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2 TAX POLICY ISSUES: STDS FOR A GOOD TAX Standards for a Good Tax Tax Rate Structure Types of Tax Rates

3 Standards for a Good Tax In general a tax should be: Sufficient Convenient Efficient Fair

4 Sufficiency (1 of 2) Sufficient to raise necessary govt 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?

5 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.

6 Convenience Convenient to administer and to pay From the Governments Viewpoint if Tax easy to administer & understand, & offers few opportunities for noncompliance. From the Taxpayers viewpoint if The tax is easy to pay, easy to determine, and requires minimal time to comply.

7 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.

8 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 EquityHorizontal Equity Persons with the same ability to pay the tax should owe the same amount of tax.

9 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?

10 Tax Rate Structure (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.

11 Tax Rate Structure (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.

12 Types of Tax Rates (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.

13 Types of Tax Rates (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?

14 Richard Newmark PhD., CPA Assistant Professor of Accounting University of Northern Colorado Kenneth W. Monfort College of Business