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TAX POLICY ISSUES: TAX POLICY ISSUES: STDS FOR A GOOD TAXSTDS FOR A GOOD TAX

Standards for a Good TaxTax Rate StructureTypes of Tax Rates

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Standards for a Good Standards for a Good TaxTax

In general a tax should be: Sufficient Convenient Efficient Fair

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Sufficiency(1 of 2)

Sufficient to raise necessary gov’t revenues. Generates enough funds to pay for public

goods and services provided by government levying the tax.

Income effect: Increase in tax rate increases income-producing activity. More powerful for lower or higher incomes?

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Sufficiency(2 of 2)

Substitution effect: Increase in tax rate decreases income-producing activity. More powerful for lower or higher

incomes? Static (base does not change) vs.

dynamic (base changes) forecasting.

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Convenience

Convenient to administer and to pay From the Government’s Viewpoint if

Tax easy to administer & understand, & offers few opportunities for noncompliance.

From the Taxpayer’s viewpoint if The tax is easy to pay, easy to determine, and

requires minimal time to comply.

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Efficiency

Efficient in economic terms. Judged by the classical standard of efficiency,

it does not distort the market, create suboptimal allocation of goods and services, or modify taxpayer behavior.

Judged by Keynesian standards it is an effective fiscal policy tool for regulating the economy.

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Fairness

Fair to taxpayers required to pay. A tax is fair if:

The taxpayer has the Ability to Pay the tax. It enhances Vertical Equity

Persons with greater ability to pay owe more than persons with a lesser ability to pay.

It enhances Horizontal Equity Persons with the same ability to pay the tax should

owe the same amount of tax.

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Horizontal Equity

Tax preferences reduce horizontal equity because they vary between taxpayers. Why not eliminate ALL tax

preferences, which would likely increase the current systems’ horizontal equity?

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Tax Rate StructureTax Rate Structure(1 of 2)(1 of 2)

Regressive Rate Structure: Tax rate decreases as tax base increases. Additional income taxed at increasing

lower rates Social security tax (0% over $80,400 in 2001).

Proportional Rate Structure: Tax rate is constant for the entire tax base.

e.g., sales and property taxes.

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Tax Rate StructureTax Rate Structure(2 of 2)(2 of 2)

Progressive Rate Structure: Tax rate increases as tax base

increases. Additional income taxed at

increasingly higher rates. e.g., income, estate & gift taxes.

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Types of Tax RatesTypes of Tax Rates(1 of 2)(1 of 2)

Average Tax Rate: Tax liability divided by taxable income.

Marginal Tax Rate: Used in decision-making analysis. Tax rate applied to next dollar of taxable

income. In a progressive rate structure this rate increases as

income levels increase. In a proportionate rate structure average and

marginal rates are the same.

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Types of Tax RatesTypes of Tax Rates(2 of 2)(2 of 2)

Can the marginal tax rate be determined by looking at the tax rate schedules?

How can the marginal tax rate be determined when phase-out provisions & limitations are taken into account?

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Richard Newmark PhD., CPARichard Newmark PhD., CPAAssistant Professor of AccountingAssistant Professor of AccountingUniversity of Northern ColoradoUniversity of Northern Colorado

Kenneth W. Monfort College of BusinessKenneth W. Monfort College of Businessrichard.newmark@unco.edu richard.newmark@unco.edu

http://student1.mcb.unco.edu/phduh/baac428/indhttp://student1.mcb.unco.edu/phduh/baac428/index.htmlex.html