A regressive tax can be defined as a tax that tends to increase the total percentage of income paid on those who must pay the tax. In contrast, those who have a higher income pay less of their total income on items taxed. A tax can also be considered regressive when poorer folks must purchase more of the items taxed than do richer folks.
An example of regressive tax can occur when people who are poorer live, as they tend to do in poorly insulated homes. Due to poor insulation, they may pay more money to heat or cool their homes, and pay a higher tax on the purchase of electricity and gas. Similarly a person with an old car that is a gas-guzzler may have to consume more gas and thus pay a higher proportion of their income on gas taxes, than does a person who is able to afford to purchase an energy efficient car or a hybrid vehicle.
The wealthier person gets something of a tax advantage in these situations, making taxes on energy or fuel regressive in nature. The wealthier person may live in a better insulated home, be able to increase energy efficiency by investing in double-paned windows or newer appliances, and can purchase a hybrid or at least newer vehicle. Thus their energy bills may be less, and the taxes are less.
In simpler terms, the person who makes $30,000 US Dollars (USD) per year and drives an old car might need to purchase more gas. Say they need 20 gallons of gas per week, and the tax is $1.00 USD per gallon. In a years time the person pays slightly over $1000 USD on gas taxes alone, about 3% of total income.
Let’s say a similar person who makes $60,000 USD has a fuel-efficient car. He purchases 10 gallons of gas a week and pays just over $500 USD a year in total gas taxes. The percentage of income spent on gas tax each year is less than 1%, approximately 0.83%. You can see how this system is regressive tax in nature. The poorer person pays three times the amount of income as the richer person.
Even if a person with greater income chooses to purchase a car with less fuel efficiency, chances are the gas tax will still consume less of his/her income than it does for the poorer person. If in our above example, the person earning $60,000 USD per year does buy 20 gallons of gas a week, he or she is still only paying 1.6% of total income on gas taxes per year, about half of what the poorer person pays.
In order to prevent regressive tax on items purchased, many states make certain types of things non-taxable, especially food. This means the poorer person is not paying taxes when he or she is already consuming a large portion of their income on food expenses. Yet many items considered staples in a home are still taxed, like cleaners or paper products. Another way in which regressive tax can hit people hard is when it comes time to pay things like vehicle registration each year, which can really be difficult for many people to pay.
The litmus test then, for defining regressive tax is the percentage of income a person must pay on a tax. Few countries have regressive tax systems in place. However it has been noted that people who make especially high incomes may have access to certain tax shelters unavailable to those with low to moderate incomes. Even though such a system is progressive, tax loopholes can ultimately mean that those who make more pay less of their income in taxes than those who make less, resulting in regressive taxation.