.jpeg)
Tax Systems
Tax systems are generally classified into four types. A brief introduction to each is as follows:
1. Progressive Tax
A progressive tax system is one in which the tax rate increases as a person's income rises and decreases as income falls. In this system, individuals with higher income levels pay a higher tax rate, whereas those with lower incomes pay a lower rate.
The tax rate increases proportionally with income, making it a progressive system.
This is illustrated in Table 5.1.
Table 5.1: Progressive Tax
| Income (in NPR) | Tax Rate (%) | Tax Amount (in NPR) |
|---|---|---|
| 5,000 | 5 | 250 |
| 10,000 | 10 | 1,000 |
| 15,000 | 15 | 2,250 |
According to Table 5.1, when the income is NPR 5,000, the tax rate is only 5%, resulting in a tax amount of NPR 250. As income increases to NPR 10,000 and NPR 15,000, the tax rate also rises progressively from 5% to 10% and then to 15%, causing the tax amount to increase to NPR 1,000 and NPR 2,250, respectively.
This demonstrates a positive relationship between income and tax rate.
Advantages of Progressive Tax:
The tax rate can be adjusted as needed.
This system allows for higher revenue collection even with minimal administrative costs.
It helps reduce income inequality between the rich and the poor.
Wealthier individuals contribute more, while those with lower income pay less.
Disadvantages of Progressive Tax:
It may discourage high-income earners, reducing savings and investments.
High tax rates may lead to tax evasion.
The tax rates may change frequently, making the system less stable.
2. Proportional Tax
A proportional tax system applies the same tax rate to all taxpayers, regardless of their income level. While the tax rate remains constant, the actual tax amount varies based on income levels.
This is illustrated in Table 5.2.
Table 5.2: Proportional Tax
| Income (in NPR) | Tax Rate (%) | Tax Amount (in NPR) |
|---|---|---|
| 5,000 | 10 | 500 |
| 10,000 | 10 | 1,000 |
| 15,000 | 10 | 1,500 |
In Table 5.2, individuals earning NPR 5,000, NPR 10,000, and NPR 15,000 all face the same tax rate of 10%.
However, the tax amount they pay differs: NPR 500, NPR 1,000, and NPR 1,500, respectively.
Advantages of Proportional Tax:
It is easy to implement since the tax rate remains uniform.
A uniform tax rate across all income levels reduces the likelihood of tax evasion.
Tax collection is straightforward, as everyone is taxed at the same rate.
Disadvantages of Proportional Tax:
It lacks the principle of tax equity, as everyone pays the same rate regardless of financial status.
The system is less flexible.
The tax burden is the same for both rich and poor, which can increase income inequality.
3. Regressive Tax
A regressive tax system applies a decreasing tax rate as income increases. This system is considered socially unjust, as higher-income individuals pay a lower tax rate while lower-income individuals bear a higher tax burden.
No country officially adopts a regressive tax system. It is illustrated in Table 5.3.
Table 5.3: Regressive Tax
| Income (in NPR) | Tax Rate (%) | Tax Amount (in NPR) |
|---|---|---|
| 5,000 | 15 | 750 |
| 10,000 | 10 | 1,000 |
| 15,000 | 5 | 750 |
In Table 5.3, when income is NPR 5,000, the tax rate is 15%, resulting in a tax amount of NPR 750. As income increases to NPR 10,000 and NPR 15,000, the tax rate decreases progressively to 10% and 5%, respectively.
This results in an increase in tax amount to NPR 1,000 before decreasing back to NPR 750.
Advantages of Regressive Tax:
Lower tax rates on higher incomes encourage economic activities.
It incentivizes people to earn more since higher income results in lower tax rates.
Disadvantages of Regressive Tax:
It disproportionately burdens low-income individuals, making them financially vulnerable.
It increases income and wealth inequality in society.
4. Digressive Tax
A digressive tax system is a hybrid between progressive and proportional taxation. Under this system, tax rates increase with income up to a certain threshold, beyond which the rate becomes constant.
This means lower-income individuals pay lower tax rates, while middle-income earners experience an increasing tax rate. However, after reaching a specific income level, the tax rate stops increasing and remains fixed.
This is illustrated in Table 5.4.
Table 5.4: Digressive Tax
| Income (in NPR) | Tax Rate (%) | Tax Amount (in NPR) |
|---|---|---|
| 5,000 | 5 | 250 |
| 10,000 | 10 | 1,000 |
| 15,000 | 12 | 1,800 |
| 20,000 | 12 | 2,400 |
In Table 5.4, individuals earning NPR 5,000 pay a tax rate of 5%, resulting in a tax amount of NPR 250. As income increases to NPR 10,000, the tax rate rises to 10%, leading to a tax payment of NPR 1,000. At an income level of NPR 15,000, the tax rate increases to 12%, resulting in NPR 1,800 in taxes.
However, beyond NPR 15,000, the tax rate stabilizes at 12%, ensuring that high-income earners do not experience further tax rate hikes.
Advantages of Digressive Tax:
It combines the benefits of both progressive and proportional tax systems.
It provides initial tax relief to lower-income individuals while ensuring fair contributions from middle-income earners.
The fixed upper tax rate prevents excessive tax burdens on high-income groups, reducing incentives for tax evasion.
It maintains economic stability by avoiding excessively high tax rates on higher earnings.
Disadvantages of Digressive Tax:
It may not be as effective in addressing income inequality as a fully progressive system.
The threshold at which the tax rate becomes constant may be difficult to determine fairly.
It may create complexities in tax administration due to the mixed structure of progressive and proportional taxation.
The digressive tax system is an attempt to balance equity and efficiency by ensuring fair contributions from different income groups while preventing excessively high taxation on wealthier individuals.
Graphical Representations of Each Systems of Tax
The graph 5.0 illustrates the relationship between income and tax rate across four different tax systems: Progressive Tax, Proportional Tax, Regressive Tax, and Digressive Tax. Each tax system applies a different method of taxation, leading to variations in the tax burden on individuals with different income levels.
The trends in the graph 5.0 depict how tax rates change as income increases.
Graph 5.0: Progressive Tax, Proportional Tax, Regressive Tax, and Digressive Tax
Progressive Tax
The progressive tax system follows an upward-sloping trend, as shown in the graph. This system imposes an increasing tax rate as income rises, ensuring that individuals with higher income contribute a larger percentage of their earnings in taxes. In the graph, the tax rate starts at 5% for NPR 5,000, increases to 10% for NPR 10,000, and reaches 15% for NPR 15,000. This reflects a positive correlation between income and tax rate, emphasizing income redistribution by taxing the wealthy more and easing the burden on lower-income earners.
Proportional Tax
The proportional tax system is represented by a flat horizontal line in the graph. This system maintains a constant tax rate regardless of income level. Here, every taxpayer is charged a fixed rate of 10%, ensuring that all income groups contribute an equal proportion of their earnings in taxes. While simple and easy to administer, this system does not consider income inequality, as the tax burden remains uniform across different income levels.
Regressive Tax
The regressive tax system exhibits a downward-sloping trend in the graph. Unlike progressive taxation, this system reduces the tax rate as income increases, imposing a heavier burden on lower-income groups. The graph illustrates how the tax rate starts at 15% for NPR 5,000, decreases to 10% for NPR 10,000, and further drops to 5% for NPR 15,000. This results in a system that benefits higher-income individuals while placing a greater financial strain on those with lower earnings, thereby exacerbating economic inequality.
Digressive Tax
The digressive tax system, as seen in the graph, follows a partially progressive pattern before stabilizing at a fixed rate. Initially, the tax rate increases from 5% for NPR 5,000 to 7% for NPR 10,000, but remains unchanged at 7% for NPR 15,000. This approach ensures that lower-income earners pay a lower rate, while higher earners experience a moderate tax rate that does not escalate indefinitely. The digressive tax balances elements of both progressive and proportional taxation, offering flexibility in tax collection while preventing excessively high tax rates on upper-income groups.
The Economic Frontline is a knowledge-driven platform offering thoughtful economic perspectives, policy-focused, and analytical content on national and global financial trends.
