Tax Structure: Tax Base, Tax Rate, Proportional, Regressive, and Progressive Taxation

The tax structure of an economy depends on its tax base, tax rate, and how the tax rate varies. The tax base is the amount to which a tax rate is applied. The tax rate is the percentage of the tax base that must be paid in taxes. To calculate most taxes, it is necessary to know the tax base and the tax rate. So if the tax base equals $100 and the tax rate is 9%, then the tax will be $9 (=100 × 0.09). Proportional taxes (aka flat-rate taxes) apply the same tax rate to any income level, or for any size tax base. So if Bill earns $50,000 and Jane earns $100,000, and the tax rate is 10%, then Bill will owe $5,000 in taxes while Jane will owe $10,000. Many state income taxes and almost all sales taxes are proportional taxes. Social Security and Medicare taxes are also proportional since the same tax rate is applied to any earned income up to the Social Security wage base limit, which, for 2021, is $142,800. The Medicare tax is a proportional tax that applies to all earned income, = 2.9%. Flat taxes are a fixed amount and do not depend on income or transaction values, such as a $10 per capita tax.

A regressive tax is higher at lower incomes. The most prominent regressive tax is the Social Security tax, because the tax drops to 0, when earned income exceeds the Social Security wage base limit. Regressive taxes especially hurt the poor. The inequitable effects of regressive or proportional taxes are often mitigated by payments to the poor and by exempting essential products and services, such as food, from regressive and proportional taxes.

A progressive tax applies a higher tax rate to higher incomes. So if the tax rate on $50,000 is 10% and 20% for $100,000, then, continuing the above example, Bill still owes $5,000 in taxes while Jane must pay $20,000 in taxes. However, almost all progressive taxes are structured as a marginal tax, meaning that the progressive tax rate only applies to that part of the income exceeding a certain amount. The portion of the tax base subject to a particular tax rate, known as a tax bracket, always has lower and upper limits, except for the top tax bracket, which has no upper limit. To see the current rates published by the IRS, scroll down to the bottom of the current tax table from the instructions for Form 1040.

The new Republican tax policy, passed at the end of 2017, known as the Tax Cuts and Jobs Act, has changed the tax brackets for 2018 and afterwards. Congruent to the Republicans' tax objective to benefit the wealthy, most of the benefits in the change to tax brackets go to those who earn more than $200,000. The marriage penalty has also been eliminated for all tax brackets, except the top 2.

Upper Limits for Taxable Income Brackets
Tax
Brackets
10% 12% 22% 24% 32% 35% 37%
2021
Single $9,950 $40,525 $86,375 $164,925 $209,425 $523,600 Excess
Amount
over
35%
Bracket
HOH $14,200 $54,200 $86,350 $164,900 $209,400 $523,600
MFJ,
QSS
$19,900 $81,050 $172,750 $329,850 $418,850 $628,300
MP
2 2 2 2 2 1.2 1
2020
Single $9,875 $40,125 $85,525 $163,300 $207,350 $518,400 Excess
Amount
over
35%
Bracket
HOH $14,100 $53,700 $85,500 $163,300 $207,350 $518,400
MFJ,
QSS
$19,750 $80,250 $171,050 $326,600 $414,700 $622,050
MP
2 2 2 2 2 1.2 1
  • Source: IRS.gov
  • Note: Married Filing Separately = 1/2 of Joint Rate

Continuing the above example, if the 20% tax rate is only applied to that portion of the income between $50,000 and $100,000, then Jane would owe $5000 on the first $50,000 of income and $10,000 on the 2nd $50,000 of income, resulting in a total tax liability of $15,000.

Without marginal tax rates, a progressive tax would skew economic decisions and would be viewed as unfair. For instance, if the 20% tax rate was applied to all earned income and Jane only earned $60,000, then she must pay $12,000 in taxes, 2.4 times more than Bill's taxes, even though she only made 1.2 times more than Bill. To take a more extreme example, consider what happens if Jane makes $50,001. She must pay slightly more than $10,000 which is $5000 more than what Bill must pay, even though he earned only $1 less. Hence, without marginal tax rates, a pay increase could actually result in a decrease in disposable income. A person's tax bracket is the highest tax bracket applicable to her income level.

A progressive, marginal tax rate also makes economic sense, since money, like everything else, has a declining marginal utility. In other words, $1 is worth a lot more to someone who earns $10,000 per year than to someone who makes $10 million per year. Poor people need the money to buy essentials, whereas rich people spend their money for luxuries, so the wealthy can pay higher taxes without seriously lowering their standard of living.

Because of marginal tax rates, the tax rate that one actually pays is not knowable just from their tax bracket, so another rate, called the effective tax rate (aka average tax rate), is calculated by dividing the actual taxes paid by the tax base. In other words, the total tax calculated by multiplying earned income times the effective tax rate will equal the same tax calculated by multiplying the amount of income in each tax bracket by the respective marginal tax rate and summing them all up. So in example 2, since Jane earned $100,000 and paid $15,000 in taxes, her effective tax rate is 15% (= $15,000 ÷ $100,000).

The federal income tax and many state taxes are progressive. Although the federal income tax itself is progressive, the effective tax rate based on all taxes collected by the federal government is progressive only until the Social Security limit is reached. Thereafter, the effective tax rate either declines or levels off with increasing income, since people who make more than the Social Security limit do not have to pay the 12.4% Social Security rate on any income earned above the limit, as can be seen from the following table for a single person who is not a head of the household (Note: For a self-employed person, the tax code allows the deduction of the employer's half of the payroll tax, which results in a net self-employment tax of 14.13%. The tax code also allows the deduction of the employer's portion of the tax, the value of which depends on the taxpayer's marginal tax bracket, but since this does not change the effective tax rate very much, it is ignored in the table below. The following table assumes that a single person with no dependents pays the entire payroll tax, which is true for the self-employed, but also applies to employees. Even though employees technically only pay ½ of the payroll tax, most economists agree that most employees pay the other half through lower wages or through higher unemployment. For more info, see Tax Incidence: How The Tax Burden Is Shared Between Buyers And Sellers):

Earned
Income
Income
Tax
Payroll
Tax
Total
Tax
Effective
Tax
Rate
SE Tax SE Effective
Tax Rate
Effective
Marginal Rate
Capital
Gains Tax
Effective
Capital
Gains
Rate
Inheritance
$20,000 $745 $2,913 $3,658 18.29% $4,599 26.72% 3.73% $0 0.00% 0.00%
$40,000 $3,095 $4,703 $7,798 19.50% $7,425 26.30% 7.74% $0 0.00% 0.00%
$60,000 $6,188 $6,493 $12,681 21.13% $10,251 27.40% 10.31% $1,058 1.76% 0.00%
$80,000 $10,588 $8,283 $18,871 23.59% $13,077 29.58% 13.23% $4,058 5.07% 0.00%
$100,000 $15,009 $10,073 $25,082 25.08% $15,903 30.91% 15.01% $7,058 7.06% 0.00%
$120,000 $19,809 $11,863 $31,672 26.39% $18,729 32.12% 16.51% $10,058 8.38% 0.00%
$140,000 $24,609 $13,653 $38,262 27.33% $21,555 32.97% 17.58% $13,058 9.33% 0.00%
$160,000 $29,409 $13,212 $42,621 26.64% $22,329 32.34% 18.38% $16,058 10.04% 0.00%
$180,000 $34,411 $13,502 $47,913 26.62% $22,865 31.82% 19.12% $19,058 10.59% 0.00%
$200,000 $40,811 $13,792 $54,603 27.30% $23,514 32.16% 20.41% $22,058 11.03% 0.00%
$220,000 $47,211 $14,082 $61,473 27.94% $24,230 32.47% 21.46% $25,341 11.52% 0.00%
$240,000 $54,152 $14,372 $68,884 28.70% $24,946 32.96% 22.56% $29,101 12.13% 0.00%
$260,000 $61,152 $14,662 $76,354 29.37% $25,662 33.39% 23.52% $32,861 12.64% 0.00%
$280,000 $68,152 $14,952 $83,824 29.94% $26,378 33.76% 24.34% $36,621 13.08% 0.00%
$300,000 $75,152 $15,242 $91,294 30.43% $27,094 34.08% 25.05% $40,381 13.46% 0.00%
$320,000 $82,152 $15,532 $98,764 30.86% $27,810 34.36% 25.67% $44,141 13.79% 0.00%
$340,000 $89,152 $15,822 $106,234 31.25% $28,526 34.61% 26.22% $47,901 14.09% 0.00%
$360,000 $96,152 $16,112 $113,704 31.58% $29,242 34.83% 26.71% $51,661 14.35% 0.00%
$380,000 $103,152 $16,402 $121,174 31.89% $29,958 35.03% 27.15% $55,421 14.58% 0.00%
$400,000 $110,152 $16,692 $128,644 32.16% $30,674 35.21% 27.54% $59,181 14.80% 0.00%
$420,000 $117,152 $16,982 $136,114 32.41% $31,390 35.37% 27.89% $62,941 14.99% 0.00%
$440,000 $124,152 $17,272 $143,584 32.63% $32,106 35.51% 28.22% $66,701 15.16% 0.00%
$460,000 $131,152 $17,562 $151,054 32.84% $32,822 35.65% 28.51% $70,541 15.33% 0.00%
$480,000 $138,152 $17,852 $158,524 33.03% $33,538 35.77% 28.78% $75,301 15.69% 0.00%
$500,000 $145,152 $18,142 $165,994 33.20% $34,254 35.88% 29.03% $80,061 16.01% 0.00%
$520,000 $152,152 $18,432 $173,464 33.36% $34,970 35.99% 29.26% $84,821 16.31% 0.00%
$540,000 $159,229 $18,722 $181,011 33.52% $35,686 36.10% 29.49% $89,581 16.59% 0.00%
$560,000 $166,629 $19,012 $188,881 33.73% $36,402 36.26% 29.76% $94,341 16.85% 0.00%
$580,000 $174,029 $19,302 $196,751 33.92% $37,118 36.40% 30.00% $99,101 17.09% 0.00%
$600,000 $181,429 $19,592 $204,621 34.10% $37,834 36.54% 30.24% $103,861 17.31% 0.00%
$620,000 $188,829 $19,882 $212,491 34.27% $38,550 36.67% 30.46% $108,621 17.52% 0.00%
$640,000 $196,229 $20,172 $220,361 34.43% $39,266 36.80% 30.66% $113,381 17.72% 0.00%
$660,000 $203,629 $20,462 $228,231 34.58% $39,982 36.91% 30.85% $118,141 17.90% 0.00%
$680,000 $211,029 $20,752 $236,101 34.72% $40,698 37.02% 31.03% $122,901 18.07% 0.00%
$700,000 $218,429 $21,042 $243,971 34.85% $41,414 37.12% 31.20% $127,661 18.24% 0.00%
$720,000 $225,829 $21,332 $251,841 34.98% $42,130 37.22% 31.37% $132,421 18.39% 0.00%
$740,000 $233,229 $21,622 $259,711 35.10% $42,846 37.31% 31.52% $137,181 18.54% 0.00%
$760,000 $240,629 $21,912 $267,581 35.21% $43,562 37.39% 31.66% $141,941 18.68% 0.00%
$780,000 $248,029 $22,202 $275,451 35.31% $44,278 37.48% 31.80% $146,701 18.81% 0.00%
$800,000 $255,429 $22,492 $283,321 35.42% $44,994 37.55% 31.93% $151,461 18.93% 0.00%
$820,000 $262,829 $22,782 $291,191 35.51% $45,710 37.63% 32.05% $156,221 19.05% 0.00%
$840,000 $270,229 $23,072 $299,061 35.60% $46,426 37.70% 32.17% $160,981 19.16% 0.00%
$860,000 $277,629 $23,362 $306,931 35.69% $47,142 37.76% 32.28% $165,741 19.27% 0.00%
$880,000 $285,029 $23,652 $314,801 35.77% $47,858 37.83% 32.39% $170,501 19.38% 0.00%
$900,000 $292,429 $23,942 $322,671 35.85% $48,574 37.89% 32.49% $175,261 19.47% 0.00%
$920,000 $299,829 $24,232 $330,541 35.93% $49,290 37.95% 32.59% $180,021 19.57% 0.00%
$940,000 $307,229 $24,522 $338,411 36.00% $50,006 38.00% 32.68% $184,781 19.66% 0.00%
$960,000 $314,629 $24,812 $346,281 36.07% $50,722 38.06% 32.77% $189,541 19.74% 0.00%
$980,000 $322,029 $25,102 $354,151 36.14% $51,438 38.11% 32.86% $194,301 19.83% 0.00%
$1,000,000 $329,429 $25,392 $362,021 36.20% $52,154 38.16% 32.94% $199,061 19.91% 0.00%
$1,020,000 $336,829 $25,682 $369,891 36.26% $52,870 38.21% 33.02% $203,821 19.98% 0.00%
$1,040,000 $344,229 $25,972 $377,761 36.32% $53,586 38.25% 33.10% $208,581 20.06% 0.00%
$1,060,000 $351,629 $26,262 $385,631 36.38% $54,302 38.30% 33.17% $213,341 20.13% 0.00%
$1,080,000 $359,029 $26,552 $393,501 36.44% $55,018 38.34% 33.24% $218,101 20.19% 0.00%
$1,100,000 $366,429 $26,842 $401,371 36.49% $55,734 38.38% 33.31% $222,861 20.26% 0.00%
$1,120,000 $373,829 $27,132 $409,241 36.54% $56,450 38.42% 33.38% $227,621 20.32% 0.00%
$1,140,000 $381,229 $27,422 $417,111 36.59% $57,166 38.46% 33.44% $232,381 20.38% 0.00%
$1,160,000 $388,629 $27,712 $424,981 36.64% $57,882 38.49% 33.50% $237,141 20.44% 0.00%
$1,180,000 $396,029 $28,002 $432,851 36.68% $58,598 38.53% 33.56% $241,901 20.50% 0.00%
$1,200,000 $403,429 $28,292 $440,721 36.73% $59,314 38.56% 33.62% $246,661 20.56% 0.00%

The 2021 standard deduction of $12,550 for a single taxpayer was deducted from the earned income to calculate the income tax in the above table. However, payroll taxes applies to all earned income. As you can see from the chart below, the federal tax on earned income is not nearly as progressive as it might seem by just looking at marginal tax rates. It is also obvious that work is the most highly taxed form of income. Investment income subject only to the short-term capital gains rate is subject only to the marginal tax rate, which is also listed in 1 of the columns above; employment taxes do not apply. Investors receiving all of their income as long-term capital gains or from qualified dividends pay a much lower tax rate. These rates also do not include the many deductions that higher income taxpayers can take advantage of, so these are the maximum rates that would apply, based on income.

Chart showing the effective tax rates for self-employment income, employee income, income subject to only marginal tax, and income subject to only long-term capital gains tax, and for gratuitous transfers for a single taxpayer. Calculations include subtracting the standard deduction of $12,550 from income before calculating taxes, then adding any applicable 3.8% Net Investment Income Tax and the 0.9% Additional Medicare Tax.
Chart showing the effective tax rates for self-employment income, employee income, income subject to only marginal tax, and income subject to only long-term capital gains tax for a single taxpayer. Calculations include subtracting the standard deduction of $12,550 from income before calculating taxes, then adding any applicable 3.8% Net Investment Income Tax and the 0.9% Additional Medicare Tax. However, the standard deduction was added back to earned income to calculate payroll taxes, since the standard deduction cannot be used to calculate employment taxes.The effective tax rate shown in the above chart is the maximum tax rate. Higher-income taxpayers have many ways to lower this rate. A major disadvantage to the economy in not taxing gratuitous transfers and investment income more is that it allows more people not to work, which lowers the labor participation rate, which depresses economic output and slows the accumulation of real economic wealth.

The Wealthy Really Do Have It Better

The above table suggests that the wealthy pay a higher effective tax rate on their income than poorer people. However, because of favorable tax treatment for investment income and, especially for capital gains, and because large amounts of wealth can be transferred through gifts and inheritance (collectively, gratuitous transfers) tax-free, the wealthy actually pay a far lower effective tax rate if the taxes that they paid is divided by all their income, including investment income and inherited wealth.

For instance, IRS statistics frequently show that the top 400 taxpayers of the United States pay about 18% of their income in taxes, including payroll taxes that they may have paid. If you look at the above table again, you will note that a self-employed person who makes a mere $20,000 per year pays an effective tax rate of almost 18% — even after subtracting the standard deduction! Furthermore, hedge fund managers, some who make more than $1 billion per year, are exempted from paying any payroll taxes on their performance fee, which is usually most of their compensation if they are profitable, thanks to their Republican friends in Congress.

The largest single factor creating this inequity in taxation is the fact that earned income is the most highly taxed income, even though, for maximum economic growth, earned income should be the least taxed, because the higher price of wages due to these income taxes decreases the demand for labor while the lower amount received by the suppliers of this labor reduces supply — reducing economic growth through the deadweight loss of taxation. Indeed, only work increases the economic wealth of any society. Even investments cannot create true economic wealth unless it is used to put people to work, and transferred wealth actually reduces economic wealth because the recipients have a reduced incentive to work. Hence, the prudent economic policy of any government should be to tax work the least and gratuitous transfers the most.