John Hood: What does tax fairness mean?
By John Hood
John Locke Foundation
Sunday, October 15, 2017
Back when I used to commission regular surveys of North Carolina voters, one of my favorite questions had to do with tax fairness.
The wording varied over time, but here’s essentially what we asked. If someone earns twice as much as income as you do, what do you think is the fairest system: that person ought to pay less than twice as much in taxes as you do, that person ought to pay about twice as much as you do, or that person ought to pay more than twice as much in taxes as you do?
Almost no one offered the first response. Some people agreed with the third response. But most people agreed with the second approach, in which one’s tax burden rises in proportion to one’s income.
In policy speak, these alternatives are called regressive taxation, proportional taxation, and progressive taxation. Politicians and analysts debate them all the time, but the terms don’t always adequately serve to convey the underlying meaning or assumptions. And if you use these terms in survey questions, you aren’t likely to get useful insights.
“Progressive” sounds good and “regressive” bad, for example, because we certainly all want to go forward and not backward. But in this context, the terms really refer to horizontal lines on a distribution chart. As you go left to right in household income, does the share of income paid in taxes progress upward or regress downward?
The reason people tend to respond favorably to proportionality as a standard, I believe, is that it comports with their intuitions and experience. The religiously minded are familiar with the concept of tithing. Those who have more are expected to give more. But the tithe – the “tenth” of one’s income – is a proportion.
In the voluntary context of a religious institution, to be sure, it’s a guide rather than a mandatory floor or ceiling. Government is different. You “contribute” – or else. Unless you are an anarchist, you believe that people ought to be compelled to help pay for government services. You probably also believe that the taxes people pay ought to be levied “fairly,” even if you haven’t explicitly defined the term for yourself.
Tax fairness exists in two directions: horizontal and vertical. If you and I have the same incomes but pay significantly different tax bills, that’s a question of horizontal fairness. I happen to think some such differences are entirely fair and necessary, because they correct for what would otherwise be biases in the tax code over time.
For instance, if government taxes money that is invested and then also tax the return on that investment, it biases the tax code. The ultimate return on that investment is taxed twice – once by reducing the original principal available, and then again by reducing the interest, dividend, or capital gain on it. One or the other ought to be taxed, but not both. That’s the rule for individual retirement accounts. It’s a good one.
The other form of fairness is vertical. What shares of income should people at different incomes pay in taxes? In this case, I’m in favor of proportionality after an initial exemption of some income from tax – the policy governments already follow in offering standard deductions as well as personal exemptions or credits (which adjust for the size of the household). In effect, then, I think the overall tax system ought to be modestly progressive.
What system do we actually have? I’ll use statistics from left-of-center think tanks, just to be fair. Among taxpaying households, the bottom 20 percent pays about 15 percent of their income in federal, state, and local taxes. The next quintile pays about 19 percent. The middle quintile pays 23 percent. The fourth quintile pays 27 percent. The highest-income quintile pays about 32 percent, with the top 1 percent of taxpayers in income paying 40 percent of that income, on average, in taxes of all kinds.
Whatever you think about this, our tax system is clearly not biased against poor- and middle-income taxpayers.