VAT Theories - Progressive or Regressive - Who pays what?
One of the 'Canons of taxation'
developed by Adam Smith said that a tax should be linked to 'ability to pay'. VAT does not tie in with this because the amount of VAT on a particular good will be the same for everyone, however much they earn. This means that VAT is regressive. In other words, the more people earn the less the proportion of their income they pay in tax. Regressive taxes will hit less-well-off people harder than the better-off.
A progressive tax, on the other hand is a tax where the more people earn the more the tax represents as a proportion of their income. The full definitions of each type of tax are:
Progressive tax - a tax that represents a greater proportion of a person's income as their income rises. In other words, the average rate of taxation
rises.
Regressive tax - a tax that represents a smaller proportion of a person's income as their income rises. In other words, the average rate of taxation falls.
Proportional tax - a tax where the percentage of income paid in taxation always stays the same. In other words, the average rate of taxation is constant.
The balance of these taxes can have a significant effect on income distribution in an economy. If a government chooses to switch the balance of taxation from progressive to regressive taxes then the less-well-off in society will be harder hit.