“A duty of administrative consistency certainly exists; the tax laws must be interpreted as uniformly as possible.” (Bunce v. United States, 28 Fed. Cl. 500). The ability-to-pay principle also is commonly interpreted as requiring that direct personal taxes have a progressive rate structure, although there is no way of demonstrating that any particular degree of progressivity is the right one. Others argue that income transfers and negative income tax create negative incentives; instead, they favour public expenditures (for example, on health or education) targeted toward low-income families as a better means of reaching distributional objectives. International taxation principles are increasingly significant in a globalized economy where businesses and individuals operate across borders. One of the primary challenges in international taxation is avoiding double taxation, where the same income is taxed by two different jurisdictions.
- Consequently, only a few instances of retroactivity applied to individual taxpayers may be sufficient to erode all taxpayers’ confidence in the tax system’s basic fairness.
- A good tax policy involves a tax system with a suitable level of predictability, stability, and reliability to empower the government to determine the timing and amount of tax collections.
- This principle helps in reducing the compliance burden and minimizes disputes between taxpayers and tax authorities.
- Second, across all states, tax complexity has increased and continues to increase,49 imposing direct costs on government and even bigger indirect costs on taxpayers and the economy.
- Retroactively applied changes necessarily violate the principles of understandability and stability and further erode the taxpayer’s trust in the system.
It Pays to Keep It Simple
- Since the days of Adam Smith and then John Stuart Mill, there has been a remarkable amount of consensus among economists about what principles should determine tax policy.
- State and local governments should not use tax policy to create “winners and losers” by promoting one sector of the economy ahead of another or by favoring one type of income over another.
- Simpler tax policies maximize tax revenue, minimize efforts spent on tax compliance, and keep businesses and governments operating efficiently and doing valuable work.
- But it is a mistake to focus solely on adjusting tax rates, and never devote effort to making the taxes themselves better.
- In the U.S., half of payroll taxes are remitted directly by employers (“employer-side” payroll taxes) while the other half are taken out of workers’ paychecks (“employee-side” payroll taxes).
It is undoubtedly possible to design taxes this way, especially now, in an economy that is many times bigger, busier, and more intricate than that of 17th century France. Accordingly alternative tax systems will result in alternative distribution of burden of taxation. From the discussion above, we may lay down the following four broad characteristics as the principles of a sound tax system.
The costs to collect are higher if there are millions of collection points compared to only a hundred or thousands collection points. A good tax policy contains tax rules that specify when and how a tax is to be paid and how the amount is to be determined. The Certainty principle is also viewed as the level of assurance that a taxpayer has that the tax is being calculated correctly.
Tax Policy and Economic Growth
The large size of government today increases the urgency and necessity of applying sound principles to tax policy. Also essential to the understandability of the tax code is its stability over time. Stability principles of sound tax policy in the tax code fosters greater certainty about the future tax treatment of the results of long-term planning. Stability also gives some assurance to the taxpayer that his or her understanding of a particular tax treatment is correct. The greater the justified certainty, the more sensible those plans will be.
How to Start a Bookkeeping Business in…
This latter principle, that of avoiding retroactivity, is sufficiently important that the Congress codified it with respect to Internal Revenue Service regulations. In 1996, as part of the Taxpayer Bill of Rights 2 (H.R. 2337), the Congress established that the effective date of any temporary, proposed, or final regulation may not be earlier than the date the regulation is published in the Federal Register. It also established that the effective date of a final regulation can be no earlier than the date it was published in the Federal Register in temporary form. As with most things, when it comes to taxes, it literally pays to keep it simple. Cigarette taxes have been a source of state revenue for decades but face consistent erosion as consumption declines.
Tax Reforms for Growth and Opportunity
For example, when taxes are overly complicated, it is possible for collection officials to use more of their own discretion, which can be flawed and biased, in applying tax laws and rules. Relatedly, when taxes are transparent, it will be more obvious if an official does exercise an unfair amount of personal discretion in applying tax rules, whereas untransparent taxes more readily conceal such abuse. For instance, 60 percent of Americans pay a professional to calculate their federal income taxes, for an average bill of $258.8 But much of the cost is borne directly by the government. Therefore, an easy way to trim some government fat would be to simplify the tax code and downsize the IRS – without having a single partisan debate about the merits of other, more politically sensitive budget items. Confidence that changes in the tax law will only be made prospectively enhances the necessary sense that the tax system is fair. On the other hand, only a few instances of reported retroactive treatment may suffice to erode this sense of fairness significantly.
Fiscal Forum: Future of the EU Tax Mix with Dr. Eva Eberhartinger
Retroactively applied changes necessarily violate the principles of understandability and stability and further erode the taxpayer’s trust in the system. Regardless of the area of human activity or endeavor, changing the rules of the game after the fact is unjust and unfair. In the context of tax policy, therefore, fairness means that the tax law as interpreted by the tax service and as relied upon by the tax payer when entering a transaction will not change after the fact.
Institute on Taxationand Economic Policy
Further, rather than apply the new tax treatment prospectively only, the Revenue Ruling reached all the way back to the 1981 through 1985 transactions. For those who would like to understand more about the tax system and good tax policy, you can check out the video above. Leave your comments below if you would like to know more about starting up a bookkeeping business. A tax gap exists for several reasons, such as underreporting of income, non-filing of income, overstating deductions, and omission of transactions. It also involves unintentional errors such as math mistakes and a lack of understanding of the rules.
Horizontal equity is a measure of whether taxpayers with similar circumstances in terms of income, family structures, and age pay similar amounts of tax. For example, if one family pays much higher taxes than a similar family next door, that violates “horizontal” fairness. This sort of unjustified disparity undermines the public support for the tax system and diminishes people’s willingness to file honest tax returns. It would be hard to defend a tax system that intentionally taxed left-handed people at higher rates than right-handed people.
Meanwhile, the issue of improving how taxes are administered is largely overlooked. Of course, it is good and necessary to tax in a fair and equitable way, and it is equally good to end all unneeded fiscal spending and to cut all unneeded taxes. But it is a mistake to focus solely on adjusting tax rates, and never devote effort to making the taxes themselves better. It lowered the individual income tax rate and doubled the standard deduction.
Numerous mechanisms exist to ensure ultimate tax compliance, including interest on understated tax liability, monetary penalties, interest on such penalties, and even incarceration. Nevertheless, in a free society these mechanisms would prove insufficient without a basic willingness of taxpayers to comply. Penalties can support the smooth operation of a tax system, but a sense of civic duty is a much more important prerequisite to the proper functioning of the tax system. In this principle of good tax policy, the Convenience of the taxpayer is given much importance. It states that the due date for paying tax should be in a manner convenient to the taxpayer.
It is a very basic idea that government is only legitimate to the degree that it is consented to. The same is true of taxes; they are just only insofar as they are consensual. This is not some vacuous libertarian moralism; it is a serious idea with influence in American history. Henry David Thoreau wrote Civil Disobedience in protest to a poll tax he did not consent to.22 The point is, ordinary people recognize taxes to be unjust without consent. Yet that is what untransparent taxes are, unconsented taxes, because they are unknown and citizens obviously cannot consent to taxes they do not know they are paying. What work remains is to implement the insight and knowledge that already exist.