What is a Graduated Tax?

A graduated tax is an income tax that adjusts in relation to the amount subject to taxation. This usually means that those earning the largest amount of income pay the largest tax percentage. When the maximum tax rate is quite high, this represents a strong incentive for high earners to shift their income into tax shelters or move to a different location that charges lower tax rates.

Advantages of a Graduated Tax

An argument in favor of graduated taxes is that the heaviest tax burden falls on those most able to pay it. This typically results in a reduction in the after-tax income gap between the poorest and wealthiest members of society. In addition, a graduated tax can generate a substantial amount of additional income for the government, which can notably boost government services and infrastructure.

Disadvantages of a Graduate Tax

An argument against graduated taxes is that those with the greatest entrepreneurial vigor, who support the economy by creating jobs, are penalized for doing so. If the increased portion of this tax assigned to the wealthiest people is quite high, this creates an incentive for entrepreneurs to move elsewhere. Over time, this can reduce the level of business activity within a region, causing the overall income level to decline.

Example of a Graduated Tax

A graduated tax might impose a 15% tax rate on the first $30,000 of taxable income, 20% on the next $20,000 of taxable income, and 25% for all additional taxable income.