Presentation by Prof. Michael Krashinsky to Lawyers for Fair Taxation
The Economic Case for Fair Taxation Michael Krashinsky Professor of Economics University of Toronto
How do economists think about the issue of equity – or fairness – in taxation?Two fundamental principles:3.Horizontal Equity4.Vertical EquityHorizontal equity requires that people with the same ability to pay taxes in fact pay the same taxes.Vertical equity requires that people with more ability to pay taxes pay more taxes.
Both principles depend on the idea of “ability to pay.” But this is not a clear cut principle.Should it be based only on income? 1. What about wealth? (eg. two individuals, each with $100,000 in gross income, one has no assets, one has $500,000 in bonds) 2. What about leisure? (eg. two individuals, each earning $100,000 per year; one works 50 hours a week, the other 25 hours a week)
Should we tax only cash income, or should we include imputed income? (eg. two individuals, each earning $100,000, but one owns a house and a vacation property)Should we tax income or consumption?And even if we decide to tax income, what about credits or deductions? (eg. two individuals, each earning $100,000, but one donates $20,000 to charity) (what about religious institutions?)
Carter said “A dollar is a dollar.” But that may be a bit too simple. It presumes that we have decided to tax income, and that we know what to do about these other issues!OK, let’s for a moment assume that we know what to do about these issues. That takes care of horizontal equity.But what is constitutes vertical equity?
Vertical equity states that those with more income should pay more tax, but how much more tax? The economics here get very fuzzy!Theory tells us that the value of each additional dollar we earn diminishes. So if every person paid the same absolute tax, it would be a much smaller burden on the rich than on the poor.So the rich should pay more, but how much more?
Equal absolute sacrifice? If a dollar is worth 5 times as much to a person with an income of $20,000 as to a person with an income of $200,000, then equal absolute sacrifice requires the $200,000 earner to pay 5X as much But as a fraction of well-being, equal absolute sacrifice asks for a smaller fraction from the wealthier person. Maybe more is required?What about equal proportional sacrifice?
There is no easy economic answer to the question of how much each group should pay. Ultimately, this is a moral issue.
But we can ask the “easier” question. Has the tax system become more or less fair in the last couple of decades?Here we do have an answer from economics: The system is less equitable than it used to be.Study by Marc Lee (Canadian Centre for Policy Alternatives – a somewhat left-leaning group)“Eroding Tax Fairness” – easily available on- line
Lee looks at all taxes paid by Canadians and asks what is the tax rate as a percentage of income in the various income deciles (lowest 10%, next 10%, etc.)This mirrors earlier studies that looked at the same issue – overall tax burden.Basic conclusions:The tax system is not as progressive as we think.It has been getting worse, not better.
This worsening has taken place during a period when the gap between the rich and the poor has been widening, so changes in tax policy have actually made things worse.Table on next slide shows this:
Two questions:2.Why isn’t the tax system more progressive?3.Why has it gotten worse?5.Why isn’t it more progressive? I thought it was progressive!Federal income tax is progressive, but capital gains. And sales taxes and property taxes are regressive, as are payroll taxes (CPP, EI)
2. Why has it gotten worse?Phase out of federal surtaxes.Bracket creepRises in payroll taxesRises in small gov’t charges