Download Tax Policy Concept Statement 4

Tax Policy
Concept Statement
4
Guiding Principles for
Tax Equity and Fairness
Issued by the Tax Division of the
American Institute of Certified Public Accountants
Copyright © 2007 by
American Institute of Certified Public Accountants, Inc.
New York, NY 10036-8775
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i
Table of Contents
Page
Forward ............................................................................................................................... ii
Equity and Fairness: Desirable Attributes for a Tax System ...............................................1
Definitions of Equity and Fairness ......................................................................................1
The Seven Dimensions of Tax Equity and Fairness ............................................................3
Exchange Equity and Fairness .................................................................................4
Process Equity and Fairness.....................................................................................4
Horizontal Equity and Fairness ................................................................................5
Vertical Equity and Fairness ....................................................................................6
Time-Related Equity and Fairness ...........................................................................7
Inter-Group Equity and Fairness ..............................................................................8
Compliance Equity and Fairness .............................................................................9
Challenges ............................................................................................................................9
Conclusion .........................................................................................................................10
Appendix – Desirable Attributes for Tax Systems ............................................................11
Bibliography ......................................................................................................................12
ii
Foreword
This is the fourth in a series of tax policy concept statements issued by the AICPA Tax Division
on tax policy matters. It is intended to aid in the development of federal tax legislation in
directions that the AICPA believes are in the public interest. Prior Tax Policy Concept
Statements include:
1. Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals
(2001)
2. Guiding Principles for Tax Simplification (2002)
3. Guiding Principles for Tax Law Transparency (2003)
Tax Policy Concept Statements are approved by the Tax Executive Committee of the AICPA
Tax Division, after they are developed and approved by the Division’s Tax Legislation and
Policy Committee. Other Division committees and technical resource panels may develop Tax
Policy Concept Statements if requested to do so.
This Statement was developed by the Tax Equity and Fairness Task Force with input from the
2006-2007 Tax Legislation and Policy Committee and the 2006-2007 Tax Executive
Committees. It was approved by the 2006-2007 Tax Legislation and Policy Committee and the
2007–2008 Tax Executive Committee. Members of the bodies that approved this Tax Policy
Concept Statement are listed below.
AICPA Tax Executive Committee
(2007-2008)
Jeffrey R. Hoops, Chair
Alan R. Einhorn, Vice Chair
Evelyn M. Capassakis
Stephen R. Corrick
Diane D. Fuller
Andrew D. Gibson
Cherie J. Hennig
Andrew M. Mattson
T. Chris Muirhead
Kenneth N. Orbach
Gregory A. Porcaro
Roby Sawyers
Joseph Scutellaro
Christopher J. Sokolowski
Norman S. Solomon
Mark A. Van Deveer
Brian T. Whitlock
Carol E. Zurcher
Additional AICPA Tax Executive Committee Members
(2006-2007)
Thomas J. Purcell, III, Immediate Past Chair
Janice M. Johnson
Dean A. Jorgensen
James W. Sansone
Patricia Thompson
iii
AICPA Tax Legislation and Policy Committee
(2006-2007)
Nicholas P. Giordano, Chair
Donald A. Barnes, Immediate Past Chair
Walter B. Doggett, III
John H. Gardner
Nicholas Lascari
David A. Lifson
W. Val Oveson
Gerald W. Padwe
M. Andrew Prior
Melbert E. Schwarz, II
Kaye F. Sheridan
Thomas A. Stout, Jr.
Deborah Walker
AICPA Tax Equity and Fairness Task Force
Judyth A. Swingen, Chair
Gerald W. Padwe
W. Val Oveson
AICPA Tax Division Staff
Edward S. Karl, Director
Bonner Menking, Technical Manager
Jean E. Trompeter, Technical Manager
The AICPA Tax Division gratefully acknowledges the significant contributions of Judyth A.
Swingen in the development of the direction and the drafting of the Statement.
iv
Guiding Principles for Tax Equity and Fairness
The subjects of every state ought to contribute towards the support of the government, as nearly
as possible, in proportion to their respective abilities. (Adam Smith, 1776)
When a number of persons engage in a mutually advantageous cooperative venture according to
rules . . . we are not to gain from the cooperative labors of others without doing our fair share.
(John Rawls, 1971)
Equity and Fairness: Desirable Attributes for a Tax System
While no one enjoys paying taxes, most recognize that taxes are the price we pay for the
essential infrastructure and services provided by federal, state and local governments. In a free
and prosperous society, citizens will generally comply with tax levies as long as certain criteria
are met. First, political processes provide citizens with input as to how and to what extent they
are taxed. Second, public officials serve as good stewards of the resources generated by the tax
system. Finally, most citizens perceive that tax burdens and benefits are distributed in a fair and
equitable manner.
In a complex economic and social environment, it may not be possible to design and administer a
tax system that is fair and equitable in an absolute sense. However, a tax system that is generally
perceived as fair and equitable is a desirable and achievable goal.
This Statement’s primary purpose is to challenge tax lawmakers and administrators to more fully
address the issues of tax equity and fairness. We also hope this Statement will motivate further
discussion and analysis by tax policy advocates and academic researchers.
The importance of tax equality, equity and fairness has long been recognized. Adam Smith
established “four maxims with regard to taxes,” one of which was the need for equality in a tax
system. [See Appendix.] Subsequent writers have expanded Adam Smith’s maxims, adding
simplicity, transparency, neutrality, economic efficiency, and other desirable attributes for a
good tax system. However, tax equality, equity and fairness continue to be the most frequently
cited characteristics when writers describe an ideal tax system.
Definitions of Equity and Fairness
Baseline definitions for key terms are essential to the full discussion of any complex topic. The
terms equity and fairness are difficult – and some would argue impossible – to define. Judgments
as to whether or not a rule or action is fair can be quite subjective. Prior experience and the
current context clearly shape personal perceptions of equity. The following observations on
equity and fairness from other fields of study are offered to help formulate a definition of tax
equity and fairness.
1
Fairness is a moral and social concept we are exposed to from childhood. Parents and elementary
school teachers patiently explain that fairness means sharing and following the rules. Religious
institutions provide moral codes and illustrative stories to guide behavior. Most faiths teach two
general rules of fairness – (1) treat others as we would want to be treated; and (2) be benevolent
to those who are less fortunate. As we mature, our framework for assessing fairness is further
shaped by observing the behavior of friends, role models and public figures.
In his Nicomachean Ethics, the philosopher Aristotle equated fairness with justice. In a just
system “equals are to be treated equally and un-equals unequally.” The differential treatment of
un-equals is not to be arbitrary, but is to be based on some relevant factor(s). The challenge in
designing a just or fair system is determining what factors should be used to define equality (or
inequality) and to allocate rights and/or resources.
Theories of distributive justice require that the rules for allocating economic resources (or
imposing economic obligations) should be set in advance. Ideally, these rules should also be
comprehensible to those who must administer or abide by them. Some commentators state that
justice can only be achieved if rules (or laws) are strictly administered without discretion.
However, even Aristotle acknowledged that a set of rules may not anticipate all scenarios and
that some administrative discretion may be needed to mitigate unfair and unintended
consequences.1
In his Theory of Justice, Rawls [1971] stated that the only way to develop a totally fair system of
rules would be “from behind a veil of ignorance.” It is natural to perceive a particular rule as
being more or less fair if it has positive or negative impact on one’s personal wealth or wellbeing. Under Rawls’ theory, rule makers could only construct a fair system if they had no
knowledge of their own current or future situations, and hence, were unable to assess the
personal impact of the rules they promulgate. This is a state that is impossible to achieve.
Lawmakers at all levels of government are usually aware of how new provisions will affect
them, their families and their constituents.
Both Aristotle and Rawls agreed that for a system of rules or laws to function in a fair and
equitable manner the persons subject to that system must willingly comply. If citizens perceive
that a system is reasonably fair, then they will comply. Noncompliance essentially negates the
structural fairness that the system’s designers intended.
In many situations, a system for setting priorities is needed to assure fairness. Educators state
that fairness in the allocation of scarce resources means that each student gets what he or she
needs, not necessarily everything that he or she wants. Computer scientists define fairness in
terms of Pareto Efficiency – i.e. “all computer jobs deserve an equal share of resources, but if
some jobs can use more without hurting others, that’s okay.”2 Medical personnel use triage
systems to determine which patients should be seen first. Tending to those with the most critical
needs is considered fair.
1
The Innocent Spouse and the Offers in Compromise rules are examples of tax provisions designed to mitigate
unintended and unfair consequences.
2
A more detailed discussion of the fairness in computer queues research done by Adam Wierman and Mor
Hachol-Balter at Carnegie Mellon University can be found at www.cs.cmu/~acw/.
2
Tax policy advocates and writers generally agree that two criteria are essential for a tax system to
be perceived as equitable – horizontal and vertical equity. Horizontal equity means that taxpayers
who are similarly situated pay the same amount of taxes. Vertical equity requires that those who
have more income (or property) pay more in taxes because they are better able to pay. This twodimensional model provides a useful, but simplistic, framework for discussing and evaluating tax
equity issues. The next section of this Statement introduces a more extensive model for
considering tax law equity.
The Seven Dimensions of Tax Equity and Fairness
The AICPA reiterates its position3 that equity and fairness is an essential attribute of a good tax
system, and recommends that equity and fairness be given due consideration in both the making
and administration of tax laws. The AICPA further recommends that the following seven
dimensions be considered in determining tax equity and fairness:4
1. Exchange Equity and Fairness – Over the long run taxpayers receive appropriate value
for the taxes they pay.
2. Process Equity and Fairness – Taxpayers have a voice in the tax system, are given due
process and are treated with respect by tax administrators.
3. Horizontal Equity and Fairness – Similarly situated taxpayers are taxed similarly.
4. Vertical Equity and Fairness – Taxes are based on the ability to pay.
5. Time-Related Equity and Fairness – Taxes are not unduly distorted when income or
wealth levels fluctuate over time.
6. Inter-Group Equity and Fairness – No group of taxpayers is favored to the detriment of
another without good cause.
7. Compliance Equity and Fairness – All taxpayers pay what they owe on a timely basis.
Before proceeding with a detailed discussion of these equity dimensions, there are two important
caveats to remember. First, equity should be evaluated within the context of the entire tax
system, not just the income tax, and not on a proposal-by-proposal basis.5 Vertical equity
provided by progressive income tax rates may be structurally offset by sales, Social Security and
property taxes. Second, whether a tax system is equitable is largely a matter of perception.
Feelings about whether a particular aspect of the tax system is fair or unfair are influenced by
prior experiences and information (or misinformation).
3
AICPA (2001). Tax Policy Concept Statement No. 1, Guiding Principles of Good Tax Policy: A Framework
for Evaluating Tax Proposals.
4
The seven equity and fairness dimensions are not listed in rank order. The relative importance of each will
depend in part on the type of tax involved and the nature of the tax law or administrative change being
considered.
5
AICPA (2005). Understanding Tax Reform: A Guide to 21 st Century Alternative, p. 11.
3
Exchange Equity and Fairness – Taxes are the price we pay for the essential infrastructure and
services provided by federal, state and local governments. Exchange equity and fairness means
that, over the long run, governmental agencies provide adequate public goods and services to
meet the needs of taxpayers and their families. Exchange equity does not mean that, during a
specific period, the amount of taxes paid by a particular taxpayer will exactly correspond with
the value of the tax benefits directly or indirectly received.
Tax revenues must be pooled to fund essential shared services, such as education, defense, health
care, public safety, social services, and even tax administration. Substantial amounts of tax
revenue must be invested in long-lived assets, such as airports, bridges, highways, schools and
public buildings. This investment in infrastructure will benefit not only today’s, but also future
taxpayers. Although individuals may not currently need to use all of the facilities or services
offered by governmental units, the lack of such facilities or services could have a negative
impact on their quality of life. For example, the presence of a police or fire department is
reassuring, even if you never need to call them.
Exchange equity also allows for the sharing of pooled resources with others in return for the
promise of future benefits if and when needed. The Social Security system largely relies on the
taxes paid by current workers to fund the benefits of retired workers. This is done with the
implicit promise that when today’s workers retire, others will fund their benefits. The funding of
disaster relief can also be viewed as implicit exchange equity. Taxpayers are willing to assist the
victims of natural or man-made disasters, not only because it is the right thing to do; but because
they all have the expectation that similar aid would be available for them, if they were victims of
such a disaster.
For a tax system based on the concept of voluntary compliance to function effectively, taxpayers
must have a positive perception of exchange equity. They must feel that, in the long run, they are
getting their money’s worth for the taxes they pay.6 Lawmakers should keep in mind that
perceptions of insufficient exchange equity and a lack of representation in tax decisions were
part of the impetus for the American Revolution.
Process Equity and Fairness – There are three key aspects to process equity and fairness. First,
political processes give taxpayers an opportunity to influence how and to what extent they are
taxed. Second, tax systems include safeguards that permit taxpayers to challenge the taxes
assessed. Third, tax administrators are expected to treat taxpayers with respect.
In the interest of both exchange and process equity, taxpayers should have some direct or indirect
voice in how tax revenues are spent. Citizens who strongly disagree with how government
spends their money may be inclined to engage in tax protests or be noncompliant.
6
Moser, Evans & Kim, 1995.
4
By agreeing to be taxed by forming a representative, democratic government, citizens have an
indirect voice in tax matters when they elect legislative bodies at the national, state and local
levels. Congress, state legislatures, city councils, and even school boards are then responsible for
approving budgets and the taxes necessary to fund those budgets. In certain instances, taxpayers
are given a direct voice in tax matters when state and local sales or property tax rates must be
approved by referendum.
Unfortunately, too many taxpayers perceive that they have little or no voice in tax matters.
Others believe that tax agencies, rather than legislative bodies, have the primary responsibility
for making tax laws.7
One danger in any tax system is that those charged with enforcing tax laws and collecting the tax
will abuse their authority. Safeguards to prevent abuse of power are a necessary condition for
process equity in any system of laws, including the tax system. Communications from tax
agencies should clearly describe taxpayer obligations and the legal basis for any additional
assessments or penalties. There should be procedures to appeal the amount of tax to be paid.
There should also be appropriate limits on the methods tax agencies can use to enforce payment.
Any appeals procedures or taxpayer rights should be available to all taxpayers, not just those
who are able to afford professional assistance.
Finally, taxpayers should be treated with respect and assisted with (not coerced into) meeting
their tax reporting and payment obligations. Federal and state governments have adopted
Taxpayer Bills of Rights in recent years. Respect, however, is an attitude or point of view and
can not be achieved solely by legislation. In many tax agencies, cultural change may be
necessary to fully achieve this aspect of process equity.
Horizontal Equity and Fairness – Horizontal equity and fairness is the most-often-cited aspect
of tax equity. Horizontal equity means that taxpayers with equal amounts of income (or property)
should pay the same amount of tax. Horizontal equity also suggests that similarly situated
taxpayers should be taxed similarly. Unfortunately, these two definitions are not synonymous.
Taxpayers may have equal amounts of income, but different tax liabilities, because income from
capital is generally taxed at more favorable rates than earned income.8
To fully explain horizontal equity, it is necessary to return to the idea that equity or fairness is
related to need fulfillment. Two households may earn exactly the same income, but may not be
“similarly situated,” and therefore have differing abilities to pay taxes. A certain amount of each
family’s income is needed to provide for basic human needs – the definition of which changes as
our society changes. This amount should not be subject to tax. The amount of income that should
7
Tax-writing committees in Congress have a history of enacting statutory provisions that mandate Treasury to
draft the detailed regulations needed to implement the statute. While Treasury staff may have a better
understanding of the technical issues involved, Congress erodes taxpayer perceptions of process equity by
passing the primary responsibility for tax rule-making to an administrative agency.
8
Congress uses the tax system to provide economic and social incentives. Preferential tax treatment of dividends
and capital gains may provide economic incentives for capital investment. However, these provisions may also
diminish the perceived horizontal equity of the tax system.
5
not be taxed depends on several factors, including the cost of living,9 the size and structure of the
family, the age of family members, and extenuating circumstances such as disabilities or illness.
Horizontal equity is the justification for personal and dependency exemptions for income taxes
and homestead credits for property taxes. Other income tax deductions and credits for personal
expenses – such as child care, education, and medical expenses – attempt to achieve horizontal
equity with varying degrees of success. Unfortunately, most of these provisions increase
complexity and decrease perceptions of equity for taxpayers who fail to qualify for these
deductions or credits.
Another issue in determining whether taxpayers are similarly situated relates to family structure.
Income tax laws at the federal level, and in most states, employ a very traditional definition of
family. An individual’s filing status and tax rate is determined by marital status. Married couples
are then taxed as a family, rather than as individuals. Historically, unmarried couples who
maintained a household together paid less in taxes than married couples with a similar level of
combined income.10 Although recent legislation has sought to mitigate this marriage penalty,
other family-related horizontal equity issues need to be addressed. Should unmarried couples,
raising children together, be taxed as a family? Should extended families that include
grandparents or elderly parents in the same household be given a larger tax-free base? Should
credits related to children favor two-earner families or reward families with a stay-at-home
parent?
Extenuating circumstances can also affect the ability of an individual or family to pay taxes.
Individuals who are seriously ill, physically or mentally impaired, or too young or too old to care
for themselves can strain family finances. In the past, federal tax laws granted extra income tax
exemptions for the elderly and blind.11 One problem with using this approach to enhance
horizontal equity is that the list of conditions that should be given special consideration would be
extremely long. Further, this would be an area that could be prone to abuse and could actually
favor families who have the resources to have maladies or disabilities diagnosed and
documented.
Vertical Equity and Fairness – Vertical equity and fairness means that the tax burden should be
based on the taxpayer’s ability to pay. Clearly individuals with subsistence levels of income
should not be subject to all types of taxes because they need all their resources to provide for
themselves and their families. Beyond this subsistence or poverty level of income, exchange
equity suggests that all citizens should pay some taxes, even a relatively small amount.
9
This often includes the basic cost to maintain a household of modest means and could include differences
among geographic locations. Currently, the federal tax system does not take cost-of-living differences among
geographic locations into consideration [California versus Arkansas].
10
While the income tax rules tend to penalize married couples with similar incomes, benefit distribution formulas
for Social Security tend to favor married couples. The “marriage benefit” still works for couples with one
wage-earner or couples with widely disparate incomes.
11
Increased standard deductions are available to elderly or blind taxpayers, although this only results in lower
taxes for those who do not itemize. The income tax laws in many states still grant extra exemptions if the
taxpayer or the taxpayer’s spouse is elderly or blind.
6
Vertical equity is generally the justification for progressive tax rate structures in income and
wealth transfer taxes.12 As income or wealth levels rise, the tax rates rise. Likewise, the marginal
utility of further earnings or wealth accumulation declines. If tax rates rise without limit, there is
a danger that taxpayers will reach tipping points at which they either stop working or move to a
different tax jurisdiction. States have been particularly sensitive to the latter problems. Taxpayers
are mobile and can move if they perceive that state tax rates are excessive. Therefore, the range
between the highest and lowest income tax rates is smaller at the state level than it is at the
federal level. However, state taxpayers tend to reach the highest marginal rate at lower levels of
income than they do under federal rate structures.
Alternatives to the current federal income tax system – consumption tax, “flat” tax, retail sales
tax, and value-added tax regimes – result in greater regressivity and lower vertical equity.13
While attractive to those with sufficient income to control discretionary spending subject to a
sales or consumption tax, these taxes would be a significant burden on middle- and lowerincome taxpayers who must spend all or nearly all their income on necessities.
Vertical equity is the one dimension of equity that is readily measurable, both as a percentage
and an amount of each family’s tax burden. Economists use a variety of techniques to assess the
extent to which tax burdens are shifted among income classes.14 The theoretical question is to
what extent tax burdens can be shifted among taxpayers with higher versus middle versus lower
income or property values without impairing exchange or inter-group equity. [See page 8.]
Time-Related Equity and Fairness – Time-related equity and fairness means that the total tax
obligation is appropriate over the long-run and not unduly distorted by fluctuations in income or
wealth. Two factors contribute to potential time-related inequities. First, tax liabilities are based
on short-term or single point-in-time measures. Second, changes in the general price level affect
the value of the monetary unit, as well as the relative value of various tax provisions.
Taxable income is measured in one-year increments, and then taxed using progressive rates.
Taxpayers with significantly higher income one year may potentially pay more in taxes than they
would have paid if the same income had been spread over a couple of years. Likewise,
individuals who temporarily leave the work force to raise families, attend college, or recover
from an illness experience time-related tax inequities. Time-related equity within the income tax
system could be improved if taxpayers were once again permitted to average income over multiyear periods. Alternatively, the progressive rate structure could be replaced with a proportional
rate structure, but that would impair vertical equity and fairness.
12
Advocates of a flat tax system argue vertical equity can only be achieved if a single rate is applied to all
income – i.e., there are no deductions and no differential treatment of earned income versus income from
capital. They further suggest that progressive tax rates actually leads to vertical “inequity.”
13
See generally, AICPA, 2005, Understanding Tax Reform: A Guide to 21st Century Alternatives.
14
See Anderson, Roy & Shoemaker, 2003; Seetharaman & Iyer, 1995; and Suits, 1977.
7
Home owners in areas with rapidly rising real estate values experience another form of timerelated inequity. Property taxes are based on market values, whether or not property owners
intend to sell their homes in the foreseeable future. Market values may, in fact, drop before the
home owner decides to sell his or her property. Prior to a sale or exchange transaction, the true
value of the home is its value in use. Unfortunately, value in use is difficult to measure.
Inflation eventually erodes the equity of certain tax provisions. Although many items are now
adjusted on an annual basis for inflation, others are not. Over time, taxpayers find themselves
paying higher marginal tax rates, not because they have experienced real growth in earnings, but
because inflation has caused “bracket creep.” Two examples of tax “benefits” that have not kept
pace with inflation are the IRA contribution limit15 and the capital loss limitation.16
Increasingly frequent changes to the tax law also affect time-related equity and fairness by
disrupting taxpayer expectations and making tax-planning more difficult. Temporary changes
that “sunset” in a few years further disrupt taxpayers’ ability to evaluate the long-term impact of
the tax law, and therefore, its overall equity and fairness.
Inter-Group Equity and Fairness – Inter-group equity and fairness implies that no group is
favored to the detriment of another without good cause. While some shifting of tax burdens
based on the ability to pay may be appropriate, tax burden and benefit inequities should be
minimized.
Several examples of actual or perceived inequities can be found in the system for determining
Social Security benefits.17 Women, low-income retirees, and married people receive higher rates
of return when their Social Security benefits are compared to the Social Security taxes they paid.
Historically, retirees have received benefits far in excess of their contributions plus a normal
return. These higher than normal returns were made possible by increases in the wage base
subject to Social Security taxes. Given current demographics, that pattern cannot be sustained.
As the post World War II “Baby Boom” begins to retire, serious intergenerational inequities will
arise as the burden of sustaining Social Security benefits shifts to younger workers.18
15
IRAs were first available in 1975 with a $1,500 limit that remained unchanged until 1982, when it was raised
to $2,000. For the next twenty years, the IRA limit remained at $2,000. The 2007 limit is $4,000 [$5,000 for
taxpayers 50 or older]. If the IRA limitation had been adjusted for inflation since 1975, it would be closer to
$5,700 today. If the limit had been indexed for inflation in $500 increments – consistent with the current
method for going forward after 2008 – the same taxpayer could have contributed an additional $44,000
[$35,000 for catch-up eligible] over the same period. The limit would have risen to $2,000 in 1979, be $4,000
by 1993, $5,000 by 2002, and $5,500 by 2006. [Calculations made using the “Inflation Calculator” at
http://www.bls.gov/cpi/.]
16
In contrast, the capital loss limitation – initially set at $1,000 in 1942, then raised to the current $3,000 limit in
1978 – has not been adjusted for almost 30 years. Indexing for inflation would have resulted in a capital loss
limitation closer to $12,600 (if indexed since 1954) or $9,500 (if indexed since 1978). [Calculations made
using the “Inflation Calculator” at http://www.bls.gov/cpi/.]
17
See Steuerle, Carasso & Cohen, 2004.
18
AICPA. (2005). Understanding Social Security Reform: The Issues and Alternatives.
8
Tax laws tend to favor homeowners by providing deductions for property taxes and mortgage
interest. This indirect subsidy of home ownership could be viewed as an inter-group inequity by
those, who for age, economic or lifestyle reasons, are not homeowners.
One often overlooked aspect of inter-group equity is the shifting of tax revenues or spending
mandates between levels of government. The framers of the Constitution envisioned a concurrent
tax system where certain public services, such as defense and transportation infrastructure, were
funded at the federal level and other items, such as education and public safety were funded at
the state and local level.19 Over time, the myriad of services that taxpayers expect from
government, as well as the cost of infrastructure, has increased substantially, resulting in
budgetary pressures.
Compliance Equity and Fairness – Compliance equity and fairness means that all taxpayers
pay what they owe on a timely basis. Significant noncompliance depresses perceptions of equity,
increases tax administration costs, shifts tax burdens, and enlarges the tax gap. A large current
tax gap makes it necessary for legislative bodies to raise future tax rates, borrow additional funds
or reduce costs or benefits. Changes in tax law or tax administration that make it easier for
taxpayers to comply (or more difficult to not comply) result in fairer tax systems.
For a tax system to achieve full and voluntary taxpayer compliance, all the other equity
dimensions must also be met. Taxpayers are more likely to feel a “natural moral duty” to pay
their taxes if they have an adequate voice in how tax burdens and benefits are distributed and if
they perceive that the tax system and its administration are fair and just.20 In addition, taxpayer
compliance should improve with a perception that most are complying and those who do not
comply experience adverse consequences.
Challenges
Tax laws and administration should be equitable and fair. However, enhancing the equity and
fairness of current tax systems presents significant challenges. First, the tax legislative process
should make room for consideration of equity issues. Second, the tax laws should be fairly
enforced. Third, a comprehensive assessment of equity and fairness within the tax system should
be undertaken. Fourth, equity and fairness should not be considered alone, but in conjunction
with other desirable attributes of a good tax system.
The process of writing tax law is often rushed and complicated. When tax legislation is initially
proposed, lawmakers call for desirable outcomes, such as equity and fairness, simplification and
economic growth. During the legislative process, these proposals encounter balanced-budget and
political constraints and trade-offs are made. Often, little time is available for thoughtful
19
See Hamilton, 1788, The Federalist Papers, No. 32.
20
See Lefkowitz, 2004.
9
consideration of equity and fairness or input from taxpayers who will be affected by the
proposed changes.
Employees of tax agencies have a dual obligation to enforce the law and to treat taxpayers
equitably and with respect. However, their desire to be fair is often thwarted. Rigidly drafted tax
laws may not allow administrative discretion to mitigate unintended and unfair consequences.
Agency administrators are under pressure to maximize collections, which may discourage
“leniency.”
One of the most significant challenges is the complexity of enhancing the equity and fairness of
our tax system. When evaluating the equity and fairness of any tax proposal, lawmakers at the
federal, state, and local levels must consider the tax regimes of all levels of government and the
interactions among these various tax rules. Any given tax law change may improve equity and
fairness for taxpayers in particular locations or situations, but may reduce overall equity and
fairness within the larger context.
In Tax Policy Concept Statement No. 1, the AICPA identified ten desirable attributes of a good
tax system. [See Appendix] Provisions that enhance equity and fairness may have either a
positive or negative impact on the simplicity, transparency or certainty of the tax system.
Provisions intended to promote economic growth may result in horizontal inequity. Interaction of
these competing objectives can pose a major challenge to tax writers and administrators.
Conclusion
Tax Policy Concept Statement No. 4 identifies and defines seven “dimensions” that should be
considered when assessing tax equity and fairness. This approach requires the collection and
analysis of an extensive amount of information. With the possible exception of vertical equity,
the measurements for these dimensions will be based on soft data that are influenced by
individual perceptions. When the data are analyzed, the relative importance of the equity and
fairness dimensions, as well as possible interactions among dimensions, will depend on the
scenario being considered and the critical perspective of the analyst. This does not mean that the
task is impossible, but it is challenging.
The AICPA hopes that this Statement will: (1) challenge tax lawmakers to more fully consider
the importance and scope of tax equity and fairness; (2) encourage tax administrators to strive for
enhanced public perceptions of tax equity and fairness; (3) provide a useful framework for tax
policy advocates and students; and (4) motivate academic researchers to develop the measures
and models needed to empirically address equity and fairness issues.
10
Appendix
Desirable Attributes for Tax Systems
Adam
Smith21
1776
Equality
CEA22
1996
Fairness
JEC23
1998
Fair
AICPA24
2001
Equity and
Fairness
Certainty
Convenience
of Payment
Economy of
Collection
Simplicity
Neutrality
Certainty
Convenience
of Payment
Economy in
Collection
Simplicity
Neutral
Economic
Impact
Economic
Efficiency
Transparent
Tax
Avoidance
Difficult and
Risky
Economic
Growth and
Efficiency
Transparency
and Visibility
Minimum Tax
Gap
IPI25
2005
GAO26
2005
Fairness
Equity
Simplicity
Neutrality
Simplicity
Economic
Efficiency
Visibility
Transparency
Appropriate
Government
Revenues
Not Costly to
Administer
Not Costly to
Calculate
Administrability
21
Adam Smith – An Inquiry into the Nature and Wealth of Nations.
22
Council of Economic Advisors – Economic Report of the President.
23
Joint Economic Committee, Study by Vedder & Galloway – Some Underlying Principles of Tax Policy.
24
American Institute of Certified Public Accountants – Tax Policy Concept Statement No. 1, Guiding Principles
for Good Tax Policy: A Framework for Evaluating Tax Proposals.
25
Institute for Policy Innovation, Study by Hunter & Entin – A Framework for Tax Reform.
26
Government Accountability Office – Understanding the Tax Reform Debate: Background, Criteria and
Questions.
11
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14