Professor Emeritus of Economics Thomas R. Brown Professor in Economics Education “WHAT MAKES A FAIR TAX?” Why do we tax? Tax Equity Rules HORIZONTAL EQUITY VERTICAL EQUITY HORIZONTAL EQUITY PEOPLE WITH EQUAL ABILITIES TO PAY THE TAX SHOULD PAY THE SAME AMOUNT OF TAXES VERTICAL EQUITY People with different abilities to pay should pay different amounts of taxes Acceptable relative treatment of persons in unequal circumstances MEASURES OF ABILITY TO PAY: INCOME CONSUMPTION WEALTH BENEFITS RECEIVED What is the appropriate relative tax on persons with different abilities to pay? PROGRESSIVE REGRESSIVE PROPORTIONAL Tax Rate X Tax Base = Tax Revenue INCOME TAXES SALES TAXES VALUE ADDED TAXES PROPERTY TAXES EXCISE TAXES USE TAXES ESTATE TAXES LUXURY TAXES SUMPTUARY/SIN TAXES Tax Elasticities How fast will the tax revenue increase relative to the growth in the tax base? Percent change in tax revenue relative to: a. Percent change in tax base b. Change in rate structure relative to tax base THE TAX REVENUES SHOULD BE SUFFICIENT TO MAINTAIN THE DESIRED FUNCTIONS OF GOVERNMENT A. The economic impact of the tax should be neutral unless it is designed to discourage or encourage a specific action B. A broad based tax has less undesirable economic impacts than a selective tax A. TAXES SHOULD BE EASY TO ADMINISTER B. TAXES SHOULD BE VISIBLE C. MAXIMUM CONVENIENCE IN CALCULATING TAX LIABILITY - SIMPLE AND STRAIGHT FORWARD D. MAXIMUM CONVIENIENCE IN MAKING PAYMENTS E. KNOW THE INCIDENCE OF TAX- WHO PAYS IT? HORIZONTAL EQUITY DETERMINING WHO IS EQUAL: EXEMPTIONS DEDUCTIONS TYPES OF INCOME TIMING OF INCOME EXAMPLES OF DEDUCTIONS USED TO DETERMINE ABILITY TO PAY INCOME TAXES NUMBER OF CHILDREN MEDICAL EXPENSES COSTS OF EARNING INCOME CHARITABLE GIVING OTHER TAXES PAID VERTICAL EQUITY: PROPORTIONAL TAX RATES PROGRESSIVE TAX RATES REGRESSIVE TAX RATES HORIZONTAL EQUITY WHO IS EQUAL? EXAMPLES OF EXEMPTIONS: -FOOD -PRESCRIPTIONS -CLOTHING VERTICAL EQUITY REGRESSIVE TAX RATE PROPORTIONAL TAX RATE PROGRESSIVE TAX RATE HORIZONTAL EQUITY TYPES OF PROPERTY USE OF PROPERTY AGE OF OWNER VERTICAL EQUITY PROPORTIONAL TAX PROGRESSIVE TAX TAX AVOIDANCE CHANGING BEHAVIOR TO AVOID PAYING TAXES – IT IS LEGAL TAX EVASION NOT REPORTING ALL THE TAX BASE FOR TAX PURPOSES – IT IS ILLEGAL KEY CRITERIA FOR TAX EVALUATION 1.APPROPRIATE TAX BASE 2.APPROPRIATE TAX RATE 3.APPROPRIATE TIME PERIOD DESIGNING A “FAIR” TAX IS TRICKY BUSINESS IS FAIRNESS IN THE EYE OF: -THE TAX PAYER? -THE GOVERNMENT IMPOSING THE TAX? -THE PUBLIC AT-LARGE?