11CHAPTER

Principles of Tax Policy

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

11-2Randall Holcombe

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Principles of Tax PolicyPrinciples of Tax Policy

Efficiency Efficiency minimize excess burdenminimize excess burden low compliance costslow compliance costs easy to administereasy to administer

Equity Equity normative in naturenormative in nature

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Benefit PrincipleBenefit Principle

People who benefit from government People who benefit from government expenditures should payexpenditures should pay

Views a tax as a price paid for Views a tax as a price paid for government supplied goodgovernment supplied good

Appealing on equity groundsAppealing on equity grounds

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Efficiency and Benefit Efficiency and Benefit PrinciplePrinciple

Can minimize excess burden of Can minimize excess burden of taxationtaxation

Features of a user chargeFeatures of a user charge Can act as a rationing deviceCan act as a rationing device

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Actual Taxes and Benefit Actual Taxes and Benefit PrinciplePrinciple

Share some characteristics of benefit Share some characteristics of benefit principleprinciple Example:Example: Property taxes and education Property taxes and education

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Ability-to-Pay PrincipleAbility-to-Pay Principle

Individuals should pay taxes in Individuals should pay taxes in proportion to ability to payproportion to ability to pay

Can apportion tax burden for Can apportion tax burden for activities undertaken for the public activities undertaken for the public goodgood

Redistribution programsRedistribution programs

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Implementing Ability to Implementing Ability to PayPay

Is it fair for someone to pay more Is it fair for someone to pay more because of greater ability to pay?because of greater ability to pay?

When do people have same ability to When do people have same ability to pay?pay?

How much more should person with How much more should person with higher income pay?higher income pay?

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Horizontal EquityHorizontal Equity

People with equal ability to pay People with equal ability to pay assessed same amount in taxesassessed same amount in taxes Example:Example: Deductions for children Deductions for children

Concept of equity may be at odds Concept of equity may be at odds with benefit principlewith benefit principle

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Vertical EquityVertical Equity

People with greater abilities to pay People with greater abilities to pay should pay more in taxesshould pay more in taxes

Does not specify how much more one Does not specify how much more one should payshould pay

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Progressive, Progressive, Proportional, and Proportional, and Regressive TaxesRegressive Taxes

Proportional tax Proportional tax Percentage of taxpayers incomePercentage of taxpayers income

Progressive tax Progressive tax Larger percentage of income as income Larger percentage of income as income

risesrises Regressive tax Regressive tax

Smaller percentage of income as income Smaller percentage of income as income risesrises

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Progressive, Progressive, Proportional, and Proportional, and Regressive TaxesRegressive Taxes

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Income and Consumption Income and Consumption over Life Cycleover Life Cycle

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Sumptuary TaxesSumptuary Taxes

Designed to discourage consumption Designed to discourage consumption of taxed goodof taxed good

Excess burden of taxationExcess burden of taxation Possible rationale for sumptuary Possible rationale for sumptuary

taxes:taxes: Corrective tax on an externalityCorrective tax on an externality Legislating morality through tax systemLegislating morality through tax system Used to raise revenueUsed to raise revenue

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Sin Taxes and Healthy Sin Taxes and Healthy LivingLiving

[Insert Figure 11.3][Insert Figure 11.3]

11-15Randall Holcombe

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Politics and Tax PolicyPolitics and Tax Policy

Special interests and taxationSpecial interests and taxation bias in tax policy to favor special bias in tax policy to favor special

interests over general public interestsinterests over general public interests Federal versus state and local Federal versus state and local

taxationtaxation special interests have greater influence special interests have greater influence

on federal tax policyon federal tax policy

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Tax ReformTax Reform

Major overhaul recommended over Major overhaul recommended over piecemeal reformpiecemeal reform Can withstand negative influence of Can withstand negative influence of

special interestsspecial interests More likely to simplify tax codeMore likely to simplify tax code

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PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Tax Policy in Real WorldTax Policy in Real World

Equity and efficiencyEquity and efficiency Individual taxes versus the tax Individual taxes versus the tax

systemsystem