Taxes are distinguished by the impact they have on the allocation of income and wealth. A proportional tax is a tax that places the same relative liability on each taxpayer—i.e., where tax liability and income move in the same proportion. A progressive tax is characterizable by a higher than proportional growth in the tax onus in regard to the growth in income, and a regressive tax is recognisable by a less than proportional increase in the related burden. So, progressive taxes are seen as taking away a lack of equality in income distribution, while regressive taxes may have the effect of increasing these inequalities.

The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so for the upper-income class—particularly if a taxpayer is allowed to lessen his tax base by claiming deductions or by leaving out particular income elements from his taxable income. Proportional tax rates when applied to lower-income classes can also be more progressive if exemptions of a personal nature are made.

Income measured over the period of a given year does not absolutely give the most suitable measure of taxpaying status. For example, transitory increases in income could be saved, and in temporary declines in income a taxpayer might decide to provide for consumption by decreasing savings. Therefore, if taxation is held in comparison with “permanent income,” it can be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (save luxuries) tend to be regressive, because the spread of one’s income consumed or spent for specific goods declines as the amount of personal income grows. Poll taxes (also called head taxes), levied as a set amount per capita, obviously are regressive.

It is not easy to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.

In regarding the economic effect of taxation, it is essential to distinguish between differing concepts of tax rates. The statutory rates will be specified in legislature; usually these are marginal rates, but in some cases they are median rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income is increased by one dollar. Ergo, if tax burden rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that increase as income rises. Careful analysis of marginal tax rates need to review provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points higher than specified in the statutory rates. Since marginal rates specify how after-tax income changes in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applied to income from business and capital, because it may depend on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates indicate the fraction of total income that is taken in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally increase with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households could dwarf these effects, allowing regressivity, as indicated by average tax rates that lower as income increases.

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