Fairness
One important criterion for a tax is that it should be fair. It should not arbitrarily target groups, individuals, or activities. It should also distribute costs in a manner that recognizes the varying abilities of people of different income levels to pay those costs. Fairness in taxation is usually looked at in two ways — horizontal equity and vertical equity.
Horizontal Equity implies that those in like financial situations should be taxed the same. This would seem to be the very heart of fairness: like pays alike. A tax system should not make arbitrary distinctions between taxpayers, or distinctions based on irrelevant criteria. For example, it violates horizontal equity if one person buys an item in a local store, and must pay sales tax, while another person buys the same item from an over the Internet, and does not pay sales tax. Horizontal equity is widely accepted by people across the political spectrum as an important principle of tax fairness.
Vertical Equity looks at how people with different financial situations are taxed differently. A regressive tax is one that requires that lower-income persons pay a greater percentage of their incomes in taxes than higher-income persons. A progressive tax, on the other hand, is one in which higher income people pay a larger percentage of their income in taxes than lower income people. A proportional tax would be one in which all income groups pay the same percentage of income in taxes. While there is acceptance of the virtue of horizontal equity across the political spectrum, the meaning of vertical equity is more controversial. While there is general agreement that there should be some connection between ability to pay and level of taxation, there are different opinions on whether a fair tax asks everyone to pay the same percentage of their income in taxes or whether higher income people, who have more disposable income, should be asked to pay a higher percentage of their income in taxes. A progressive tax, such as the federal income tax, recognizes that lower income persons must use much more of their income for basic needs such as housing, food, clothing, and thus taxes them at lower rates.
There are, however, different opinions as to whether taking ability to pay into account in this manner is appropriate. Some believe that a fair tax involves everyone paying the same share of their income in taxes regardless of means. This type of tax, like a single rate income tax, is often called a flat tax.
While there is generally agreement that a fair tax is either flat or progressive, most state tax systems are neither.3 Remarkably, most state tax systems are regressive — they tax lower income people at higher rates than higher income people. This is primarily because states often rely heavily on sales taxes. Sales taxes, as this report will examine in more detail, ultimately tax lower income people at higher rates than higher income people. This is because sales taxes tax consumption not savings. Lower income people generally need to consume all of their resources to get by, while higher income people often save a substantial portion of their incomes and thus a large share of their income is not subject to a sales tax.
Another theme sometimes considered in the context of tax fairness is the Benefit Principle. This is the idea that those who benefit from particular government services should pay for those services. In this view taxes are like the prices of government services. To some degree, this principal can confuse tax debates. At their core, most general taxes fund programs and services that society thinks should be provided for everyone: police and fire protection; clean air and water; education; a safety net to spread risk; roads and bridges; courts; and, other public institutions. Our whole society is stronger when we have good schools, safe neighborhoods, clean air, and well maintained roads. Nobody believes that the fire department should be financed only by those who experience a fire in a given year or the police only by those who are victims of crime. Few would argue that public schools should be financed only by parents with children or nursing homes only by the low-income seniors who need them.
While the benefit principle may have limited utility when examining entire tax systems, there are some areas where it is relevant. For example, gas taxes that fund highway repair assign more of the cost to those who use the most gas — which should be related to utilization of roads. Yet even in this context, it is important to recognize that the benefit principle may conflict with other principles of fairness and equity. Since lower income people often spend a greater share of their income on transportation than higher income people, the benefit principle here collides with the goal of vertical equity. The various principles for evaluating tax systems will often point in different directions and thus are best thought of as tools to create a meaningful structure for democratic decision making, rather than rules that provide formulaic answers to questions about how a tax system should be structured.
The benefit principle is particularly relevant to allocating costs and benefits between generations. Particularly at the federal level where deficit spending is allowed, the benefit principle is important to consider in the context of making decisions about when to borrow to pay for current spending and when to make sure that spending that benefits the current generation is paid for by the current generation. There are cases where borrowing to pay for current spending is consistent with the benefit principle. This occurs when the product of the spending will benefit people for many years: that is why states sell bonds to pay for roads, schools, and other infrastructure to benefit present and future generations and taxpayers. In contrast, when taxes are reduced and current needs are met through borrowing, a society is shifting the costs onto future generations while realizing the benefits of current spending, violating the benefit principle.
Staff
previous
