It’s that time of year when a new Congress has been seated in Washington and the Nebraska Legislature is in session in Lincoln. Both levels of government are debating tax proposals, claiming that what we currently have is unfair. What determines fairness in taxation?
Before we focus on fairness, realize that our governing bodies will look at several criteria to determine whether a tax is politically acceptable. Will the tax produce enough revenue to help the government perform its functions? Does it have low administrative costs? Is it easy to understand? Can we ensure that it doesn’t hurt the economy?
Most taxes meet these criteria when they are first passed. However, over time they might be manipulated to meet the needs of special interest groups who want to avoid paying their share. Think about all the credits and deductions offered on income tax, for example. In future articles we will look at several of the specific taxes we pay, the reasons for their passage, and whether there are problems with them today.
Taxes are either regressive or progressive, with the ultimate goal being that they are proportional, meaning everyone pays about the same percentage of their income to support government. Regressive taxes take a larger share, sometimes much larger, from low-income people. Progressive taxes have higher rates for high earners.
When we discuss fairness, the first thing we look at is benefits received. Some taxes are tied to specific benefits; for example, gas and tire taxes are used to fund highway construction. Property tax funds local projects like schools, county roads, and city streets.
Our government also uses the benefit principle to influence behavior. Tobacco use is discouraged by high taxes on cigarettes, cigars, chewing tobacco, and vaping products. We pay high taxes on alcohol to discourage its use. These taxes are incredibly regressive, punishing the poor for their “vices”. The government also influences behavior by offering tax credits and deductions for things like installing energy efficient products, going to college, or saving for retirement.
The next fairness issue is ability to pay, a concept of tax fairness that states that people with different amounts of wealth or different amounts of income should pay tax at different rates. Wealth includes assets such as houses, vehicles, stocks, and bonds. Income includes wages, interest, and dividends.
In 1909 Senator Norris Brown, republican from Nebraska, proposed a Constitutional Amendment to allow the government to levy an income tax. The United States ratified the 16th Amendment in 1913. The new income tax was set up to be progressive to counter all the regressive taxes paid in the nation. Only the wealthiest individuals and corporations paid this tax until after World War II.
Some taxes are hidden. Excise taxes, for example on gas or alcohol, are added to the price of the product. Sales tax, on the other hand, is listed on the receipt when we purchase items.
Sometimes we pay layers of taxation, where the same money might be taxed more than once. Corporate profits are taxable income for the business, but also as taxable income when they are paid out as dividends to shareholders. Income is taxed when it is earned and again when it is spent. Social Security is a tax withheld from our paychecks, and we pay income tax on it when it is paid out to us.
When politicians talk about passing a Fair Tax, be aware that they are using propaganda. Taxes are complicated! But we have to pay them, because a society cannot function without a government.