Regardless of what proposal President Bush?s tax reform commission comes up with, the principal debate about it inevitably will be how much more or less will each income class pay relative to current law? While a valid consideration, the overwhelming emphasis on distributional effects tends to push other important tax issues off the table.
To begin with, there are two different concepts of distributional equity: horizontal and vertical. But only the latter ever really comes up in congressional debate. Horizontal equity has to do with treating equals equally. In simple terms, if you and I have roughly the same income, we should each pay about the same taxes. Vertical equity has to do with ensuring that those with a greater ability to pay?i.e., the rich?pay a higher share of their income in taxes than the poor.
Other important principles of taxation are simplicity and efficiency. Ideally, we should have a tax system that the average person is capable of understanding and complying with, which does not involve excessive complexity or demand professional assistance. Obviously, our current tax system falls far short of this ideal. Growing numbers of moderate-income taxpayers require the aid of accountants and expensive tax software just to file their returns. And even tax professionals increasingly find themselves baffled by confusing and contradictory provisions of the law.
Tax efficiency involves taking money out of the economy in a way that discourages as little output as possible. Every tax discourages some production over and above the tax itself. Economists call this the deadweight cost of taxation. Some taxes are known to discourage more than a dollar of economic activity for every dollar raised. Others impose a cost of just a few cents. A common estimate is that the federal tax system as a whole has a deadweight cost of about 20 cents per tax dollar.
Economists know fairly well how to achieve reasonable equity, efficiency and simplicity in the tax system. The problem is that it is extraordinarily difficult to achieve all these goals simultaneously, because they are inherently in conflict with each other. For example, any effort to increase efficiency will tend to be at the expense of vertical equity, because it will necessarily involve reducing taxes on capital, the income from which mostly goes to the wealthy.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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