Three ways a tax can fall on income
Definition
Progressive tax: a tax that takes a larger percentage of income as income rises.
Regressive tax: a tax that takes a smaller percentage of income as income rises, so it falls hardest on the lowest earners.
Proportional tax: a tax that takes the same percentage of income at every level of income.
- The test is always the percentage of income taken, never the amount of money, because a richer household pays more in cash under almost any tax.
- UK income tax is progressive, since the tax-free allowance and the rising bands mean the share taken climbs with income.
- VAT is regressive, because everyone pays the same rate on what they buy while lower earners spend a larger share of their income.
- A tax can be direct and progressive at the same time, so the two classifications answer different questions and both may be needed.
Example
- Two households each spend £6,000 a year, VAT included, on standard-rated goods, so each pays £1,000 of VAT.
- Household A earns £15,000 a year and household B earns £60,000.
Step 1: express household A's VAT as a share of its income:
£1,000£15,000×100=6.7% \frac{\pounds1{,}000}{\pounds15{,}000} \times 100 = 6.7\% £15,000£1,000×100=6.7%Step 2: do the same for household B:
£1,000£60,000×100=1.7% \frac{\pounds1{,}000}{\pounds60{,}000} \times 100 = 1.7\% £60,000£1,000×100=1.7%- The same £1,000 takes four times as large a share of A's income as of B's, which is exactly what makes a flat-rate tax on spending regressive.
Governments redistribute in cash and in kind
Definition
Redistribution: government action that changes the distribution of income or wealth, usually by taking more from higher earners and giving more to lower earners.
- Progressive taxation is the first route, since taking a rising share from higher incomes narrows the gap after tax.
- Cash transfers are the second, because the state pension, Universal Credit and Child Benefit raise low incomes directly.
- Redistribution in kind is the third, as free state education and NHS treatment are worth far more relative to a low income than to a high one.
- A wage floor is a fourth route, and the National Living Wage rose to £12.71 an hour for workers aged 21 and over on 1 April 2026 (Source: GOV.UK).
- Taxing wealth rather than income is a fifth, through inheritance tax and taxes on property and on gains.
Note
Inequality before tax and benefits is considerably wider, which is the clearest evidence that the system does narrow the gap.
Redistribution has real economic costs
- Incentives to work can weaken, because a high marginal rate leaves a worker keeping little of any extra earnings.
- Incentives to claim can strengthen in the same way, if a benefit is withdrawn quickly as earnings rise.
- Incentives to take risks can fall, since heavy taxation of profits and gains reduces the reward for starting a firm.
- Mobility of labour and capital limits what is possible, because very high rates can push high earners and their money abroad.
- Administration costs money too, as targeting benefits accurately requires checks that are expensive and sometimes get it wrong.
How far redistribution is worth its costs
- It depends on how it is designed, because a benefit withdrawn gradually as earnings rise damages incentives far less than one withdrawn all at once.
- It depends on how high the rates go, since moderate progressive rates raise revenue while very high ones can raise less as behaviour changes.
- It depends on what the money buys, because spending that raises the skills of low-income households lifts their earnings permanently rather than topping them up each year.
- It depends on whose position you take, as the same transfer is a gain to the recipient, a cost to the taxpayer and, if it raises output, a gain to the economy as a whole.
- Overall: redistribution is worth its costs when it is designed to keep work paying and aimed at raising what low-income households can earn, because it then reduces poverty and adds to output at the same time, but redistribution built on very high rates and sharp benefit withdrawal buys a narrower gap at the price of weaker incentives and lower total output.
Exam technique
- Argue in shares of income rather than amounts of money, because that is the only way progressive and regressive can be told apart.
- Name the specific policy you are judging, since progressive tax, cash benefits and free provision fail and succeed for different reasons.
Self review
- What is the difference between a progressive and a regressive tax?
- Why is VAT regressive even though everyone pays the same rate?
- Give one example each of redistribution in cash and redistribution in kind.
- Explain how redistribution can weaken the incentive to work.
- Which factor most affects whether redistribution is worth its economic costs?
