policy principles must be determined at least implicitly before
it is possible to evaluate a state's tax system. Otherwise, there
are no points of reference from which to determine if a particular
tax or recommended change is an improvement. Commentators consistently
state that a proposal is "unfair" or would "hurt the state's competitive
position", or is the "wrong way to finance" a particular service.
All of these comments show that the speaker or writer has a tax
policy principle in mind, even if it is not expressed.
first expression of tax policy principles date back to Adam Smith
in 1776 in his seminal work, The Wealth of Nations. His four principles
were equality, certainty, convenience of payment, and economy
most quoted work in this area may be the guide from the National
Conference of State Legislatures and the Lincoln Institute of
Land Policy entitled Principles
of a High-Quality State Revenue System. There were 10
principles in that publication as follows:
- A high-quality revenue system should be composed of elements
that function well together as a logical system, including
finances of both local and state governments.
- A high quality revenue system should produce revenue in a reliable
- A high-quality revenue system should have substantial diversification
of revenue sources over reasonably broad bases.
- A high-quality revenue system should be equitable. Minimum
aspects of a fair system are (a) that it shields genuine subsistence
income from taxation, (b) that it is not regressive, and (c)
that it imposes approximately the same tax burden on all households
earning the same income.
- A high-quality revenue system should be easy to understand,
raise revenue efficiently, minimize compliance costs for taxpayers,
and be as simple to administer as possible.
- A high quality revenue system should have accountability.
- A high quality revenue system should be administered professionally
- A high quality revenue system should result in enough equalization
of the resources available to local governments that they
able to provide an adequate level of services.
high-quality revenue system should minimize interstate
tax competition and business tax incentives.
- A high-quality revenue system should not be used as an instrument
of social policy to encourage particular activities, although
it is appropriate to discourage some actions through tax policy.
later NCSL publication compiled with the National Governors' Association entitled Financing State Government in the 1990s listed only five.
- A state tax system should provide appropriate and timely revenues.
state tax system should distribute burdens equitably.
- A state tax system should promote economic efficiency and growth.
state tax system should be easily administered.
- A state tax system should ensure accountability.
policy principles have been expressed explicitly in most comprehensive
tax studies. The McClelland
Study presented to the Nebraska Legislature in 1962 stated
five tax policy principles: (1) equity and fairness, (2) economic
neutrality, (3) Economy of administration, (4) stability of yield,
and (5) decentralization of government decision-making. The Syracuse Tax Study presented to the Legislature
in 1988 did not explicitly state tax policy principles, but
recommendations showed that many were used.
recently, a North Dakota tax study released in February 2001 lists
13 characteristics for evaluating taxes while a 2002 Washington
State Tax Structure study gets by with six, including an entirely
new one, "encouraging home ownership". This shows that many times,
the important principles are determined for the researchers prior
to the study by those that commissioned the study.
we have listed here is a combination of the most commonly cited
principles distilled down into five that are largely independent
of each other. In many cases, all principles cannot be served
at once. A balance must be struck among the principles in setting
specific tax policy.
Adequacy - A good
revenue system should be able to provide funds for the operation
of government for the short and long run without frequent changes.
Two elements are at play here. First, stability of revenue
is important. The revenue system should produce revenue even
if the economy is faltering. Property tax is an example of
a stable tax source while corporate income tax is one that
growth in the tax base without changes in tax rate or base is
equally important. Elasticity measures the ability of the tax
to grow as fast as the need for revenue grows. Revenue sources
that produce natural tax receipts growth faster than the economy
is growing are said to be relatively elastic while those that
naturally grow more slowly than the economy are relatively inelastic.
Equity - A good
tax system should be fair to taxpayers. "Fairness,"
in large measure, is in the eye of the beholder. Russell Long
is credited for the famous quote "Don't tax you, don't tax
me, tax that fellow behind
the tree." However, from the standpoint of tax policy principles,
it is impossible to achieve tax equity by simply shifting everyone's
burden to someone else. Most tax studies focus on three elements
under the umbrella of equity.
Horizontal equity considers how the tax
affects similar taxpayers. In other words, do taxpayers with
similar amounts of purchases face similar sales tax burdens,
taxpayers with similar amounts of income face similar income
tax burdens, or do taxpayers with houses of similar value have
property tax burdens.
Vertical equity considers the distribution
from low to high-income taxpayers. The issue is whether
the tax is progressive, proportional, or regressive. Regressive
taxes exact a higher percentage of the income of a low-income
than a high-income one. Sales taxes are a good example of a regressive
tax. Progressive taxes tax higher-income taxpayers at a higher
rate. Nebraska's individual income tax is a progressive tax.
Benefits received considers if the taxes
paid are matched by the benefits received by the taxpayer
the government. The motor vehicle fuel tax is a good example
of benefits received taxation because the more the taxpayer
consumes fuel on the roads, streets
and highways of the state, the more he or she pays in tax. Obviously,
not all public services can
be financed in this way, but where it is possible, taxpayers
more likely to view such taxation as "fair."
the umbrella of equity, even these three considerations conflict
with each other. If a particular tax
policy or legislative bill is to reflect the benefits received
principle, then it cannot be a progressive change. It very well
may not equalize the burdens of similar taxpayers either. On
the other hand, treating everyone the same will not recognize
differences between high and low income taxpayers or differences
in the benefits received by various taxpayers. Ultimately, what
is "fair" or equitable in any given situation is
a matter of judgment by the Legislature.
- A good tax system is easy for the taxpayer to comply with.
It is also easy for the government to collect the tax. Complexity
increases costs for both the government and its taxpayers and
results in inefficiency in the economy. Complexity and public
costs engendered thereby are to be avoided wherever possible.
- A good tax system should allow taxpayers to know how much tax
they are paying and for what purposes. In essence, tax policy
should be explicit and not hidden from taxpayers. Rational decisions
about priorities can only be made if citizens know and appreciate
the costs. Another term that is sometimes used for this principle
competitive - A good tax system should not
place taxpayers in the state, including businesses
at a competitive disadvantage relative to
others both within and without the state. Some tax studies use
the term economic neutrality
instead, but we have intentionally chosen a broader term. Economic
neutrality is essentially another way of saying that the state
should have a broad base and a low rate. There should not be
a multitude of exemptions that favor certain activity over other
things. A good tax system should not distort economic behavior. Instead,
the existence of favorable raw materials, suppliers, workforce,
and other conditions in the marketplace should determine
economic activity. The lower the rate, the less likely it is
that the tax affects economic decision-making.
term "economically competitive," on the other hand, considers
the relationship of tax burdens across state borders. A
good tax system should not place business enterprises located
within the state at a competitive disadvantage relative to similar
enterprises in other states. State tax policy is not set in a
vacuum. The behavior of other states, especially contiguous states
limit tax policy options.
noted earlier, these principles tend to conflict with each
a progressive income tax system that protects low-income taxpayers
detracts from the principle of simplicity. Taxing according
to the benefits conferred by the government may result in regressive
taxation and may also be economically non-competitive. High
"sin taxes," like cigarette and alcohol taxes violate
horizontal equity and economic competitiveness principles.
perhaps most significantly, tax incentives violate adequacy,
simplicity, and accountability principles even in situations
where such incentives serve the economic competitiveness principle. Yet,
they continue to expand in Nebraska and other states.
short, tax policy principles provide guidelines for evaluating
proposals. They cannot be shackles that prevent state legislatures
from determining priorities.
each tax system description contained in this presentation, a
short examination of the particular tax in relation to these five
tax policy principles will be given.