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September 23, 2018 

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MARGINAL-COST PRICING: A pricing scheme in which the price received by a firm is set equal to the marginal cost of production. This is not only the efficient outcome achieved by competitive markets, it is commonly used for comparison of other regulatory policies, such as average-cost pricing, that are used for public utilities (especially those that are natural monopolies). The bad thing about marginal-cost pricing for natural monopolies is that a normal profit is not guaranteed. The good thing about marginal-cost pricing is that marginal cost is equal to price, and the public utility is operating according to the price equals marginal cost (P = MC) rule of efficiency.

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PROPORTIONAL TAX:

A tax in which the proportion of income paid in taxes is the same for all income levels. A proportional income tax exists if ever taxpayer pays exactly the same tax rate relative to income regardless of income level. A proportional tax is one of three alternations. The other two are progressive tax, in which the proportion of income paid in taxes is greater for higher income levels, and regressive tax, in which the proportion of income paid in taxes is smaller for higher income levels.
While taxes are levied on a variety of tax bases (sales, property, gasoline, corporate profits), tax proportionality evaluates the proportion of income paid in the tax at alternative income levels. A proportional tax exists if all income levels pay the same proportion of income in tax.

Suppose, for example, that someone like Winston Smythe Kennsington III earns $10 million of income and pays $1 million in income taxes (10 percent) and that another person like Pollyanna Pumpernickel earns $10,000 in taxes and pays $1,000 in income taxes (also 10 percent). Because Winston and Pollyanna both pay 10 percent of their incomes in taxes, the income tax is proportional.

The same notion applies to other types of taxes. If Winston pays $100,000 in assorted state and local sales taxes over the course of year of luxury consumption (1 percent of his $10 million income) and Pollyanna pays $100 in state and local sales taxes for a year of her consumption (1 percent of her $10,000 income), then sales taxes are also proportional.

Proportional tax is one of three tax proportionality alternatives. In fact, this alternative is perhaps best thought of as a dividing line between the other two. A progressive tax is one in which a larger proportion of income is paid in tax for higher income levels. That is, the tax rate effectively increases with income. A regressive tax is then one in which a smaller proportion of income is paid in tax for higher income levels. In this case, the tax rate effectively decreases with income. With the complexities of real world tax collections, few taxes are perfectly proportional in practice.

The Pros and Cons of Proportional

On the surface, generating government revenue using proportional taxes seems to be fair and reasonable. Every member of society pays the same proportion of their income to finance government operations, they pay their fair share. Proportional taxes correspond quite well with the ability-to-pay principle of taxation.

However, reasonable arguments can also be made that proportional taxes are not the best, that tax rates should increase or decrease with income levels.

  • Rich Pay More: One consideration, from an ability-to-pay perspective, is that people actually have a greater ability to pay with increases in income. This occurs because a smaller proportion of income is spent on necessities, such as food, housing, and energy, for those with more income. The wealthier thus have more discretionary income and can better afford to finance government operations.

  • Poor Pay More: Another consideration, from a benefit principle view, is that the poor tend to benefit more from government operations and public goods (public transportation, public assistance programs, etc.) and as such should pay accordingly. Moreover, from an investment and economic growth perspective, those with more income are also more likely to invest in capital goods, which stimulates economic growth and hence benefits all members of society. If they pay a lower tax rate, they have more income to invest.

Progressive and Regressive

Proportional tax is one of three tax proportionality alternatives. The other two are progressive tax and regressive tax.
  • Progressive: A progressive tax is one in which the proportion of income paid in taxes is greater for higher income levels. A progressive income tax exists, for example, if taxpayers with more income pay a larger proportion in taxes, that is, a higher tax rate. Suppose that Winston Smythe Kennsington III earns $10 million of income and pays $2 million in income taxes (20 percent) and that Pollyanna Pumpernickel earns $10,000 in taxes and pays $1,000 in income taxes (10 percent). Because Winston pays a greater proportion of income in taxes than Pollyanna, the income tax is progressive.

  • Regressive: A regressive tax is one in which the proportion of income paid in taxes is smaller for higher income levels. A regressive income tax exists, for example, if taxpayers with more income pay a smaller proportion in taxes, that is, a lower tax rate. Suppose that Winston Smythe Kennsington III earns $10 million of income and pays $1 million in income taxes (10 percent) and that Pollyanna Pumpernickel earns $10,000 in taxes and pays $2,000 in income taxes (20 percent). Because Winston pays a smaller proportion of income in taxes than Pollyanna, the income tax is regressive.

The Politics of Proportionality

Taxes are never far removed from politics. Few members of society actually like paying taxes. Most do so only reluctantly knowing that government provides valuable public goods. Almost everyone, though, prefers that someone else pays the taxes.

As such, while the use of proportional taxes would seem to be a fair and reasonable approach to generating the funds needed for government operations, most taxes end up being either regressive or progressive. Those on the upper end of the income spectrum tend to prefer regressive taxes and those on the lower end tend to prefer progressive taxes.

To the extent that people with conservative political leanings also occupy the upper end of the spectrum, they also tend to favor more regressive taxes, while opposing more progressive taxes. To the extent that people with liberal political leanings also occupy the lower end of the spectrum, they also tend to favor more progressive taxes, while opposing more regressive taxes.

With political power ebbing and flowing between conservative and political views, so too taxes ebb and flow between regressive and progressive, seldom settling on proportional.

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Recommended Citation:

PROPORTIONAL TAX, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: September 23, 2018].


Check Out These Related Terms...

     | tax proportionality | progressive tax | regressive tax | taxation principles | taxation basics | tax effects | revenue effect | allocation effect | tax equity | ability-to-pay principle | benefit principle | horizontal equity | vertical equity | tax efficiency | tax incidence | tax wedge | deadweight loss |


Or For A Little Background...

     | taxes | government functions | equity | distribution standards | public finance | public goods | political views |


And For Further Study...

     | political views | public choice | good types | market failures | public goods: demand | public goods: efficiency | tax multiplier | personal tax and nontax payments | transfer payments |


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