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 U.S. Bureau of Labor Statistics publishes a consumer expenditures report annually—the latest (2018) of which found that the lowest-earning fifth of the population spent an average of $26,399 for the year. Of that, they spent $10,413 on housing, $4,109 on food, and $3,718 on transportation. They only spent $556 on retirement savings and personal insurance.
The highest-earning fifth spent $118,781 a year. Of that, they spent $35,501 on housing, $13,229 on food, and $18,387 on transportation. They spent $19,209 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 of Tax and Economic Policy found that the lowest-earning fifth paid 10% of their income in state taxes. These include sales, property, and income tax. The highest-earning fifth paid around 7% of their income. The lowest-earning group paid the most in sales tax, while the highest-earning group paid more income tax.
Most consumption taxes are regressive. The only progressive consumption tax—taxes that increase based on income—are those on luxury items, such as fine jewelry, yachts, and private jets.
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 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—at least 30% of those earning below the poverty line smoke cigarettes, while about 15% of those who earn more than twice the poverty line smoke.
Alcohol taxes, on the other hand, aren't as regressive. A 2015 Gallup Poll found that 45% of those earning less than $30,000 reported they drink, while 78% of those with incomes of $75,000 drink.
The gasoline tax is a mildly regressive excise tax. The federal gas tax is 18.4 cents per gallon, while the average state tax is 29.76 cents per gallon. 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 $137,700 in 2020 and $142,800 in 2021, 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. Since they are flat taxes, 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.