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Taxes are differentiated by the effect they have on the allocation of income and wealth. A proportional tax is a tax that imposes the same relative liability on each taxpayer—i.e., in the case where tax liability and income increase in equal levels. A progressive tax is characterizable by a higher than proportional rise in the tax liability in relation to the growth in income, and a regressive tax is recognisable by a less than proportional growth in the related onus. So, progressive taxes are regarded as removing a lack of equality in income distribution, while regressive taxes are believed to have the effect of increasing these inequalities.

The taxes that are normally believed to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, might become less so within the upper-income class—in particular if a taxpayer is able to lower his tax base by claiming deductions or by excluding particular income components from his taxable income. Proportional tax rates that are applied to lower-income demographics could also be more progressive if exemptions of a personal nature are made.

Income measured over the period of a year might not absolutely provide the most appropriate measure of taxpaying ability. For example, transitory increases in income could be saved, and within temporary declines in income a taxpayer may elect to provide for consumption by reducing savings. Therefore, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (with the exception of luxuries) are mostly regressive, because the share of individual income consumed or spent for a specific good lessens as the rate of personal income rises. Poll taxes (also known as head taxes), levied as a set amount per capita, patently are regressive.

It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of a lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden lays essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic purposes of taxation, it is necessary to differentiate between several ideas of tax rates. The statutory rates will be specified in the legislation; commonly these are marginal rates, but in some cases they are median rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income is increased by one dollar. Therefore, if tax burden rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that rise as income grows. Heavy analysis of marginal tax rates should consider provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points more than nominated within the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, as it may be reliant on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem holds that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates indicate the fraction of total income that is demanded in taxation. The pattern of average rates is the one that is necessary for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households can dwarf these effects, forcing regressivity, as displayed by average tax rates that lower as income increases.

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