Progressive Tax: Merits and Demerits | Public Finance

Let us learn about the merits and demerits of progressive tax in economics.

A progressive tax is one which charges different tax rates on different incomes. Under this system, the higher the income the higher the rate of taxes. All modern economies have adopted progressive taxation because of certain advantages of it.

These are:

In the first place, progressive taxes are equitable because rich people pay more taxes as they have greater ability to pay. Rich people are taxed at a higher rate than the poor because the ability to pay of the former increases as their incomes rise.

Secondly, as progressive taxes are based on the ability to pay principle, it tends to reduce disparities in the distribution of income and wealth.

Thirdly, a progressive tax is productive as it yields more revenue.

Fourthly, it is economical in the sense that its costs of collection tend to be lower.

Fifthly, it is elastic. A rise in income during prosperity is automatically taxed at a higher rate and a fall in income during recession is taxed at a lower rate.

Finally, progressive taxation is viewed as an engine of social improvement. It is such rate of taxes that narrows down the differences between the rich and the poor people of the society. It not only helps social improvement by achieving a more equitable distribution of income but also by financing socially desirable expenditures.

But progressive taxation has certain disadvantages.

These are:

In the first place, the benefit principle of taxation goes against the progressive taxation system. The benefit principle states that he who receives greater benefit from the government activities should pay higher tax rate. Usually, poor people are the largest beneficiaries and, hence, they should be taxed more.

Secondly, progressive taxation dampens incentive to work and save and, thus, it lowers capital formation. Rich people save more than the poor. Now, if the rich is taxed more following the progressive system of taxation, the incentive to work of the rich people to work more will suffer, because they know that they will be taxed more if they work more. Consequently, their savings and, hence, capital formation, will suffer.

Finally, there is a greater scope for tax evasion in the case of progressive tax. It is the higher rate of taxes that encourages taxpayers to evade their income by making false declarations of their incomes.

Although these criticisms are partly valid, the case for progressive taxation in any country has not been weakened. Its popularity lies in its real advantages.