Econ 132 Public Finance
Holcombe, 11, Principles of Tax Policy
Normative goals of economic policy: efficiency, equity, sustainability.
P. 225: there are no absolutely indisputable principles of tax equity. Really?
The benefit principle
Justification: avoids subsidy.
Those who directly benefit from a service pay the full costs.
A direct link, no just vague benefits.
Fee or tax as the price for the good.
Or for a gain received.
The benefit principle is efficient.
But proxies are not really in the benefit principle.
Gasoline tax does not ration the use of roads.
Is not tied to specific streets and roads.
A land-value tax satisfies the benefit principle because landowners receive higher land value.
But high house prices are a vague proxie at best for good schools.
Tuition is a direct payment for schooling benefit.
Redistribution is not in the benefit principle.
The other rationale: ability to pay.
What justifies that?
How much more should the rich pay?
Some taxes can satisfy both principles.
Fees. Property taxes.
Horizontal and Vertical equity.
The conventional equity criterion is that people with equal income should receive equal treatment (horizontal equity)
and people with different incomes receive different treatment (vertical equity).
There is also factor equity:
The different factors of production - land, labor, capital goods - should be treated differently.
Labor should keep its wage, capital should keep its return, land rent should be shared.
Factor justification is based on equal self-ownership and equal benefit from nature.
Ability to pay is generally taken simplistically to relate to income.
However, for a tax to be truly equitable the total economic situation of the individual should be considered.
Income tax disregards notional income.
The owner-occupier of a house has a notional income in addition to any actual income, he does not pay explicit rent.
The tenant on the other hand must first pay the landlord before being able to assess disposable income.
Furthermore, those on subsidised rents have a notional income equal to the difference between the economic rent and the rent charged.
Fringe benefits and working conditions are also largely untaxed notional incomes.
A salex tax violates horizontal equity because people with equal income can consume unequally.
Horizontal equity is also violated with different tax rates for married and single payers.
Which income to use? Lifetime income.
Proportional, regressive, progressive, based on fraction of income (not normative).
A sales tax has the same rate for all, but differs relative to income.
There is no single tax treatment that actually constitutes vertical equity.
Flat and progressive scales could all be claimed to meet the vertical equity criterion.
Only a tax in which the wealthy pay the same or less than the poor cannot be claimed to be vertically equitable (i.e. not just a smaller proportion of income but actually less).
It is generally acknowledged that it is easier for some to reduce their income tax liability.
These people are more likely to have high incomes, consequentially there is a reduction in the effective progressivity of the income tax scale.
Land value taxation at a state level imposes the same rating scale on all sites and therefore tends to be progressive.
It is reasonable to assume that the wealthier own more valuable properties and the concentration of land ownership in terms of value bears this out.
US taxes reduce inequality, but not by much.
Sumptuary taxes, also called “sin” taxes.
Justifications: disapproval, reduction, compensation for medical costs
Politically easy to tax tobacco.
Politics and tax policy
“The tax system is not designed by a benevolent overseer who considers only the equity and efficiency aspects of taxation but rather is produced through a political system in which individuals have the opportunity to express their personal preferences, which often will be motivated more out of personal interest than a concern with the overall efficiency and equity of the tax system.”
More than 90 percent of federal revenues come from taxes on income.
Special interests are constantly pressuring for favorable tax treatment.
Few lobby for the general interest.
This results in an ever more complex tax code biased in favor of special interests.
State income taxes are based on federal rules.
A major overhaul of the tax system can overcome special interests,
since some of them may benefit, and simplification will reduce costs.