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What is Progressive Tax?

Some politicians have recently been talking about making the U.S. federal tax system more progressive. Under a progressive tax system, high-income taxpayers pay a larger share of the overall tax burden than low-income taxpayers.

Why Progressive Tax is Important

This subject is important because low-income taxpayers spend a larger proportion of their income on basic living expenses like food, clothing, shelter and transportation. The taxes they pay have a greater impact on their standard of living than they do on high-income taxpayers, most of whom can easily afford to pay for the basics. Instead, the taxes paid by the wealthy generally impact their ability to invest in the financial markets or buy luxury items.

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The federal government uses progressive tax as a way to lower income inequality. Progressive tax generally refers to income tax and tax credits and deductions. The taxes paid by individuals and families become progressively higher or lower depending on their income. Tax credits and deductions offset taxes even further.

How Does Progressive Tax Work?

Progressive taxation is achieved by taxing earned income at progressively higher rates as it increases. The federal marginal income tax brackets tax each dollar of income at a certain rate that rises as the taxpayer’s income rises. The faster tax rates rise in relation to increases in income, the more progressive a tax system is.

The Tax Cuts and Jobs Act created seven marginal income tax brackets at the federal level, abd the tax rate increases as the amount of income earned increases. Therefore, lower-income taxpayers pay a lower tax rate than higher-income taxpayers.

Is the U.S. Tax System Progressive?

In a progressive tax system, the wealthy will pay a larger overall share of taxes than those who earn less. So how progressive is the U.S. tax system?

According to the Tax Foundation, the bottom half of taxpayers earned 11.6% of all the income that was earned in the U.S. in 2016 and paid 3% of income taxes that year. Conversely, the top 1% of taxpayers earned 19.7% of income and paid 37.3% of income taxes that year. In addition, the top 1% of taxpayers paid more money in income taxes in 2016 than the bottom 90% of taxpayers, who paid 30.5% of income taxes that year.

In addition, the average income tax rate of the bottom half of U.S. taxpayers in 2016 was 3.7%. Conversely, the average income tax rate of the top 1% of U.S. taxpayers in 2016 was 26.9%, or more than seven times higher than the average rate paid by the bottom half of taxpayers.

If the U.S. tax system were not progressive, different income groups would pay a more similar share of total taxes. However, this isn’t the case, which means that the U.S. system is a progressive tax system.

Why Progressive Tax Systems Are Advantageous

Progressive tax systems are generally considered to be advantageous because they lower the tax burden on citizens who can least afford to pay taxes. At the same time, they permit citizens who possess the most resources — and hence, can better afford to pay taxes — to pay for more of the government services we all use.

Suggested Next Steps for You

  1. Want to learn more about a tax-efficient financial life? Read our free tax guide, 5 Tax Hacks for Investors.
  2. Sign up for free financial tools to calculate your net worth, assess your retirement readiness, track your cash flow, and analyze your portfolio.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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