An excise tax is the easiest tax to analyze, making it a good vehicle for understanding the general principles of tax analysis. However, in the United States today, excise taxes are actually a relatively minor source of government revenue. In this section, we develop a framework for understanding more general forms of taxation and look at some of the major taxes used in the United States.

Every tax consists of two pieces: a base and a structure. The tax base is the measure or value that determines how much tax an individual or firm pays. It is usually a monetary measure, like income or property value. The tax structure specifies how the tax depends on the tax base. It is usually expressed in percentage terms; for example, homeowners in some areas might pay yearly property taxes equal to 2% of the value of their homes.

Some important taxes and their tax bases are as follows:

Once the tax base has been defined, the next question is how the tax depends on the base. The simplest tax structure is a proportional tax, also sometimes called a flat tax, which is the same percentage of the base regardless of the taxpayer’s income or wealth. For example, a property tax that is set at 2% of the value of the property, whether the property is worth $10,000 or $10,000,000, is a proportional tax. Many taxes, however, are not proportional. Instead, different people pay different percentages, usually because the tax law tries to take account of either the benefits principle or the ability-to-pay principle.

Because taxes are ultimately paid out of income, economists classify taxes according to how they vary with the income of individuals. A tax that rises more than in proportion to income, so that high-income taxpayers pay a larger percentage of their income than low-income taxpayers, is a progressive tax. A tax that rises less than in proportion to income, so that higher-income taxpayers pay a smaller percentage of their income than low-income taxpayers, is a regressive tax. A proportional tax on income would be neither progressive nor regressive.

The U.S. tax system contains a mixture of progressive and regressive taxes, though it is somewhat progressive overall.

Most, though not all, people view a progressive tax system as fairer than a regressive system. The reason is the ability-to-pay principle: a high-income family that pays 35% of its income in taxes is still left with a lot more money than a low-income family that pays only 15% in taxes. But attempts to make taxes strongly progressive run up against the trade-off between equity and efficiency.

To see why, consider a hypothetical example, illustrated in Table 7-3. We assume that there are two kinds of people in the nation of Taxmania: half of the population earns $40,000 a year and half earns $80,000, so the average income is $60,000 a year. We also assume that the Taxmanian government needs to collect one-fourth of that income—$15,000 a year per person—in taxes.

One way to raise this revenue would be through a proportional tax that takes one-fourth of everyone’s income. The results of this proportional tax are shown in the second column of Table 7-3: after taxes, lower-income Taxmanians would be left with an income of $30,000 a year and higher-income Taxmanians, $60,000.

Even this system might have some negative effects on incentives. Suppose, for example, that finishing college improves a Taxmanian’s chance of getting a higher-paying job. Some people who would invest time and effort in going to college in hopes of raising their income from $40,000 to $80,000, a $40,000 gain, might not bother if the potential gain is only $30,000, the after-tax difference in pay between a lower-paying and higher-paying job.

But a strongly progressive tax system could create a much bigger incentive problem. Suppose that the Taxmanian government decided to exempt the poorer half of the population from all taxes but still wanted to raise the same amount of revenue. To do this, it would have to collect $30,000 from each individual earning $80,000 a year. As the third column of Table 7-3 shows, people earning $80,000 would then be left with income after taxes of $50,000—only $10,000 more than the after-tax income of people earning half as much. This would greatly reduce the incentive for people to invest time and effort to raise their earnings.

The point here is that any income tax system will tax away part of the gain an individual gets by moving up the income scale, reducing the incentive to earn more. But a progressive tax takes away a larger share of the gain than a proportional tax, creating a more adverse effect on incentives. In comparing the incentive effects of tax systems, economists often focus on the marginal tax rate: the percentage of an increase in income that is taxed away. In this example, the marginal tax rate on income above $40,000 is 25% with proportional taxation but 75% with progressive taxation.

Our hypothetical example is much more extreme than the reality of progressive taxation in the modern United States—although, as the upcoming Economics in Action explains, in previous years the marginal tax rates paid by high earners were very high indeed. However, these have moderated over time as concerns arose about the severe incentive effects of extremely progressive taxes. In short, the ability-to-pay principle pushes governments toward a highly progressive tax system, but efficiency considerations push them the other way.

Table 7-4 shows the revenue raised by major taxes in the United States in 2013. Some of the taxes are collected by the federal government and the others by state and local governments.

There is a major tax corresponding to five of the six tax bases we identified earlier. There are income taxes, payroll taxes, sales taxes, profits taxes, and property taxes, all of which play an important role in the overall tax system. The only item missing is a wealth tax. In fact, the United States does have a wealth tax, the estate tax, which depends on the value of someone’s estate after he or she dies. But at the time of writing, the current law phases out the estate tax over a few years, and in any case it raises much less money than the taxes shown in the table.

In addition to the taxes shown, state and local governments collect substantial revenue from other sources as varied as driver’s license fees and sewer charges. These fees and charges are an important part of the tax burden but very difficult to summarize or analyze.

Are the taxes in Table 7-4 progressive or regressive? It depends on the tax. The personal income tax is strongly progressive. The payroll tax, which, except for the Medicare portion, is paid only on earnings up to $117,000 is somewhat regressive. Sales taxes are generally regressive, because higher-income families save more of their income and thus spend a smaller share of it on taxable goods than do lower-income families. In addition, there are other taxes principally levied at the state and local level that are typically quite regressive: it costs the same amount to renew a driver’s license no matter what your income is.

Overall, the taxes collected by the federal government are quite progressive. The second column of Table 7-5 shows estimates of the average federal tax rate paid by families at different levels of income earned in 2013. These estimates don’t count just the money families pay directly. They also attempt to estimate the incidence of taxes directly paid by businesses, like the tax on corporate profits, which ultimately falls on individual shareholders. The table shows that the federal tax system is indeed progressive, with low-income families paying a relatively small share of their income in federal taxes and high-income families paying a greater share of their income.

Since 2000, the federal government has cut income taxes for most families. The largest cuts, both as a share of income and as a share of federal taxes collected, have gone to families with high incomes. As a result, the federal system is less progressive (at the time of writing) than it was in 2000 because the share of income paid by high-income families has fallen relative to the share paid by middle-and low-income families. And it will become even less progressive over the next few years, as some delayed pieces of the post-2000 tax cut legislation take effect. However, even after those changes, the federal tax system will remain progressive.

As the third column of Table 7-5 shows, however, taxes at the state and local levels are generally regressive. That’s because the sales tax, the largest source of revenue for most states, is somewhat regressive, and other items, such as vehicle licensing fees, are strongly regressive.

In sum, the U.S. tax system is somewhat progressive, with the richest fifth of the population paying a somewhat higher share of income in taxes than families in the middle and the poorest fifth paying considerably less.

Yet there are important differences within the American tax system: the federal income tax is more progressive than the payroll tax, which can be seen from Table 7-5. And federal taxation is more progressive than state and local taxation.

Why are some taxes progressive but others regressive? Can’t the government make up its mind?

There are two main reasons for the mixture of regressive and progressive taxes in the U.S. system: the difference between levels of government and the fact that different taxes are based on different principles.

State and especially local governments generally do not make much effort to apply the ability-to-pay principle. This is largely because they are subject to tax competition: a state or local government that imposes high taxes on people with high incomes faces the prospect that those people may move to other locations where taxes are lower. This is much less of a concern at the national level, although a handful of very rich people have given up their U.S. citizenship to avoid paying U.S. taxes.

Although the federal government is in a better position than state or local governments to apply principles of fairness, it applies different principles to different taxes. We saw an example of this in the preceding Economics in Action. The most important tax, the federal income tax, is strongly progressive, reflecting the ability-to-pay principle. But the second most important tax, the federal payroll tax, or FICA, is somewhat regressive, because most of it is linked to specific programs—Social Security and Medicare—and, reflecting the benefits principle, is levied more or less in proportion to the benefits received from these programs.