Income taxes can be difficult to understand, particularly for people in one of the highest tax brackets, where tax calculations tend to be more complex than those in the lowest tax brackets.
At CMP, we help taxpayers every day, and one of the questions we are often asked is how a progressive tax code works. It’s a worthwhile question that gets to the heart of how and why we pay income taxes.
We’ve created this guide to help you understand what a progressive tax code is and how progressive taxation works, with comparisons to other tax structures and pros and cons for you to consider.
What is Progressive Tax?
A progressive tax system is one where the percentage of income tax paid increases proportionately to the individual’s taxable income. It places a greater tax responsibility on high-income taxpayers while allowing low-income taxpayers to pay less. The thinking behind a progressive tax system is that when all earners pay the same percentage, it impacts low-income families more negatively because they may be living from paycheck to paycheck and struggling to make ends meet.
The United States has a progressive income tax system at the federal level. A progressive tax may be differentiated from two other forms of taxation: the flat tax and the regressive tax. We will compare the progressive tax to each of these options later in this post.
How Does Progressive Tax Work?
Progressive taxes work by creating a tiered pay table for income taxes, assigning low rates to people in the lowest income levels, and a larger share of the tax burden to those who earn the most taxable income. It may help to look at the 2023 tax rate brackets for US federal income taxes as an example.
- 37% for individuals with taxable income greater than $578,125 ($693,750 for married couples filing jointly.)
- 35% for taxable income above $231,250 ($462,500 if married and filing jointly.)
- 32% for taxable income above $182,100 ($364,200 if married and filing jointly.)
- 24% for taxable income above $95,375 ($190,750 if married and filing jointly.)
- 22% for taxable income over $44,725 ($89,450 if married and filing jointly.)
- 12% for taxable income over $11,000 ($22,000 if married and filing jointly.)
- 10% for taxable income under $11,000 (under $22,000 if married and filing jointly.)
Taxes are calculated based on each income tier for people in every bracket except the lowest. Someone earning $600,000 per year would pay 10% on the first $11,000 they earned, 12% on the next $34,725, and so on. Only income over $578,125 would be taxed at the 37% rate. As a taxpayer’s income increases, so does the percentage of income tax they pay.
What Are the Different Types of Progressive Taxes?
The US federal income tax is not the only progressive tax. There are several types. Here are the most common examples:
- Estate tax: The estate tax typically applies only to situations where the value of the deceased person’s estate is above a number set by the government. The excluded amount for 2023 is $12,060,000, so only estates larger than that are required to pay the estate tax, which can range from 18% to 40%.
- Capital gains tax: Taxes on long-term capital gains are tiered, with levels at 0%, 15%, and 20%, depending on your taxable income.
- Investment income tax: Taxes apply to people who make money on income-generating investments and typically only apply to higher-income individuals and families.
- Rental earnings: Taxes on rental earnings are not progressive in the same way federal income taxes are. Still, they tend to apply only to people who invest in rental properties, usually high-income individuals. Be sure that you understand how taxes on rental come work.
- Tax on interest earned: You must report any interest you earn over $10 to the IRS and pay taxes on it. This tax is progressive in that people with high incomes are more likely to earn significant amounts of interest and thus be required to pay taxes on it.
In addition to progressive taxes, there are also credits that phase out as income rises. A family who claimed the Child Tax Credit because they had less than $200,000 ($400,000 if filing a joint return) of income would no longer be eligible for that credit if their income increased sufficiently.
Pros and Cons of Progressive Tax System
There are advantages and disadvantages of a progressive tax system. Here are some things to consider, starting with the pros.
- Progressive taxes lower the tax burden for those who earn the least money. Since a lower-income person must spend a higher percentage of their income on basics such as rent and groceries, paying lower taxes gives them more money to spend on essentials, thus stimulating the economy.
- Progressive taxes allow the government to collect more money than a regressive tax or flat tax, thus providing necessary funds for infrastructure and other things that benefit everyone.
- Progressive taxes require those who earn the most money to take a proportional responsibility for paying for necessary programs and public services.
Here are the arguments against a progressive tax system:
- Opponents feel that a progressive tax may act as a disincentive to hard work because people know that if they work hard and increase their income, they’ll need to pay more taxes.
- On a related note, critics of a progressive tax see it as a form of income redistribution that punishes not only the highest earners but the middle class as well. Many of these opponents would prefer a flat tax, which they see as more fair than a progressive tax.
Arguments on both sides provide a lively debate in the political realm, with the US tax code being revised frequently depending on which political party is in power.
Progressive Tax vs Regressive Tax
A regressive tax is the opposite of a progressive tax, meaning that it places a higher burden on low-income earners than it does on high earners. The percentage of the tax may not change, but the impact it has on low earners may be significantly higher than the impact on high earners.
Examples of regressive taxes include the following:
- Sales taxes
- Excise taxes
- Payroll taxes
- Property taxes
For example, someone earning the minimum wage and working 40 hours per week would earn only $15,080 annually. If they spent $5,000 of their annual income on taxable consumer goods and lived in a state with a 6% sales tax (slightly below the national average), they would spend just under 2% of their income in taxes.
By contrast, an earner who made $100,000 per year would pay only a tiny fraction of that percentage by spending the same dollar amount, so let’s increase the dollar amounts. For example, if they spent $15,000 on taxable goods, they would still pay less than 1% of their annual income on sales taxes.
Progressive Tax vs Flat Tax
A flat tax is a tax that has the same flat rate for everybody, regardless of income. In that sense, a flat tax may also be regressive because it significantly impacts people in the lowest income brackets more than those in the highest brackets.
A sales tax is an excellent example of a tax that is both flat and regressive. The flat tax has many proponents whose main argument in its favor is that it is fairer than a progressive tax. Every taxpayer is required to pay the same percentage. Another argument favoring flat taxes is that they incentivize people to work hard and increase their income and that they don’t disincentivize high earners from continuing to grow their income.
Many states have a flat income tax rate, including Arizona, Colorado, Idaho, Illinois, Indiana, Kentucky, Michigan, Mississippi, North Carolina, Pennsylvania, and Utah. Most others have a progressive state income tax, while a few have no income tax at all.
Staying Updated with Tax Laws and Changes
The United States tax code is highly complex and changes often, and Congress is responsible for levying taxes and creating rules around taxes. Because there are frequent changes on the federal level, it is essential to stay updated and ensure you understand what you owe.
If you take itemized deductions and have a complicated tax return, your best option is to work with a Certified Public Accountant who can help you understand the tax code and how it applies to you. A professional can also research tax deductions and income tax credits to ensure you take advantage of any that apply to you and ensure that you don’t overpay when you file your taxes.
Final Thoughts on Progressive Tax System
A progressive tax code like the one we use for federal taxes can be beneficial or frustrating depending on how much money you earn. For high earners, it’s essential to calculate your taxes correctly to make sure you’re not paying more than you need to.
Do you need assistance preparing and filing your taxes to minimize your tax burden and ensure you take advantage of every break, deduction, or credit available to you? CMP can help! Contact us today to learn about our income tax services and schedule a free consultation today.
