Defining fairness is tricky. Economists are mostly agreed on one notion of fairness—so-called horizontal equity—the idea that the tax system should treat similar people in a similar way. That means, for example, that the tax system shouldn’t discriminate between owners and renters, people with health insurance and people without, or those who choose to drive a hybrid car and those who drive an old clunker. Of course, the tax system does discriminate in each of those cases, always with the rationale that a higher policy goal is being advanced: building community (mortgage interest deduction), encouraging health insurance coverage (health insurance exclusion), and improving the environment and reducing reliance on foreign oil (hybrid vehicle tax credit). Thus, even when we have an objectively supportable standard, other goals may trump it and often do. The consequence is that neighbors with identical incomes might often pay very different amounts of tax.
The more controversial notion is that of vertical equity—the idea that higher-income people should pay a larger share of their income in tax than those less able to pay. This concept underlies our progressive federal income tax, but all of the loopholes and deductions in the tax system can undermine progressivity. Also, an income tax violates horizontal equity in the sense that it taxes people who choose to save more than otherwise similar people who prefer to spend all of their incomes.
Three aspects of tax fairness:
1.Simplicity
‘Simplicity’ is an important indicator when assessing the
fairness of tax systems. The more complex a tax system,
the greater opportunities there are for avoidance, evasion
and other forms of abuse and also greater chance for
exclusion for non-tax experts who are unable to
understand the system. The simplicity of a tax system can
be measured for instance by the ease to calculate tax
liability, the number of tax rates and allowances and the
number of loopholes in the system. Of course ‘Simplicity’
does not automatically result in ‘fairness’. Where conflicts
do arise, a trade off is needed.
2.Transparency
‘Transparency’ is the extent to which the tax system is
designed to be easily understood and accessed. For
example, how easy it is to obtain an allowance or
deduction for tax purposes for a specific item, say a
depreciation allowance for an asset used in the business.
Transparency also relates to the extent to which it is
understood how much tax is collected, and how this tax
funds government activities.
3.Burden
‘Burden’ refers to the extent to which certain groups, such
as businesses and families, may pay disproportionately
more tax. The tax ‘burden’ may also include the level of
administration required in order to comply with the
requirements of the tax regime. Taxes that cost a lot to
administer not only distort the economy but can place an
onerous burden on certain groups.
