Understanding Regressive Taxes: What You Should Know
Assessing taxes is complicated. Local, state and federal governments need to tax citizens so that they can pay for the programs and services those citizens need. Not everyone can — or should — be taxed at the same rate. However, governments use regressive taxes in some situations, so it’s important to understand how these work.
Here’s what you need to know.
Learn: 3 Ways Smart People Save Money When Filing Their Taxes
What Is a Regressive Tax?
A regressive tax is one that is assessed at the same rate to everyone, regardless of their income. They are also sometimes called flat taxes.
While it may seem to be a fair way to impose a tax, it ends up being creating a greater burden on those who have lower incomes, because they pay a higher percentage of their income toward that tax.
What Is an Example of a Regressive Tax?
There are several regressive taxes in the U.S., some more common than others.
A sales tax is a regressive tax. Typically, sales tax is imposed at the same rate no matter the size of the purchase or the income of the person who is purchasing the item. Some items, such as food and clothing, may be exempt from sales tax, but they are exempt for everyone.
Suppose two taxpayers who live in a state with a 5% sales tax each purchase a new television for $500. Each person pays $25 in tax when they purchase their new TV. Taxpayer A earns $250,000 per year, so the tax they paid on their television is 0.01% of their annual income. Taxpayer B earns $25,000 per year, so the tax they paid on the same television represents 0.10% of their annual income.
The argument could be made that wealthier people buy more things, and therefore pay a larger share of the total amount of sales tax that may be collected by any given state. That is true, but a sales tax is still regressive, since it levies the same amount of tax on each item purchased, regardless of the income level of the purchaser.
Gas taxes are also regressive. The same dollar amount of tax is levied on every gallon of gasoline, regardless of who purchases it. A uniform gas tax per gallon is more burdensome on lower earners than it is on higher earners — especially because many people have no choice about whether to buy gas or not.
Payroll taxes are also regressive because the same percentage is applied to every wage earner.
In 2023, the combined payroll tax for the employee’s share of Medicare and Social Security is 7.65%, of which 6.2% is for Social Security and 1.45% is for Medicare — the employer also pays 7.65% for each employee. However, only the first $160,200 of wages is subject to Social Security tax, meaning that those making more than that are paying an even lower percentage of their income for this tax.
Those earning over $200,000 per year pay an additional 0.9% in Medicare tax; however, this is more than offset by the cap on the Social Security tax.
Products like alcohol and tobacco and earnings from gambling are subject to “sin” taxes. Because these are taxed at a flat rate, they are also regressive taxes.
Some Income Taxes
Some states and municipalities have a regressive tax on income. If there is a single state or local income tax rate for all taxpayers, that is a regressive tax.
Progressive taxes are proportionally higher for those with higher incomes. They are proportionally lower for those with lower incomes.
The federal income tax in the United States is a progressive tax. The higher your income, the higher percentage you pay on each additional dollar of income. Remember that a higher tax bracket doesn’t mean that you pay that higher percentage on every dollar of income.
It is important to understand the difference between regressive and progressive taxes. At first glance, it may seem that a regressive tax would be more “fair,” since everyone gets taxed the same dollar amount or the same percentage. But a regressive tax places a higher burden on those with lower incomes.
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- Internal Revenue Service. 2023. "Topic No. 751 Social Security and Medicare Withholding Rates."
- Personal Capital. "Regressive Tax."