American Institute of Certified Planners (AICP) Practice Exam

Which type of tax has a rate that decreases as income rises?

1. Progressive Tax

2. Proportional Tax

3. Regressive Tax

4. Capital Gains Tax

The correct answer is: Regressive Tax

The correct answer is a regressive tax, which is characterized by a tax rate that decreases as a taxpayer's income rises. In a regressive tax system, individuals with lower incomes pay a higher proportion of their income in taxes compared to those with higher incomes. This can be illustrated through consumption taxes, such as sales taxes. Since everyone pays the same rate regardless of their income level, lower-income individuals end up paying a larger percentage of their limited income on these taxes. In contrast, a progressive tax system imposes higher tax rates on higher income levels, meaning that as income increases, the percentage of income paid in taxes also increases. Proportional taxes maintain a constant rate regardless of income, meaning everyone pays the same percentage. Capital gains tax specifically refers to the tax on profit from the sale of assets or investments and is typically progressive, depending on how long the asset was held and the individual's income. Therefore, the concept of decreasing tax rates as income rises aligns with the definition of a regressive tax, which distinguishes it from the other tax types listed.