A progressive tax is a tax which takes a larger percentage from high-income earners than it does from low-income individuals; this means a person who is earning more will have a higher average tax rate. It is based on the concept of ability to pay. A progressive tax is one of many systems used by governments raise revenue.
The main idea of a progressive taxis controversial. Supporters of a progressive tax argue that people with higher incomes can more easily afford a higher tax burden and opponents tend to believe that it punishes high earners for their success and eliminates monetary incentives for workers who want to increase their income level. Progressive generally refers to the way in which tax rate moves from low to high. They reduce the burden of incidence of taxes that have a lower ability to pay and people bear the burden of taxation having higher ability o pay. This type of taxation also overcomes societal issues and deals with income inequality.
Tax rate increases with increase in income. Thus, high income and high net worth individuals are being taxed a larger amount overall. These higher taxes are in the form of other taxes such as a luxury tax or an estate tax.
A regressive tax is a tax which takes a larger percentage of income from low-income earners than from high-income earners. It is the opposite of a progressive tax. A regressive tax is generally a tax that applies uniformly to all situations, regardless of the payer. This means as income increases, the proportion of the income paid in tax decreases.
Regressive taxes affect the people with low incomes more severely than people with high incomes. Mostly, income tax systems employ a progressive tax system, while other types of taxes are uniformly applied. Examples of regressive taxes are sales taxes, user fees, excise duty etc.
Here, relatively a heavier burden (sacrifice involved) tends to fall upon the poor than on the rich. A regressive tax takes away a greater percentage of lower incomes as compared to higher incomes.
This curve is a graphical representation of the relationship between tax rates and tax revenues. This curve suggests that the revenues will decline after a certain tax rate.
The horizontal axis shows the tax rate and the vertical axis shows the revenue collected from taxes which go to the government. This curve shows the trade-off which government needs to decide between tax rate and tax revenue. The Laffer curve depicts two types of relationship. First, arithmetic i.e. when the tax rate increases, more revenue will be collected but this happens only till the peak tax rate which maximizes the revenue (T*). Second, economic i.e. tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all because of no incentive is left to work thereby reducing tax revenue. Eventually, if tax rates reached 100%, shown to the far right on this curve, all people would choose not to work because everything they earn will go to the government and nothing will be left with them. Thus, 0% tax rate and 100% generates no revenue at all. The economic effects recognize the positive impact of lower tax rates on work, output, and employment because it provides incentives to increase these activities. However, higher tax rates penalize people for engaging in these activities.
Thus, Laffer curve does not say whether a tax cut will raise or lower revenues, nor it says that any and all tax rate reductions would necessarily bring in total revenues but it tells us that tax rate reductions will always result in a smaller loss in revenues. This means that the higher the starting tax rate, the more effect it will have on the supply-side stimulus. It can be concluded that tax rate cuts will generate growth, jobs, and income for all which is desirable for the economy.
Therefore, the government needs to know that optimal tax rate (T*) which will maximize the revenue and also people will continue to work hard.
Automatic stabilizers describe the way in which fiscal instruments influence the rate of growth and help counter the fluctuations in any economic cycles. These are economic policies and programs which are designed to offset swings in a country’s economic activity without governmental intervention or policymakers on an individual basis because they govern and affect the economic behavior of the country. Some of the automatic stabilizers are corporate and personal taxes, and transfer systems like unemployment insurance and welfare.
Automatic stabilizers are popularly known as this because they stabilize the economic cycles and automatically triggers without explicit government action. An automatic stabilizer represents the tax and transfer systems which temper when there is overheating in an economy i.e. booms or recessions and provides economic solutions and decision-making process when the economy slumps without any direct intervention by policymakers.
Through an increase in transfer payments and reduced taxes, automatic stabilizers provide significant economic stimulus during and in the aftermath of any recession, which thus helps to strengthen other economic activity.
If a country takes an economic downturn and the number of people unemployed increases then more people file for unemployment benefits and other welfare measures, which thus increases government spending and aggregate demand. Also, the government revenue is falling because those who are unemployed are paying less tax as they are not earning any wage. Due to all this, the budget deficit increases. The deficit spending is used as a measure to boost economic activity so that the economy recovers and the government is able to recuperate the funds through increased employment and higher productivity.
Similarly, the budget deficit decreases during booms, thus making a fall in the aggregate demand. This happens because people are earning more wages during booms which enable the government to collect more taxes. Also, fewer individuals demand social services support during a boom. The decrease in spending lead to a decrease in the aggregate demand too. Therefore, automatic stabilizers try to manage and reduce the size of the fluctuations of the GDP of a country.