Is the U.S. Tax System Fair?

By :: May 3rd, 2012

These days, some people want to impose a new Buffett tax on millionaires while others are outraged that low income people pay no income taxes at all and still others want to cut taxes on “job creators.” All in the name of fairness.

Is the tax code fair? Should it be?

It all depends on what you mean by fair, of course, but at an Urban Institute panel this week, two economists, a tax historian, and a philosopher agreed that in many important ways, it very likely is not.

Fairness is one of those concepts that makes economists really nervous. Because it is so subjective and impossible to measure, they usually avoid the idea entirely, preferring to stick with what they can count.

Still, my Tax Policy Center colleague Gene Steuerle, Brookings Institution economist Belle Sawhill, Tax Analysts historian Joe Thorndike, and Howard University philosophy professor Charles Verharen joined moderator Greg Ip, The Economist’s U.S. economics editor, in tackling the issue. The result was a fascinating look at a complicated issue from some very different perspectives.  It is well worth watching.

Gene divided fairness into three categories:  The first, which he calls the king of principles, is equal justice (what economists define as horizontal equity). Are people with equal ability to pay taxed equally?

The second is progressivity (vertical equity in econo-speak). Do the better off pay more tax than those who are less well off?  

The third is individual equity. Are we entitled to keep the rewards of our own work? Is it unfair if we cannot?

To that, one could add a fourth, which Gene and TPCs Rudy Penner have written about extensively. And that is generational equity. For instance, is it fair to burden those not yet born with the bill for the cost of maintaining our standard of living?

Verharen argued that fairness, which he defined as love for those most in need  (others may say individual sacrifice for the greater good), is hard-wired in family relationships and in much religious thought—to say nothing of Karl Marx. But, he noted, the concept of fairness has changed dramatically over the centuries. Once, and still in some cultures, killing a sick child to preserve the rest of a family is considered “fair.”

In a much less profound way, our concept of tax fairness has also evolved over the past two centuries. Joe Thorndike reminded the audience that for much of U.S. history, people were taxed on what they consumed (mostly through tariffs and excise taxes). But from the Civil War though the late 19th century, tax fairness was redefined as ability to pay. The result: the rise of the progressive income tax.

But, Joe says, the idea was to distribute the tax burden, not to redistribute wealth. And that raises the question about whether today’s tax laws are an effective way to address income inequality. Assuming, of course, that you think it is even a problem.  

Much of the current political debate is over Gene’s concept of equal justice. With a tax code larded with $1 trillion in tax preferences aimed at rewarding some taxpayers and punishing others, we are far from a system where people with equal incomes are taxed equally. As Greg asked, if this concept is so important, why do we do it so badly?

And that raises yet another interesting question: Fair relative to what? Why do we presume that the current distribution of taxes is the right one, and thus judge proposals not on their own merits but compared to what we do today?  

Finally, Belle and other panelists warned that it is dangerous to think about the tax code in isolation. Shouldn’t a measure of fairness also consider who benefits from direct government spending, as well as that $1 trillion in tax preferences?

It probably should. That is, once we decide what we mean by fairness in the first place.

10Comments

  1. Jack B  ::  5:35 pm on May 3rd, 2012:

    Forget fairness in the tax debate, you will never have a meeting of the minds. It is just to subjective a topic filled with bias and ideology. Leave it to the politicians to demagogue the fairness issue to see who is the best snake oil salesman.

  2. rjs  ::  7:20 pm on May 3rd, 2012:

    i would answer this:
    is it fair to burden those not yet born with the bill for the cost of maintaining our standard of living?

    with another question:
    is it fair to burden those not yet born with the bill for the cost of maintaining our interstate highway system? or do we leave them with a crumbling infrastructure?

  3. Peter  ::  8:30 pm on May 3rd, 2012:

    I wish to speak to the final point. I would be prepared to argue that a component of a fair tax code is an economically efficient code. For a tax code that isn’t economically efficient would defeat the very purpose of having a tax code, right?

  4. AMTbuff  ::  11:14 pm on May 3rd, 2012:

    Having the US government go bankrupt slowly, then quickly, is unfair. Failure to align benefit promises with fiscal reality is unfair. Using myriad phase-outs and surcharges to hide the true marginal income tax rate from most taxpayers is unfair.

    Next to those outrages, distribution of the burden is truly a minor issue.

  5. Michael Bindner  ::  11:48 pm on May 3rd, 2012:

    While fairness is important, it is not the only value. We are a nation founded on a commitment equality, although the attainment of it has been spotty once industrialization made slavery and factory worker exploitation profitable in the early nineteenth century. The progressive movement fought back against this, its success has been far from total. Making sure society is sustainable is as important as making it fair. When wealth becomes concentrated and the tax code helps that, then the situation is not sustainable. When tax rates were essentially confiscatory at the high end, that was unsustainable too and industrial modernization suffered under the weight of union wages. The 1981 tax cuts reversed that and now we seem to have gone too far the other way, with dividend and capital gains recipients among both the investor and CEO classes benefitting matierially from lowering labor costs with such a low tax cut that going to extremes really pays in the short run, although in the long run it saps the economy of purchasing power. The answer is somewhere between the pre-Reagan rates and the Bush II rates. Another aspect of sustainability is whether families have the income to have adequate children to fund the retirement of the parents when the children become workers. The aging crisis is all about that – and should be countered with tax policies to make childbearing easier to afford while penalizing those who expect to retire without adding children to the mix. That would be only fair. My tax plan, by the way, does that by shifting the tax benefits for children to the employer and making them so generous that non-parents will face a pay cut for either not having children or when the children leave, rather than having these benefits show up on the personal income tax side.

  6. Ralph H  ::  9:06 am on May 4th, 2012:

    Is it fair that almost 50% of citizens pay no income tax – no. Is it fair that double W2 earners pay a higher rate than investors – no. Is it fair that the AMT hits middle income taxpayers – no.

  7. Tax Roundup, 5/4/2012 « Roth & Company, P.C  ::  9:09 am on May 4th, 2012:

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  8. AMTbuff  ::  12:58 pm on May 4th, 2012:

    That’s a fascinating concept, Michael: A subsidy for having children if you are employed, but not if you are unemployed. I’ve never heard of that one before. The next step would be an additional subsidy paid to two-parent families but not to single parents. Unlike some other types of government spending, these would actually be investments in the future revenue stream of the government and the economy, conceivably having a positive rate of return.

    But you have a big problem here, Michael. In today’s political climate it’s unlikely that one could propose any policy designed to alter birth patterns without being called a racist. Furthermore unlike some welfare policies the right labels social engineering, these policies really would be social engineering. That concept is more than slightly unsettling. The end of that road might see the complete loss of reproductive freedom, as in some bad science fiction story.

  9. Dave Thomas  ::  1:32 am on May 5th, 2012:

    Is it fair that one person gets lung cancer from smoking cigarettes and another one gets a cough? Applying the relative and impossible to define concept of fairness to something as important as taxation is about as futile as an exercise can be.
    You set a revenue target, you divide that target by the number of taxpayers and you charge each taxpayer the same rate, because to do anything else would be corrupt.

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