Regressive Tax

What is a Regressive Tax?

A regressive tax is a tax applied in a way that the tax rate decreases with the increase of the taxpayer’s income. This type of tax places more burden on low-income demographics rather than the high-income population. The imposed burden is determined by the percentage of the tax amount relative to income.

Generally, a regressive tax is a tax that is an absolute currency amount levied uniformly to all of the population. Therefore, the low-income population carries a bigger burden than those with high income because the tax amount takes a greater percentage of their income, although the tax dollar amount is the same.

A regressive tax system is not commonly used for income taxation. However, it is used with many other taxes, such as sales or sin tax. The regressive tax is directly opposite to progressive tax.

Types of Regressive Tax

Regressive taxation can be encountered in different taxes with a uniform tax amount. Nevertheless, the degree of regression varies.

1. Sales tax

Sales taxes are imposed on major goods available to consumers. Since sales taxes are applied uniformly and affect all demographic groups within a population, they are considered regressive.

2. Sin tax

Sin taxes are levied on the goods that are considered harmful to society. The goods include tobacco, alcohol, and products with excessive sugar. Sin taxes are highly regressive because of the consumption differences between the low- and high-income parts of the population. Many studies show that people who earn less tend to consume more harmful products such as tobacco or alcohol relative to individuals who earn more.

3. Property tax

Property taxes are regressive in theory. They are based on the property’s value and not on the owner’s income. Thus, if a person with a low income and a person with a high income own properties with the same value, they will pay the same tax amount.

Therefore, property tax is considered regressive. However, in reality, wealthier people tend to purchase properties of higher value than poor people. Therefore, property tax is – effectively – the least regressive in our list.

Tax Example

Last weekend, John and Sam went shopping. They both bought new clothing, and each spent $300. The sales tax rate is 13%. Therefore, each of them paid $39 in taxes. However, John’s salary is $3,000 per month, while Sam makes $4,000 monthly.

While both John and Sam paid the same amount of tax, the proportion of the tax amount to income for Sam was only $39/$4,000=0.975%, while John’s rate was $39/$3,000=1.30%. Thus, the sales tax is regressive.

Additional Resources

CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA)® designation for financial analysts. From here, we recommend continuing to build out your knowledge and understanding of more corporate finance topics such as:

• Ad Valorem Tax
• Flat Tax System
• Permanent/Temporary Differences in Tax Accounting
• Tax Shield
• See all accounting resources