Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What does a progressive tax system entail?

1. A flat tax rate for all income levels

2. A lower tax rate as income increases

3. A higher proportion of tax as income rises

4. No tax for low-income earners

The correct answer is: A higher proportion of tax as income rises

A progressive tax system is designed to impose a higher tax rate on individuals with higher income levels, thereby ensuring that those who have a greater ability to pay contribute a larger proportion of their income in taxes. This structure is based on the principle of equity, where the tax burden is distributed according to an individual's financial capacity. In such a system, as one’s income increases, the rate at which income is taxed also increases. For example, a taxpayer earning a higher income may face a tax rate of 30%, while those earning much less may only be subject to a rate of 10%. This approach aims to reduce income inequality and provide funding for public services that benefit everyone, particularly those with lower incomes. The other options refer to tax structures that do not align with the principles of a progressive tax system. A flat tax rate applies the same tax percentage across all income levels, which does not account for variations in ability to pay. A lower tax rate as income increases would disproportionately benefit wealthier individuals, which is contrary to the progressive tax principle. Not taxing low-income earners can be part of a progressive system, but it doesn't encapsulate the entire idea of progressively higher rates for increasing income.