Proportional tax
Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Class 12, Ch 5 "Government Budget and the Economy"
Meaning
A proportional tax charges one flat rate at every level of income or profit. It is written as T = tY, where t is the tax rate and Y is income. Disposable income, the income left after tax, becomes (1 − t)Y. So the marginal propensity to consume (MPC), the share of each extra rupee that is spent, falls from c to c(1 − t). The multiplier then becomes 1 / [1 − c(1 − t)], which is smaller than with a lump-sum tax. This makes a proportional tax an automatic stabiliser: it softens swings in income without any new government decision.
Example
NCERT's example: with c = 0.8 and t = 0.25, c(1 − t) = 0.6 and the multiplier is 1 / 0.4 = 2.5. With a lump-sum tax the multiplier would be 1 / 0.2 = 5. In India, corporation tax charged as a fixed share of company profits is a proportional tax.
Don't confuse with
- Progressive tax: the rate rises as income rises, as with India's income-tax slabs. Under a proportional tax the rate stays the same.