Updated July 7, 2023
Definition of Regressive Tax
A regressive tax is a tax system applied uniformly to all taxpayers, irrespective of income level. This tax system does not differentiate among individuals based on their Income level and charges an equal tax rate to them.
All the Indirect forms of taxes, such as Sales Tax, Service Tax, and Value Added Tax (VAT), are types of Regressive Tax. In short, it doesn’t differentiate between low-wage earners and high-wage earners. The regressive Tax rate varies from jurisdiction to jurisdiction; however, this tax system is most prevalent across all jurisdictions.
The impact of a regressive tax system, which assesses a percentage of goods and services without being influenced by the individuals availing of them, is often criticized for its negative effect on low-income groups. Such taxes disproportionately affect low-income earners compared to high-income earners, reducing disposable income in their hands. On the other hand, progressive taxes increase the tax rate as the income level of people rises, making them a more equitable alternative.
Let’s understand with a simple example.
Two individuals, Mr. A and Mr. B having monthly Net pay of $10000 and $5000, respectively, buy a Mobile phone worth $2000, which carries a Regressive Tax in the form of Sales Tax at the rate of 10%. Thus the tax amount on the mobile phone is $200, which effectively is 2% of the income of Mr. A ($200/$10000=2%), whereas, for Mr. B, it is 4% of the income ($200/$5000=4%).
Thus, it burdens individuals with lower income more than those with higher income.
Example of Regressive Tax
ABC Limited has two employees who are paid a monthly salary of $4000 and $8000, and both pay a Payroll tax deduction of $600 and $1000, respectively. So effectively the Net Pay of two employees is $3400 and $7000 respectively.
Both of them undertake the following activities from their Net pay, as shown below:
- Consumption of goods worth $1000 and paying Sales Tax of 10%
- Purchase of Television worth $1200 and paid Value Added tax of 18%
- Availed the services of a Broking Firm worth $700 and paid a Service tax of 12%.
The below table shows the amount of Regressive Tax paid by both:
|Particulars||Employee 1||Employee 2|
|B||Sales Tax on goods consumed worth $1000 @10%||$100||$100|
|C||Value Added Tax on Television items purchased worth $1200 @18%||$216||$216|
|D||Service Tax paid on services of Broking firm worth $700 @12%||$84||$84|
|E||Total Regressive Tax paid E = (D+C+B)||$400||$400|
|F||Percent of Total Income paid as Regressive Tax F = E /A||12%||6%|
Types of Regressive Tax
Popular types of Regressive tax are usually Indirect Taxes, as enumerated below:
- Sales Tax: A common and very popular form of Regressive tax levied on goods purchased by the customer and varies based on the product; however, it remains the same for all individuals and is unaffected by the individual’s income level. For instance, a Sales Tax of 10% is applicable on Television sets irrespective of the buyer.
- Value Added Tax: Another Regressive type of tax collected at each production stage for the value-added at each stage.
- Excise Tax: These are taxes on imported goods and are taxed differently in different jurisdictions; however, the tax rate is fixed based on the value of goods imported and other specifications.
- Tax on Gambling: These taxes also carry a fixed tax rate and are usually paid more by people in the lower-income group who opt for such activities to become overnight rich and end up paying this Regressive Tax. It usually carries a higher rate.
- Goods and Service Tax: Goods and Service tax is another type of Regressive Tax and is hugely popular for its simplicity and applicability to the end-user of the product or service. Typically GST rates are the same across the spectrum of products and services and are indifferent to the individual’s income level.
Who is Eligible to Pay Regressive Tax?
Individuals must pay it when they consume goods on which this tax is applicable or avail of services where it is exercised. In both cases, the relationship remains inverse, which implies that the higher the income more minor the percent of income shelled out in the form of Regressive tax (in absolute terms) and vice versa.
- It is uniform across different individuals, making it simple, understandable, and applicable.
- An efficient source of the tax system. It is used by government authorities to discourage the consumption of certain goods by applying a higher tax rate, such as the Sin Tax on the consumption of Tobacco and Alcoholic products, which are not suitable for health. Using a Progressive tax of a higher rate discourages people in Lower-Income groups from consumption at least.
- It encourages higher earnings as the percentage of the regressive tax to total income decreases as income increases.
- Results in more tax for low-Income groups and less income tax for the higher-income group leading to more Inequality of Income and the rich-poor divide.
- It is a discretionary tax, which means one can avoid it by not buying the product or service it is applicable, unlike Income tax which is a direct tax.
- It ultimately leads to double taxation and further reduces savings for low-income earners.
It is a popular and straightforward tax system applicable in almost all countries in some way or another. It is usually criticized for being too anti-poor and promoting more income inequality; however, it continues to be a popular tax system.
This is a guide to Regressive Tax. Here we also discuss the definition and example of regressive tax and its advantages and disadvantages. You may also have a look at the following articles to learn more –