April 15 is rolling around. Time to think about taxes. In 1997, federal tax collections amounted to a bit more than $1.7 trillion dollars (or about $6,300 per citizen). Of that amount, about 44 percent came from federal personal income taxes; 38 percent came from social security and other payroll taxes; 12 percent was corporate profit taxes; and the remaining 6 percent came from federal excise taxes, import taxes (tariffs), and similar small items such as estate and gift taxes.
It is noteworthy that in 1997 the top 1 percent of income earners paid one-third (33.2 percent) of all personal income taxes. The top 5 percent of income earners paid more than half (51.9 percent), and the top 50 percent of income earners paid 95.7 percent. Those at the lower half of the income distribution therefore paid a mere 4.3 percent of total federal personal income taxes.
What are the characteristics of a "good" tax system? Economists list five criteria:
First, low costs of administration and compliance, i.e., administrative simplicity.
Second, the system should be flexible to quickly adapt to changing economic and political circumstances.
Third, the tax system should be transparent and amount to political accountability and responsibility.
Fourth, it should be perceived as generally fair across various income groups.
Fifth, the tax system should enhance economic efficiency.
The first three are straightforward. Numbers four and five are contentious.
An efficient tax system should not distort economic efforts. For instance, excessively high federal cigarette taxes lead to cigarette smuggling and therefore distort the economy. Similarly, excessive income tax rates may reduce the amount of taxable work people wish to perform. And excessive capital gains taxes lead to inefficiencies in the capital markets.
By the same token, undertaxing undesirable economic activities permits them to continue unabated. For instance, the environmental effects of automobile exhaust fumes could be mitigated by taxing fuel-guzzlers at higher rates than fuel-efficient vehicles.
Even marriage and divorce can be affected by the tax system. Because the federal system taxes married couples at their combined annual income even when you marry on December 31, the lower-earning spouse's income is taxed at a higher rate (the marriage penalty) for the entire tax year. Thus you should marry in early January.
This leads to issues of fairness. The tax system should display horizontal and vertical equity.
Horizontal equity means that two people who are equal in every respect should be treated equally. But, as we just noticed, if one of these two people is married and the other is not, they will not be treated equally in terms of tax obligations. Vertical equity means that those capable of paying more taxes should pay more. This still leaves the political problem of determining the cutoff income brackets and the tax-rates for those brackets.
In Canada, for instance, tax rates for 2000 are 17 percent for income up to C$ 29,590 (U.S. $20,121), then 24 percent for every additional dollar up to C$ 59,180 (U.S. $40,242), and 29 percent for every additional dollar thereafter. In the United States, the 15 percent rate applies to incomes up to roughly $25,000. Thereafter, up to roughly $60,000 the 28 percent bracket sets in, and then over 30 percent for even higher incomes.
But should income be taxed at all? Economists and others argue that because income represents a person's ccontribution to society, it should not be taxed. The prevailing wisdom now holds that instead of income we should tax consumption (a national sales or value-added tax), i.e., what a person takes out of society. This has the beneficial side-effect of encouraging savings and therefore investment and future economic growth and, incidentally, would do away with most of the IRS bureaucracy and greatly simplify the tax system. Now, wouldn't that be a great gift politicians could give to the nation?
Happy filing everyone!