Progressivity measures the extent to which the income tax burden increases with income. Hence a more progressive tax system would have people on higher incomes paying a higher proportion of their income in tax than people on lower incomes.
Progressive personal income tax systems reflect the redistributive role played by governments. Progressive taxes are characterised by an increasing average rate of tax as income rises. As such (and in the absence of negative taxes), the marginal personal income rate of tax must lie above the average rate of tax.
However, it should be noted that progressivity does not in itself equate to equity. A progressive system may not be equitable if it results in a large number of higher income earners avoiding or evading taxes. The measure of progressivity discussed below is only relevant to questions of vertical equity. More broadly the progressivity of a tax system does not measure the equity of various expenditures. Lastly, a more progressive tax and welfare system generally results in higher effective marginal tax rates.
There are different measures of progressivity which vary in complexity. It is beyond the scope of this study to provide an in-depth analysis of these methods.
The OECD (OECD 2006) has developed a simple measure of determining progressivity. Using this methodology Chart 4.14, compares the progressivity of the tax wedge for a single individual with no dependants on 67 and 167 per cent of average wages.5 Higher numbers indicate higher progressivity.
Chart 4.14: Progressivity between 67 and 167 per cent average wages(a)
- Comparison for a single worker with no dependants.
Source: OECD Taxing Wages, 2005.
On this measure, Australia has the second most progressive tax system in the OECD-10 after Ireland for single incomes between 67 per cent of average wages and 167 per cent of average wages.
An OECD report (Whiteford 2005) shows that, of the 24 OECD countries considered in this study, Australia has the most progressive distribution of benefits on two different measures (Chart 4.15). This is the result of the relatively tightly targeted nature of Australia’s welfare system. The study also calculates a measure of churning (the notion that households can be both recipients of welfare and taxpayers simultaneously) across OECD countries where data were available. The results shows that Australia has the lowest level of churning across those countries.
Chart 4.15 shows progressivity of transfers through a ratio of the benefits received by the poorest quintile to benefits received by the richest quintile for the total population for the OECD-10.
Chart 4.15: Progressivity of transfers
OECD-10, around 2000
Source: Whiteford, OECD (2005).
Chart 4.16 shows Whiteford’s measure of churning6 as a percentage of household disposable income and as a percentage of direct taxes. In both measures Australia has the lowest level of churn. Caution should be exercised when interpreting these results as the tax mix within a country can significantly affect the results. For example, countries with a high reliance on indirect taxes will have a high percentage of churn as a percentage of direct taxes.
Chart 4.16: Measures of churn
Sub-set of OECD-10, 2000(a)
- Data on Spain not available.
Source: Whiteford, OECD (2005).
5 Progressivity between 67 to 167 per cent average wages is calculated by ((T167-T67)/T167) where T167 is the tax wedge at 167 per cent average wages and T67 is the tax wedge at 67 per cent average wages.
6 Churning is calculated by comparing the level of transfers by each decile with the level of direct taxes (income taxes and employee social security contributions) paid by each decile. Where transfers exceed taxes, the churning is the level of taxes and where taxes exceed transfers, churning is the level of transfers. This measure of churning only counts direct financial transfers, not indirect transfers through subsidised services such as health and education.