A regressive tax is one that imposes a harsher burden on lower-income households than on households with higher incomes. In lower-income families, a larger proportion of their income pays for shelter, food, and transportation. Any tax decreases their ability to afford these basics.
Regardless of your income level, it is important to understand how these taxes affect your income so that you can make more informed decisions regarding your financial circumstances—such as when you are voting on new tax laws, making purchases, or creating a budget.
What Is a Regressive Tax?
Higher-income families, on the other hand, have no problem affording the basics. Taxes can decrease their ability to invest in stocks, add to retirement savings, or purchase luxury items. They may affect their standard of living but won't deprive them of living essentials.
The Bureau of Labor Statistics annual Consumer Expenditure Survey found that the lowest-earning fifth of the population spent an average of $28,724 in 2020. Of that, they spent $12,317 on housing, $4,099 on food, and $4,363 on transportation. They only spent $610 on retirement savings and personal insurance.
The highest-earning fifth spent $114,840 that year. Of that, they spent $36,645 on housing, $12,245 on food, and $16,796 on transportation. They spent $19,952 on retirement savings and insurance.
The following chart illustrates the typical spending statistics by quintiles (fifths) of the population.
Types of Regressive Taxes
A regressive tax takes a higher proportion of earnings from lower-income households than those with higher incomes. This is because they are taxed the same when consuming as higher earners—$100 when shopping is worth more to a lower-tiered earner than it is to a higher-tiered earner, so taxes take more from them.
The Institute on Taxation and Economic Policy found that the lowest-earning fifth paid 11.4% of their income in state and local taxes. These include sales, property, and income tax. Most of the highest-earning fifth paid from 8% to 8.9%, and the highest-earning 1% paid only 7.4% of their income. The lowest-earning group paid the highest percentage of income in sales tax, while the highest-earning group paid at higher rates in income tax.
Sales taxes are applied as a percentage of sales prices. States apply them to most goods except for groceries, prescription drugs, and housing. Many states also levy them on certain services. By omitting these taxes from food, shelter, and health costs, they become less burdensome on lower-income earners.
An excise tax is a flat tax imposed on specific items such as fuel, tobacco, and alcohol. It becomes more regressive if it is imposed on goods and services lower-income families are more likely to use.
Cigarette taxes are the most regressive excise tax.
Tobacco is taxed very heavily. Cigarettes are levied by federal, state, and local governments on each pack. The cigarette tax is regressive on two levels. First, the tax takes a larger percentage of income. Second, lower-income earners are more likely to smoke. One-fifth of adults with an income under $35,000 smoked in 2019, while about 7% of those who earned more than $100,000 smoked.
Alcohol taxes, on the other hand, aren't as regressive. A 2021 Gallup Poll found that 44% of those earning less than $40,000 reported they drink, while 62% of those with incomes from $40,000 up to $100,000, and 81% of those with incomes of $100,000 or more, drink.
The gasoline tax is a mildly regressive excise tax. The federal gas tax was 18.4 cents per gallon, while the average state tax was 30.63 cents per gallon, as of July 2021. It's regressive because lower earners are still paying the same percentage as higher earners.
The gas tax is also a Pigouvian tax (a tax on activities or items that can cause negative effects on others), with its own set of pros and cons. Fuel taxes are designed to cover the cost of road usage and environmental impacts.
Tariffs are excise taxes levied on imports. They are regressive because they raise the price of goods and services. To cover the price of the tax, retailers must raise the prices they charge, effectively passing the tax on to consumers. The United States imposes tariffs on food, manufactured goods, chemicals, and clothing. It waives tariffs on imports from countries with which it has free trade agreements.
The value-added tax (VAT) is a special type of excise tax not used in the U.S. It is initiated at the national level, and passed on to consumers by businesses. It is popular in the European Union and other countries, but the U. S. may not be able to make it work because it would take the place of state sales taxes—which are not simple to replace with a one-size-fits-all tax.
A user fee is a government charge to use public facilities or services. States charge a fee to drive on toll roads. The National Park Service charges admission to its facilities. Some states charge prisoners fees for health care.
Cities charge admission to municipal golf courses and tennis facilities. They also charge fees for services such as building permits, vehicle registration, inspection fees, and zoning hearings. This is a politically acceptable way to raise revenue without increasing tax rates. User fees are regressive because they take a larger percentage of low incomes.
Any other tax that confers an advantage to wealthy individuals is regressive.
Medicare and Social Security withholding are payroll taxes that are also collectively known as FICA (Federal Insurance Contributions Act) taxes. At a certain level of income, withholding for Social Security is capped, but there is no cap on earnings for the Medicare tax, which is 1.45% of income. Employees pay 6.2% of their income, up to the limit of $142,800 in 2021 and $147,000 in 2022, for the Social Security tax.
Once a worker earns more than that amount, they don't have to pay any more Social Security tax for the year. For example, if a high-income worker earned the limit by the end of September, they would not have to pay any more payroll tax for the rest of the year—in contrast to a worker who earns $50,000, who pays throughout the year.
The Affordable Care Act instituted a 0.9% Medicare tax on high-income earners: those who make more than $200,000, for individual filers, or $250,000, for married couples filing jointly. That's in addition to the regular 1.45% Medicare tax.
Is a Flat Tax a Regressive Tax?
A flat tax is an alternative income tax that applies the same rate to every income level. Technically, it's not a regressive tax because the rate is the same. But it does impose a greater burden on lower-income families—they end up reducing their spending on the basics to pay it.
- Regressive taxes place more burden on low-income earners. They take a higher percentage of income on the poor than on high-income earners.
- Taxes on most consumer goods, sales, gas, and Social Security payroll are examples of regressive taxes.
- Pigouvian and sin taxes are specific types of regressive taxes.