Indirect taxes tend to be regressive

When calculating the impact of taxes on a nation’s population, an economist looks for the distributional incidence among segments. While every nation differs in the way their taxes are gained - some receive a majority via direct income tax while others through an indirect sales tax - in general, direct taxes are progressive and indirect taxes are regressive. What this means for a distribution of the nation’s population is that the poorest population are less impacted than the richest in a progressive tax scheme, while the inverse is true in a regressive tax scheme.

Income tax is typically calculated as a function of an employee’s gross income. As income rises, the employee enters a new tax bracket with a higher percentage. For the lowest income bracket, no income tax may be incurred. This makes for a clear progressive tax scheme.

Sales tax; however, is independent of the purchaser. Whether the purchaser is wealthy or poor, the sales tax remains the same. For this reason, sales tax affects the total disposable income of the poor at a higher rate than the wealthy and is therefore a regressive tax scheme.

Although a progressive tax scheme may sound positive and a regressive tax scheme negative, many other factors that affect the net gain of poor vs. rich in an economy must be reviewed before taxes are changed.

A business calculates the price of its product and the number of employees it may hire by the income and sales tax. If a grocer has a bushel of apples, and each apple accrues a 5% sales tax, then the grocer will sell that apple at a 5% higher rate to account for the profit loss due to taxes. Similarly, if a software developer’s average income is $50,000 and a corporation has $200,000 to spend on new hires, the number of actual hires will be fewer than four. This is because the true cost of each employee will include the income tax (as well as a list of other taxes, such as social security and benefits). Knowledge of this effect is critical to financial decisions lest a business mistakenly fail to calculate the impact of taxes on their prices and hires. Likewise, the societal-minded business will consider the burden of sales tax on the poorest in their community and may find creative ways to ease hardship by a redistribution of their prices.

Businesses can choose to see the distribution of taxes as a means to benefit their community. A grocer who feeds a diverse community of poor and rich may decide to negate the effect of sales tax on family staples like bread and milk and balance the profit loss with a marginal increase in prices on luxury goods. This perspective makes taxes a neutral force in an economy that a business may wield for the unique needs of the community the business serves. Rather than viewing the high taxes a business pays for operation as a necessary evil, I want to perceive taxes as a neutral force that supplies an opportunity to do good.

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