Next page. MAKING TAXES LESS NASTY. Make them Transparent

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MAKING TAXES LESS NASTY

• Make them Transparent
• Make them Fair
• Minimize Efficiency Losses and Leaks
• Minimize Collection Cost

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The American Federal Structure

• A system of assigned responsibilities and revenue
  sources with three primary levels

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The American Federal Structure

• A system of assigned responsibilities and revenue
  sources with three primary levels of government
• Federal
• State
• Local

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The Main revenue sources of the federal level of
government are?
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The Main revenue sources of the federal level of
government are?
Income Tax Payroll tax
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The Main revenue sources of the state level of
government are?
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The Main revenue sources of the state level of
government are?
Sales Tax Income Tax
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The Main revenue sources of the local level of
government are?
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The Main revenue sources of the local level of
government are?
Property Tax User Fees
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TRANSPARENCY?
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TRANSPARENCY I

• Adoption
• Open legislative process
• Open hearings
• Non-retroactive
• Consistency between elements of tax system
• Certainty about how change in tax law will change
  tax burdens

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TRANSPARENCY II

• Administration
• Payments based on fair and explicit, uniform and
  impersonal criteria
• Access to tax procedures and those who administer
  them
• Opportunity for appeal and right to fair and
  impartial judgment
• Compliance steps clearly communicated
• Taxpayers should know HOW MUCH they are obligated
  to pay

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TAX FAIRNESS?
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TAX FAIRNESS

• Tax burdens should always be proportional to
  benefits received -- at least, they should appear
  to be to the average guy median voter
• Where it isnt feasible to match burdens to
  benefits on the basis of usage, ability to pay is
  usually the best available proxy for benefits
  received

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ABILITY TO PAY

• TWO ASPECTS
• Horizontal Equity
• i.e., treating equals equally
• Vertical Equity has to do with the relative tax
  burdens imposed on individuals with different
  abilities to pay taxes

• TWO PROBLEMS
• Assessing ability to pay
• Pursuit of horizontal and especially vertical tax
  equity is further complicated by shifts in the
  incidence of taxes. Laws define obligation, but
  markets determine incidence.

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VERTICAL INCIDENCE
Assume Government services cost 20K
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VERTICAL INCIDENCE
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VERTICAL INCIDENCE
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The Same Average Tax Rates Can be Produced TWO
Ways

• PROGRESSIVE TAX
• Zero percent on Y lt 30K
• 10 on Y gt 30K and lt 80K
• 15 on Y gt 80K and lt 200K
• 30 n all Y gt 200K
• avg. rate of 0 on 20K and 11 on 180K

• DECREMENTAL or FLAT TAX
• Zero percent on income (Y) lt 90K
• 20 percent on all Y gt 90K
• avg. rate of 0 on 20K and 11 on 180K

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How To Measure Tax Equity

• For a Random Sample of citizens, estimate
• lnT a b(lnY) e
• Where
• T the TAX BURDEN on each individual (i)
• Y the AFFLUENCE level of each i
• Using Ordinary Least Squares Regression analysis.
• b measures Vertical Equity,
• r-square Horizontal Equity

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Problem 1 with Ability to Pay

• Measuring AFFLUENCE
• Economists would like to use PERMANENT INCOME or
  NET WORTH, but those measures are unobtainable
• So we use a proxy

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Problem 1 with Ability to Pay

• Measuring AFFLUENCE
• Haig-Simons definition of Income algebraic sum
  of (1) market value of rights exercised in
  consumption (2) the change in the store of
  property rights between beginning and end of
  period. Major differences between AGI and HSY are
  unrealized capital gains and imputed incomes.
• So we use a proxy
• Current Income AGI
• Property
• Some combination thereof
• These proxies are not entirely satisfactory

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Problem 2 with Ability to Pay

• Vertical Equity cannot be deduced simply from
  Rates specified in Tax Law
• Tax payments are not the same as TAX BURDEN
• Tax payments can be avoided and evaded, which
  also affects tax efficiency and compliance costs
  (avoidance is legal, evasion is not)

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Tax Shifting
Note All taxes are ultimately imposed on people
paying higher prices for things is the same as
have less money income
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EFFICIENCY?
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Tax Avoidance I
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Tax Avoidance II
Excess Burden of Taxation, SUBSTITUTION The
Triangular Portion of tax wedge is deadweight
loss
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Tax Avoidance III

• TAX EVASION INCREASES WHEN TAX RATES ARE
  INCREASED, INCREASING ADMINSTRATIVE COSTS AND
  COST TO TAX PAYERS -- BOTH TAX AVOIDERS AND
  NON-AVOIDERS

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Tax wedges
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The calculation of deadweight losses is central
to a number of policy questions including

• which tax measures impose the least burdens or
  costs on the community to finance a public
  program or project?
• how valuable do public projects have to be to
  cover the full costs of the revenue needed to
  finance them? and
• how much redistribution from rich to poor can
  society afford?

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How Much?

• Studies have typically found that the deadweight
  losses associated with raising taxation revenue
  range from a minimum of 10 cents for each
  additional dollar of revenue raised to well in
  excess of 1 for each additional dollar of
  revenue raised.

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Depends on?

• The size of deadweight losses is influenced by a
  range of factors but deadweight losses are likely
  to be greatest where the actions of producers and
  consumers are highly responsive to after-tax
  prices, where existing marginal tax rates are
  high and where savings are highly responsive to
  after-tax returns.

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The Marginal Cost of Public Funds
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Which is more transparent?

• Income Tax
• Payroll Tax

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Which is fairer?

• Income Tax
• Payroll Tax

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Which is more efficient?

• Income Tax
• Payroll Tax

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Which has the lower compliance cost?

• Income Tax
• Payroll Tax

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Are they adequate?

• Income Tax
• Payroll Tax

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When we assess federal tax policy

• Should we lump the income tax and payroll taxes
  together or discuss them separately?
• Should we consider spending simultaneously?

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EFFICIENCY

• Keep Tax Rates low
• a. Broadest possible tax base
• b. Use portfolio of taxes -- income, wealth,
  consumption
• Avoid different tax rates on goods, services, and
  factors, especially where they are close
  substitutes (except where you are more concerned
  about reducing consumption than raising revenue
  -- tax bsd things not good things)
• Avoid taxes in markets where buyers sellers
  react substantially to changes in price