- There is considerable debate – but arguably somewhat less understanding – about what constitutes a “fair” tax system.
- There is no simple numerical rule that defines fairness. It is, instead, a collective political judgment.
- There are arguably reasonable conditions for making a sound collective judgment – but they are not met in the real world.
- If the nation can agree on opportunity as an objective, we are left with a choice: Will we direct our resources to reward the few spectacular successes, as an incentive to others; or will we instead use those resources to limit the tax burden on many ongoing businesses, to facilitate effort? This blog argues for the latter, on both economic and fairness grounds.
With recent changes in tax rates as part of the year-end “fiscal cliff” deal have come renewed discussion of the most fundamental question of tax policy: What is “fair?”
A frequent form of this question is a lament that “the 1 percent of taxpayers with the highest incomes pay 22.3 percent of the taxes” (typically using the figures published for some time now by the Congressional Budget Office (CBO); the number I quote here is from their latest estimate, using 2009 data, available here). A possible subtext, never articulated, is that because 22.3 percent is greater than 1 percent the tax system is excessively progressive. To interpret that subtext we need a conceptual marker. If the top 1 percent of taxpayers paid 1 percent of the taxes (and the same for every other 1 percent ranked by income), then we would have the numerical equivalent of a head tax – both Warren Buffett and the proverbial elderly widow in the walk-up cold-water flat would write a check (if the widow had a checking account) to the Treasury for the same number of dollars. That probably would not strike too many people as a “fair” tax system.
Sometimes the lament is a bit more sophisticated. With a one-layer-deeper dive into the data, it can be worded as “the 1 percent of taxpayers with the highest incomes earn 13.4 percent of the income, but pay 22.3 percent of the taxes.” Again, the unstated subtext can be read that 22.3 percent of the taxes, being greater than 13.4 percent of the income, is too high. But the implied standard that those with 13.4 percent of the income should pay 13.4 percent of the taxes is the numerical equivalent of a single-rate income tax with no exemption or deduction. Both Warren Buffett and the proverbial elderly widow would pay the same 13.4 percent of their income in taxes – and not the marginal rate (on their last dollar of income), but the average rate (the percentage of all of their income that they actually paid). Most Americans probably would question whether that was a fair outcome, either.
(Footnote: The numbers quoted above are for total federal taxes paid – income taxes, payroll taxes, excise taxes, and everything else. This yields a different perspective than looking at income taxes alone. The differences between the two are debated with an almost religious fervor, and are a topic for another, very long, day. Also note that the sum of those different taxes is more a patchwork quilt than a “system.” But we must persevere, because that is the tax “system” with which we must live.)
So if the 1 percent of Americans with the highest incomes earn 13.4 percent of the total income in the country, how much of the taxes should they pay? Probably more than 13.4 percent; but how much more? In truth, there is no simple numerical answer – as the very basic review of the tag lines above suggested. This question can be answered only by the American people themselves, through the political process.