginal Tax Rate = Incremental Taxes/ Incremental Income
The following example will illustrate the difference between the two:
If John earns $100,000 earns and pays $18,000 in taxes, the average tax rate is 18%. If John earns an incremental income of $5,000 and is subject to $1,500 in incremental taxes, the marginal tax rate is 30%.
In essence, the marginal tax rate recognises the degree to which the tax rate impacts the taxpayer to earn incentives (by working more for more income). The average tax rate only gives a measure of how the tax rate has impacted the taxpayer. Clearly, the application of marginal tax rate is of no use in the proportional tax system as it violates the rule of maintenance of equal tax incidence.
Proportional Tax Graph
Let us take a small economy that has 9 income groups with different incomes each. Below is a graph representing the taxation imposed on this economy and tries to justify how the tax collection is skewed.
| Tax Rate | Taxable Income | Taxes Paid | Income After Tax |
| 20% | $40,000 | $8,000 | $32,000 |
| 20% | $50,000 | $10,000 | $40,000 |
| 20% | $60,000 | $12,000 | $48,000 |
| 20% | $70,000 | $14,000 | $56,000 |
| 20% | $80,000 | $16,000 | $64,000 |
| 20% | $90,000 | $18,000 | $72,000 |
| 20% | $100,000 | $20,000 | $80,000 |
| 20% | $110,000 | $22,000 | $88,000 |
| 20% | $120,000 | $24,000 | $96,000 |
Understanding the Graph
We have assumed a flat tax of 20% applicable for all income groups, 9 groups taken here. Look at the increase in the taxable income represented by the blue line. The taxable income is increasing by $10,000, and the two extremes denote the essence of proportional taxes. The orange line denotes the taxes paid and are calculated as tax rate times taxable income.
The steep increase in the taxable income suggests how the income spread is within the economy. The relatively gradual increase in the taxes paid suggests that the tax collection is not as high in the higher income groups as in the lower-income groups. Remember that the fraction of tax collection is the same at 20% for groups 1 to 9. It is the amount of taxes collected in absolute terms that matter for the tax collector.
In case if the tax collection needs to be improved, a tax rate based on earnings potential can be imposed such that high-income groups contribute more in absolute terms.
Advantages
Some of the advantages are given below:
- The proportional tax brings the concept of equality into the socio-economic fabric of the society.
- A proportional tax is simple to implement, manage and revoke if need be
- It does not incentivize the taxpayers, thereby avoiding any adverse effects such as impacts on work-life, tax evasion, manipulation in taxable income, etc
Disadvantages
Some of the disadvantages are given below:
- As opposed to the notion of equality, the proportional tax system does not take of equitable distribution. By imposing a flat tax, the low-income group end up paying more taxes in absolute terms than a high-income group.
- More often than not, it does not motivate or incentivize the taxpayer or non-taxpaying population of the society to work aggressively to earn more.
- Proportional tax widens the bridge between the rich and the poor as flat taxes end up taking more from the poor and less from the rich.
Conclusion
A proportional tax system essentially follows the rationale of vertical segmentation of the society where all economic classes are subject to the same taxes. In contrast, a horizontal segmentation classifies economic classes based on economic ability to pay the tax. Thus, most of the tax systems use a hybrid form where the lower strata are taxed on the ability-to-pay principle while the higher strata are subject to a flat (proportional) tax but above a certain income.
Taxation is a significant tool that helps the governments of the world to generate revenue in order to expend it on welfare works, much-needed projects, eliminating poverty, paying its people, etc. However, proportional tax may endanger these goals of the governments, considering the lower taxes that the richer societies are subject to because of the flat tax. Moreover, a flat tax raises questions that relate to the equal inflation and price rise for all income groups, for which activists argue that it becomes unjust to pay a flat tax across different income groups.
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This is a guide to Proportional Tax. Here we also discuss the definition and example of a proportional tax along with advantages and disadvantages. You may also have a look at the following articles to learn more –
