Regressive Tax

Published Oct 25, 2023

Definition of Regressive Tax

A regressive tax is a tax system in which the tax burden falls more heavily on lower-income individuals or households compared to higher-income individuals or households. This means that as income increases, the proportion of income paid in taxes decreases. In other words, the tax rate decreases as income increases.

Example

Let’s consider a sales tax on essential goods, such as groceries. A sales tax is typically a fixed percentage of the price of the goods purchased. For example, let’s say the sales tax rate is 5%.

Now, imagine two individuals, Jane and John, who have different income levels. Jane earns $20,000 per year, while John earns $100,000 per year.

If Jane spends $5,000 per year on groceries, she would pay $250 in sales tax (5% of $5,000). This amounts to 1.25% of her annual income.

On the other hand, if John spends $10,000 per year on groceries, he would pay $500 in sales tax (5% of $10,000). This amounts to 0.5% of his annual income.

Even though the tax rate is the same for both individuals, the sales tax imposes a higher burden on Jane with her lower income compared to John with his higher income. This is an example of a regressive tax.

Why Regressive Tax Matters

Regressive taxes can have a significant impact on lower-income individuals and households, as they may have to allocate a larger portion of their income to pay the taxes. This can exacerbate income inequality and create financial hardships for those who are already financially disadvantaged.

Understanding the regressive nature of certain taxes is important for policymakers and economists when designing tax systems. By recognizing the potential regressiveness of a tax, policymakers can take measures to introduce progressive elements or consider alternative tax policies that better distribute the tax burden across income levels and promote fairness.