The Lazy Economist: Breaking down tax systems

The mechanisms and justifications for each model

The three most popular tax systems are progressive, regressive, and proportional.

If there’s any constant in life, it's taxes.

Taxes are society's bank account. They're what we use to fund new roads, garbage services, and emergency responders. They also pay for programs like Canada's child benefit or employment insurance.

There are differing opinions about which income tax system is the most fair or in the best interest of taxpayers. If you want to gain a better understanding of the three main tax systems used globally, here's a breakdown.

Progressive taxes

A progressive system, which is used in Canada, means the tax rate a citizen is subject to depends on their income, with the tax rate rising simultaneously with income. The higher your income, the higher your tax rate. This means a larger proportionnot just dollar amountof high-income workers' earnings are taken for taxes.

Regressive taxes

A regressive tax is where the tax rate goes up as income goes down. As such, it's rarely used as an income tax system. Regressive taxes are seen most often with consumption taxes: an example of a regressive tax is the HST. If person A makes $10 and person B makes $1000, a sales tax of 13 per cent on a $5 purchase will take more of A's earnings than B’s.

In short, a higher proportion of low-income workers' earnings are taken—the opposite of a progressive system.

Proportional taxes

This system means every citizen has the same proportion of their income taxed. For example, every income group may be taxed at 15 per cent, an equal fraction among all. While the tax rate is the same, the dollar amount contributed by higher income groups will be more, since that 15 per cent is multiplied by a bigger number. The label "proportion" is a reminder that it comes down to the same share of everyone's income being taxed.

The debate about which income tax system should be used can often be contentious. However, a regressive tax is uncommon because a majority of people don't believe lower income earners should bear higher tax burdens.

As a result, it boils down to a choice between progressive or proportional systems.

Which system is favoured depends on whether someone believes in redistributing wealth to level the playing field, or establishing fair rules by treating everyone equally.

If a progressive system is in place, high income citizens pay more and their money is redistributed to fund more programs and services for all groups. If you believe some people start off economically disadvantaged, it would make sense to retroactively even everybody out.

Supporters of the proportional tax argue that higher earners shouldn't be penalized for what they've worked for and that it’s unfair for them to bear a higher burden when the burden should be evenly distributed.

Taxes will follow us until the day we die, and as they fund key programs and services, it's important to understand how they work.

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