Definition: A proportional tax is a tax that is charged at a flat rate. Every individual pays the same percentage of tax under this system. In other words, a proportional tax does not vary with the level of income.
What does Proportional Tax mean?
A proportional tax system does not differentiate between different levels of income. A person earning $25,000 per year would pay the same percentage of income as tax as an individual who makes ten times as much. On the surface, this may seem to be a fair system. After all, everybody pays the same rate of tax. There is no discrimination or bias, and each person’s income is taxed at the same percentage. However, if you dig a little deeper, a proportional tax may be regressive. To understand this point, we must first grasp the meaning of a regressive tax. This type of tax favors high-income earners at the expense of those who earn less. A person who earns $300,000 a year would spend a small portion of this sum on essentials. But an individual who makes only $24,000 a year would allocate most of the money towards necessities. It’s not fair to tax them at the same rate. If the proportional tax rate were 20%, the person earning $300,000 would pay tax of $60,000 and have $240,000 left over. On the other hand, the post-tax income of the person making $24,000 a year would be only $19,200. That’s a meager amount, and it is for this reason that proportional taxation is considered to be regressive.
Example of Proportional Tax
Samuel works as an accountant at a large firm. He earns a salary of $40,000 a year. Under the proportional tax system in force, he is left with $32,000 a year. This is calculated in the following manner: ⇨ Proportional tax rate: 20% ⇨ Tax on $40,000: 20% of $40,000 = $8,000 ⇨ Income after paying tax: $32,000 ($40,000 – $8,000) Samuel is happy about the fact that when his income goes up, he will continue to be taxed at the same rate of 20%. A progressive tax would have meant that the rate would have increased with an increase in income.
A proportional tax rate remains unchanged regardless of the level of income. In many ways, this is unfair because high-income earners pay the same percentage of tax as those who earn less.