Taxes in Nebraska > Source of Major State and Local Taxes > Tax Policy Principles



Tax 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.

Perhaps 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 of collection.

The 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:

  1. A high-quality revenue system should be composed of elements that function well together as a logical system, including the finances of both local and state governments.
  2. A high quality revenue system should produce revenue in a reliable manner.
  3. A high-quality revenue system should have substantial diversification of revenue sources over reasonably broad bases.
  4. 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.
  5. 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.
  6. A high quality revenue system should have accountability.
  7. A high quality revenue system should be administered professionally and uniformly.
  8. A high quality revenue system should result in enough equalization of the resources available to local governments that they are able to provide an adequate level of services.
  9. A high-quality revenue system should minimize interstate tax competition and business tax incentives.
  10. 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.

A later NCSL publication compiled with the National Governors' Association entitled Financing State Government in the 1990s listed only five.

  1. A state tax system should provide appropriate and timely revenues.
  2. A state tax system should distribute burdens equitably.
  3. A state tax system should promote economic efficiency and growth.
  4. A state tax system should be easily administered.
  5. A state tax system should ensure accountability.

Tax 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 the recommendations showed that many were used.

More 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.

What 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 is not.

Second, 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, do taxpayers with similar amounts of income face similar income tax burdens, or do taxpayers with houses of similar value have similar 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 taxpayer 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 from 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 are more likely to view such taxation as "fair."

Within 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.

Simplicity - 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.

Accountability - 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 is transparency.

Economically 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.

The 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.

As noted earlier, these principles tend to conflict with each other. Creating 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.

And perhaps most significantly, tax incentives violate adequacy, equity, 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.

In short, tax policy principles provide guidelines for evaluating proposals. They cannot be shackles that prevent state legislatures from determining priorities.

Under 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.


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