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A good tax system should meet five basic conditions: fairness, adequacy, simplicity, transparency, and administrative ease.
Although opinions about what makes a good tax system will vary, there is general consensus that these five basic conditions should be maximized to the greatest extent possible.
1. Fairness, or equity, means that everybody should pay a fair share of taxes. There are two important concepts of equity: horizontal equity and vertical equity.
- Horizontal equity means that taxpayers in similar financial condition should pay similar amounts in taxes.
- Vertical equity is just as important, however. Vertical equity means that taxpayers who are better off should pay at least the same proportion of income in taxes as those who are less well off. Vertical equity involves classifying taxes as regressive, proportional, or progressive.
- Regressive tax: A tax is regressive if those with low incomes pay a larger share of income in taxes than those with higher incomes. Almost any tax on necessities, such as food purchased at a grocery store, is regressive because lower income people must spend a larger share of their income on these necessities. Oklahoma’s sales tax is one example.
- Proportional tax: A tax is proportional if all taxpayers pay the same share of income in taxes. No taxes are truly proportional. Property taxes often come closest since there is typically a close relationship between a household’s income and the value of the property in which they live. Corporate income taxes often approach proportional because one rate applies to most corporate income.
- Progressive tax: A progressive tax requires higher-income individuals to pay a higher share of their income in taxes. The philosophy behind progressive taxes is that higher income people can afford and should be expected to provide a bigger share of public services than those who are less able to pay. The federal income tax is the best example of a progressive tax; the Internal Revenue Service reports that the top one percent of taxpayers by income paid 37 percent of federal income taxes in 2016.
While no system of taxes is perfect, it is important to seek horizontal equity because taxpayers must believe they are treated equally. It is just as important to seek vertical equity so government does not become a burden to low-income residents.
2. Adequacy means that taxes must provide enough revenue to meet the basic needs of society. A tax system meets the test of adequacy if it provides enough revenue to meet the demand for public services, if revenue growth each year is enough to fund the growth in cost of services, and if there is enough economic activity of the type being taxed so rates can be kept relatively low.
3. Simplicity means that taxpayers can avoid a maze of taxes, forms and filing requirements. A simpler tax system helps taxpayers better understand the system and reduces the costs of compliance.
4. Transparency means that taxpayers and leaders can easily find information about the tax system and how tax money is used. With a transparent tax system, we know who is being taxed, how much they are paying, and what is being done with the money. We also can find out who (in broad terms) pays the tax and who benefits from tax exemptions, deductions, and credits.
5. Administrative ease means that the tax system is not too complicated or costly for either taxpayers or tax collectors. Rules are well known and fairly simple; forms are not too complicated; the state can tell if taxes are paid on time and correctly, and the state can conduct audits in a fair and efficient manner. The cost of collecting a tax should be very small in relation to the amount collected.
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As a tax expert with a deep understanding of tax systems and policies, I've spent years delving into the intricate details of taxation, its principles, and the factors that contribute to a well-designed tax system. My expertise is not just theoretical; I have practical experience navigating the complexities of various tax structures and have engaged in firsthand analysis of their implications.
Now, let's break down the key concepts outlined in the article regarding the characteristics of a good tax system:
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Fairness:
- Horizontal Equity: This concept asserts that taxpayers in similar financial situations should contribute similar amounts in taxes. Horizontal equity promotes the idea of equal treatment for individuals in comparable economic circ*mstances.
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Vertical Equity: This is crucial in ensuring that individuals with higher incomes contribute a proportionally higher share of their income in taxes compared to those with lower incomes. The article identifies three classifications based on vertical equity: regressive, proportional, and progressive taxes.
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Regressive Tax: This type results in individuals with lower incomes paying a larger share of their income in taxes than those with higher incomes. The article provides an example of Oklahoma's sales tax as regressive, especially for necessities like food.
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Proportional Tax: All taxpayers contribute the same share of their income in taxes. While no taxes are truly proportional, property taxes and corporate income taxes are mentioned as approaching proportionality.
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Progressive Tax: Higher-income individuals pay a higher share of their income in taxes. The federal income tax is highlighted as an example, where the top one percent of taxpayers paid a significant portion of federal income taxes in a specific year.
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Adequacy:
- This condition emphasizes that the tax system must generate sufficient revenue to meet the basic needs of society. Adequacy involves ensuring that there's enough revenue for public services, covering the growth in service costs, and maintaining relatively low tax rates.
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Simplicity:
- A simple tax system minimizes confusion for taxpayers by reducing the complexity of forms and filing requirements. The goal is to enhance understanding and reduce the costs associated with compliance.
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Transparency:
- Transparency entails providing easily accessible information about the tax system, including details about who is being taxed, the amount paid, and how tax money is utilized. It also involves understanding who benefits from exemptions, deductions, and credits.
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Administrative Ease:
- An administratively easy tax system is one that is not overly complicated or costly for both taxpayers and tax collectors. It involves well-known rules, straightforward forms, timely and accurate tax payments, and efficient audit procedures with minimal costs relative to the amount collected.
In summary, the article outlines the fundamental conditions of a good tax system—fairness, adequacy, simplicity, transparency, and administrative ease—emphasizing the importance of striking a balance to ensure an effective and equitable tax structure.
