regressive tax

regressive tax definition - business

regressive tax

A tax that has a rate that declines as the amount to be taxed increases. In terms of income, federal and state taxation of cigarettes is regressive because low-income smokers pay a higher rate of taxation in terms of their income than high-income smokers do. A system of regressive taxation tends to free more funds for investment because high-income individuals tend to save a greater portion of their income. However, a regressive tax is often considered socially and politically unacceptable. Compare progressive tax.

Why is the payroll tax that funds Social Security and Medicare considered a regressive tax?

Social Security tax is paid on income up to a certain level. For instance, in 2008 an individual paid the statutory tax rate of 6.2% on all income up to $102,000, for a maximum tax of $6,324. Taxes paid on income up to a fixed level are not regressive—everyone pays the same percentage rate, based on income. However, for someone who earned above $102,000 in 2008, the actual average tax rate paid was less than 6.2%. For example, a person who earned $204,000 would have paid the maximum tax of $6,324, or only 3.1% of income. This makes the tax regressive—the more you earn, the lower your tax rate is as a percent of your income.

Medicare taxes are not regressive; everyone pays the same percentage of their earnings, and there is no cap on income. Medicare taxes would be considered a proportional tax.

Michael W. Butler, PhD, Professor of Economics, Angelo State University, San Angelo, Texas

The American Heritage® Dictionary of Business Terms Copyright © 2009 by Houghton Mifflin Harcourt Publishing Company. Published by Houghton Mifflin Harcourt Publishing Company. All rights reserved.

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