In recent years, taxation has been one of the most prominent and controversial topics in economic policy. Taxation has been a principal issue in every presidential election since 1980—with a large tax cut as a winning issue in 1980, a pledge of “Read my lips: nomor new taxes” in the 1988 campaign, and a statement that “It’s your money” providing an enduring image of the 2000 campaign. Taxation was also the subject of major, and largely inconsistent, policy changes. It remains a source of ongoing debate.
Objectives
Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them.
Simplicity means that compliance by the taxpayer and enforcement by the revenue authorities should be as easy as possible. Further, the ultimate tax liability should be certain. A tax whose amount is easily manipulated through decisions in the private marketplace (by investing in “tax shelters,” for example) can cause tremendous complexity for taxpayers, who attempt to reduce what they owe, and for revenue authorities, who attempt to maintain government receipts.
Efficiency means that taxation interferes as little as possible in the choices people make in the private marketplace. The tax law should not induce a businessman to invest in real estate instead of research and development—or vice versa. Further, tax policy should, as little as possible, discourage work or investment, as opposed to leisure or consumption. Issues of efficiency arise from the fact that taxes always affect behavior. Taxing an activity (such as earning a living) is similar to a price increase. With the tax in place, people will typically buy less of a good—or partake in less of an activity—than they would in the absence of the tax.
The most efficient tax system possible is one that few low-income people would want. That superefficient tax is a head tax, by which all individuals are taxed the same amount, regardless of income or any other individual characteristics. A head tax would not reduce the incentive to work, save, or invest. The problem with such a tax, however, is that it would take the same amount from a high-income person as from a low-income person. It could even take the entire income of low-income people. And even a head tax would distort people’s choices somewhat, by giving them an incentive to have fewer children, to live and work in the underground economy, or even to emigrate.