Principles of Good Tax Policy Annette Nellen San José State University

Presentation Overview Purpose of the statement Overview to the 10 principles Examples of application of the 10 principles

Tax Policy Concept Statement #1 Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals –product of the policy, legislation & simplification committee –created as preliminary step to analyzing tax reform proposals –but - also useful for analyzing any tax proposal - any size, any degree, any level –basically - Adam Smith’s tenets + 6 more

Purpose of the Framework To answer the question: How should proposals to change existing tax rules be analyzed? To be short and to the point. To be a prelude to series of add’l tax policy papers.

Equity & Fairness Similarly situated taxpayers should be taxed similarly. Horizontal and vertical equity. “Fairness” (or really, the perception of fairness). Should really look at entire range of taxes a taxpayer is subject to.

Certainty Tax rules should specify when the tax is to be paid, how it is to be paid, and how the amount to be paid is to be determined. Certainty, rather than ambiguity. Ability to determine tax base and rate. Basically, the level of confidence that exists that the tax is being calculated correctly.

Convenience of Payment A tax should be due at a time or in a manner that is most likely to be convenient for the taxpayer. Helps ensure compliance. Appropriate payment mechanism depends on amount of liability and ease of collection.

Economy of Collection The costs to collect a tax should be kept to a minimum for both the government and taxpayers. How many revenue officers are needed? Closely related to simplicity principle.

Simplicity The tax law should be simple so that taxpayers can understand the rules and comply with them correctly and in a cost-efficient manner. Reduces the amount of errors. Increases respect for the system. Enables taxpayers to understand tax consequences of their transactions.

Neutrality The effect of the tax law on a taxpayer’s decisions as to how to carry out a particular transaction or whether to engage in a transaction should be kept to a minimum. Taxpayers should not be unduly encouraged or discouraged from engaging in certain activities due to tax law. Primary purpose of tax system is to raise revenue, not change behavior.

Economic Growth & Efficiency The tax system should not impede or reduce the productive capacity of the economy. Tax system should be aligned with the economic goals of the jurisdiction imposing the tax. –For example, should be aligned with jurisdiction’s economic goals for economic growth, capital formation and int’l competitiveness. –Should not favor one industry or type of investment at the expense of others.

Transparency & Visibility Taxpayers should know that a tax exists and how and when it is imposed upon them and others. Enables taxpayers to know the true cost of transactions. Enables taxpayers to know when tax is being assessed or paid and to whom.

Minimum Tax Gap A tax should be structured to minimize noncompliance. Tax gap = amount owed less amount collected. Procedural rules needed to attain compliance. Generally, is a need to strike a balance between (a) desired level of compliance and (b) costs of enforcement and the level of intrusiveness of the tax system.

Appropriate Government Revenues The tax system should enable the government to determine how much tax revenue will likely be collected and when. Need to have some level of predictability and reliability to enable governments to know how much will be collected and when. Generally, government realizes better stability with a mix of taxes.

Challenges Desire to use the tax law for more than raising revenue. Frequent changes to the tax laws. Not all ten principles can be achieved to same degree for all proposed changes - need to strike a balance though.

Example: Armey Flat Tax Mostly meets: Certainty Convenience of payment Economy of collection Simplicity Minimum tax gap Needs work: Equity & fairness Neutrality Economic growth and efficiency Transparency Appropriate government revenues

Example: Charitable deduction for non-itemizers No problem with: Convenience of payment Transparency Appropriate government revenues Problem areas: Equity (how are taxable income and ability to pay to be measured?) Certainty (more recordkeeping) Simplicity (not as simple as just taking the standard deduction) Neutrality (tax law would encourage donations) Minimum tax gap (many might believe they should claim something)

Example: SUT and E-commerce Equity: Internet vendors and Main Street really are not similarly situated, so should compliance rules apply similarly? Possible solutions: –require Main Street retailer to charge SUT based on where customer lives –use origin approach –compensate vendors –third party collector funded by government –use a different form of consumption tax which consumer computes

Example: SUT and E-commerce Certainty, Economy in Collection, Simplicity taxing jurisdictions creates uncertainty & complexity Possible solutions: –uniform rules among jurisdictions; streamlined system –third party collection –better use of technology –federal level tax as a replacement (a VAT?)

Example: SUT and E-commerce Neutrality, Minimum Tax Gap, Appropriate Government Revenues if SUT not charged by seller and state doesn’t enforce use tax, neutrality is not achieved Possible solutions: –educate consumers about use tax –simplify and unify rules –improved use of technology –replace SUT with an easier consumption tax

Questions? Comments?