Reviewed by Sep 30, 2020| Updated on
A progressive tax system is the one where tax rates increase with incremental income. Taxpayers earning lower incomes are subject to a low rate of tax, with the tax rates increase with an increase in income.
A tax system is said to be progressive when it imposes tax according to the taxpayer’s ability to pay. The percentage of the tax rate is higher for high-income earners in comparison to low-income earners. A progressive tax system is built on the understanding that low-income earners spend a maximum of their earnings towards their daily expenses or to maintain a basic standard of living. The taxpayers who earn higher incomes would be in the high tax rate and pay an incremental tax.
A progressive tax system reduces income inequality. The system follows the principle of equity. The tax system of the United States of America and India follow a progressive tax system.
According to the principle of equity, taxes should be fair. Taxes should be on the ability-to-pay of the taxpayer. The principle can be classified as vertical equity and horizontal equity. As per vertical equity, people earning higher incomes should pay more taxes. As per horizontal equity, people with higher necessary expenses should pay less tax than someone else with equal income but without the expenses.
The nature and extent of the progressive tax system would depend on the steep jump in the tax rates from the lower-income slab to the middle-income slab, and from the middle-income slab to the higher-income slab. In India, the lower-income slab (Rs 2.5 to 5 lakh) rate is 5% with a steep jump to 20% for income-earners above Rs 5 lakh.
A countrys tax system must depend on its need for investment, capital formation, need for economic growth and other broad market factors. A tax system that leaves more money in the hands of the low-income earners who would spend most of their earnings on essential goods and services and benefit the economy.