Regressive tax is one of two main types of tax systems utilized by a country. Under a regressive tax system, taxes are assessed uniformly on everyone regardless of their income.
Most nations, including the U.S., feature both regressive and progressive tax systems. For example, our income tax system is progressive, but there are also a number of regressive taxes that are assessed at the federal, state, and local levels.
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Impact of Regressive Tax on Low Earners
Regressive tax is generally considered to have a disproportionate impact on those who earn the least amount of money because it doesn’t factor income into the equation. Instead, the tax is applied uniformly to everyone in all situations. This results in low earners paying a higher percentage of their total income in taxes than high earners.
For example, according to the Consumer Expenditures Report published by the Bureau of Labor Statistics, the bottom 20% of U.S. households from an income standpoint spend 15% of their household income on food and 35% on shelter and utilities. In comparison, the top 20% of U.S. households from an income standpoint spend just 11% of their household income on food and 33% on shelter and utilities.
Assessing the same amount of tax on both income groups makes it more difficult for lower-earning individuals and families to afford the basic essentials of living. As a result, low-earners also tend to save less money for retirement.
According to the Consumer Expenditures Report, the bottom 20% of U.S. households saved just 2% of their income for retirement in 2015 while the top 20% of U.S. households saved 14% of their income for retirement that year.
Read More: The Average 401k Balance By Age
Examples of Regressive Taxes
Income taxes in the U.S. are progressive taxes because the more money an individual or family earns, the higher their tax rate will be. Following are some common taxes that are regressive.
- Sales taxes — Sales taxes are charged by states and localities as a percentage of the sale price whenever most items are purchased (groceries and prescription drugs are the main exceptions). These taxes are regressive because they consume a larger percentage of low-income families’ total household income.
- “Sin” taxes — A form of sales tax, these are taxes levied on products considered to be harmful, such as alcohol, tobacco and gambling. They usually take up a larger percentage of the income of low earners than more wealthy families and individuals. For example, the bottom 20% of U.S. households from an income standpoint allocate 1.3% of spending to cigarettes while the top 20% of U.S. households allocate just 0.3% of their income to cigarettes.
- Property taxes — These are assessed on the purchase of real estate, such as a primary residence. While they are fundamentally regressive, property taxes generally aren’t considered to be purely regressive because low-income households tend to live in less-expensive homes than high-income households. Therefore, they usually end up spending a lower percentage of their income in these taxes.
- Gasoline taxes — The federal gasoline tax is 18.4 cents per gallon while the average state gasoline tax is 27.8 cents per gallon. The gas tax isn’t as regressive as cigarette taxes: The bottom 20% of U.S. households from an income standpoint allocate 4% of spending to gasoline while the top 20% of U.S. households allocate 3% of their spending to gasoline.
- Payroll taxes — All employees pay 6.2% of their income in Social Security payroll taxes until income reaches a certain level ($137,700 in 2020). Since the payroll tax rate is the same for everyone, payroll taxes are regressive because they hit low-income families and individuals harder than wealthier families and individuals.
- User fees — Not technically considered taxes, these are fees charged by the government for the use of public facilities or services. They include fees paid to drive on toll roads and bridges, entry fees to national parks and museums, vehicle registration and driver’s license fees, building permits and inspection fees.
- Tariffs — These are excise taxes paid on goods imported into the country. Retailers raise the price of goods to cover the tax, which effectively passes the tax on to consumers. In the U.S., tariffs are mainly imposed on food, clothing, chemicals and manufactured goods, except on imports from countries with which we have free trade agreements.
Most nations use a combination of regressive and progressive tax systems, not just one. Therefore, it usually isn’t an all-or-nothing situation.
Read More: Your Guide to Filing Taxes in 2021
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Personal Capital compensates Brian E. Leyde (“Author”) for providing the content contained in this blog post. The information and content provided herein is general in nature and is for informational purposes only. Individuals should contact their own professional tax advisors or other professionals to help answer questions about specific situations or needs prior to taking action based on this information. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation. 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.