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IT’S OFTEN SAID THAT beauty is in the eye of the beholder. The same could be said of fairness in taxation.
A recent article by Kelly Phillips Erb addresses this contentious topic. Erb, who tweets as @TaxGirl, is the team lead for insights and commentary at Bloomberg Tax and Accounting. Her article was titled, “Did you pay your ‘fair share’ of federal income tax this year?”
The piece discusses the history and current state of U.S. income taxes. When the federal income tax was introduced in 1913, tax returns only had to be filed by those with a net income in excess of $3,000. That’s about $86,000 in today’s dollars. That first year, the tax hit just 1% of the population. During the Second World War, the government needed to raise revenue, so the personal exemption was effectively reduced to the point where nearly 70% of the population paid income taxes.
More recently, 2017’s tax law brought significant change. Personal exemptions were eliminated and the standard deduction was increased to today’s higher level. The standard deduction now effectively sets the threshold for who has to pay income taxes.
Erb includes an interesting quote from a Tax Policy Center study on the impact of 2017’s tax law: “The large percentage of people who don’t owe federal income tax is a feature, not a bug, of the revenue code. By design, the federal income tax always has excluded a significant fraction of households through a combination of personal exemptions, the standard deduction, zero bracket amounts, and more recently, tax credits.”
The percentage of taxpayers paying no federal income tax is typically in the low- to mid-40s. The Tax Policy Center study, written in 2018, indicated that the 2017 tax law would increase the percentage of taxpayers who pay no income tax by about two percentage points. The majority of those who don’t pay income taxes still pay payroll taxes and state taxes. Pennsylvania, for instance, taxes the first dollar of earned income.
The number of taxpayers not paying federal income taxes was 60% in 2020 and 57% in 2021. These high levels were due to pandemic-related factors, and the numbers should fall back to more normal levels.
According to 2019 IRS data, the average effective income tax rate was 14.1%. That was based on 158 million tax returns, of which 104 million were taxable. Erb notes that, “In 2019, the top 1% of taxpayers paid 38.8% of all federal income taxes. According to the Tax Foundation, the top 1% paid more income taxes than the bottom 90% combined.”
As I suggested at the start, tax fairness is in the eye of the beholder. We certainly don’t know how to define—much less measure—it. We can’t even agree on the terms of the debate. Are we discussing income taxes, payroll taxes, consumption taxes, excise taxes, estate taxes, wealth taxes or total tax burden? As Erb opines, it’s unlikely we’ll resolve this issue any time soon. But tax time is as good a time as any to understand what your personal tax burden really is—and ponder whether it strikes you as fair.
Economists specializing in public finance claim the best tax policy is one that achieved all four objectives: simplicity, efficiency, fairness, and sufficiency. Anyone can look at them and define it for themselves. That’s the difference between fair and equitable. Fair means treating me as I think I should be treated. Equitable treatment means treating similarly situated people the same and differently situated people, differently.
Having had a couple of courses in public finance, I can confirm that there is no consensus, agreement, …
However, if the beltway folks weren’t so interested in granting tax preferences/tax expenditures to those they want to favor, we could have a system that does both fairness and equity – and achieves widespread support because it would be transparent and taxes would be certain.
Instead, as my corporate tax counsel once confirmed when I complained to him that certain tax provisions for employee benefits were illogical and arbitrary, he threw his Prentiss Hall 3 ring loose leaf binder (just one of six) at me and exclaimed – “show me anything in there that isn’t arbitrary, Jack”.
Nice article. I have no expertise in taxation, and am unsure what the “fair share” is that each of us ought to pay. I have wondered about the influence tax rules may have on our behavior. Consider what message the IRS was sending years ago when we could deduct interest paid, not only for home mortgages but also consumer loans and credit cards, while our earned interest and dividends were taxable. I favor simplicity, but realize that nuance will result in more complex rules. Nevertheless, I would love to see a serious bipartisan effort to lessen the ridiculous complexity which now exists.
The IRS administers the the tax laws that Congress writes and passes. It’s easier to blame the IRS than to hold Congress accountable for the mess we call a tax system. And don’t forget all the lobbyists in Washington as well. And as mentioned below, I don’t think Congress will ever give up the ability to grant favors to their constituents, however defined, through the tax code.