Tax Reform Principles Part 2: A Fair System

This is the second installment in a three-part series discussing the principles to consider for tax reform. In the first part, we reviewed how the tax system is able to modify behavior with the intent of increasing economic activity, and more specifically, how the tax code helps grow the U.S. economy.

The second principle for tax reform is having a fair tax system. Two criteria are typically used to assess fairness.

• Does the tax system treat similarly situated taxpayers the same?
• Does the system account for the different capacities to bear the burden of taxation?

Tax law is supposed to be administered equally, fairly and objectively. Individual persons or companies should not receive different treatment when applying the same law. Even though fairness is a general foundation of U.S. tax laws, there are two areas of concern. The first is the special tax benefits (often referred to as loopholes) for a certain class or type of taxpayer. Most of these loopholes are the result of special interest lobbying and the power of individual members of Congress to write tax law that is beneficial to their constituents. These special provisions may affect a relatively small group of taxpayers (e.g. advantageous depreciation for motor sports track owners), but they rarely apply to a single taxpayer. Thus, all taxpayers meeting the criteria are to be treated equally (i.e. all racetrack owners). The second involves the ability to hire experts to maneuver an increasingly complex tax code. Large corporations and wealthy individuals are often better positioned to hire a team of experts who scour the tax code seeking the most advantageous benefits. These experts may allow them to structure their affairs to achieve tax benefits unknown to the average taxpayer. Again, these benefits are available to everyone, but you need the ability to hire the experts to know how to utilize them.

The issue of capacity to bear the burden of taxation is a subjective assessment of fairness and is open to a wide range of opinions. Fairness in taxation is very much like beauty; it's in the eye of the beholder. For some people, fairness is a very progressive tax structure whereby the more you pay a higher rate of tax when you make more money. The rate could be as high as 70-90%, which could be considered as confiscatory. A progressive tax system is designed to restrict income inequality and wealth accumulation. There is still a lot of subjectivity in a progressive system to determine how much is too much, and who gets to decide the limits. On the other end of the spectrum are those who believe in a flat tax, where everyone pays the same rate of tax, no matter how much you make. For them, the same rate of tax treats everyone fairly and equally. Our current system is a mixture of both a progressive and flat tax structure. 

Considering these two factors, do you think the U.S. tax system is fair?