Wednesday, November 24, 2010

Taxes and Two Kinds of Fairness

When people talk about something being "fair," they are generally referring to one of two kinds of fairness.

The first kind of fairness is "results fairness." We look at the results and conclude they are fair. If two kids each get the same size piece of cake, that result is fair. If one kid baked the cake while the other kid played video games, and the baker gets a larger piece than the gamer, most people would still consider that result to be fair.

The other kind of fairness is "process fairness." In this case we assume that if the process is fair, the results will also be fair. With a piece of cake if a parent says, "One of you gets to cut the cake and the other gets to choose their piece first," we view that as a fair process -- even if one kid ends up with a bigger piece of cake than the other. Our criminal justice system is based on this kind of fairness -- each side has a zealous advocate; an impartial jury hears both sides of the argument, and as long as the process is fair (i.e., no one bribes the jury), we believe the result will be fair -- or at least as close to fair as we're capable of getting.

What does this have to do with fairness of the federal income tax system? We have been at a point for many years where very few people believe that the federal income tax system demonstrates either results fairness or process fairness. We know that the results aren't fair because we hear too many stories of billionaires who pay little or nothing in taxes. We know that the process isn't fair because there are too many loopholes in the tax code, and we believe that those loopholes are exercised more often by affluent tax payers than by poor tax payers. (I will comment on the numerous ways in which the tax system is unfair in future articles.)

The concept of fairness is one reason that I advocate a flat tax. I believe the federal income tax system should be structured as a flat percentage tax on all income, regardless of source, with no deductions except for a a standard deduction of $10,000 per taxpayer. This would replace federal income tax and employee social security and medicare tax and would be "revenue neutral" at a rate of approximately 24%.

This system has several advantages in fairness over our current system:
  • It's simple enough that people can understand it without an accounting degree.
  • It doesn't tax very low income people, which social security and medicare currently do.
  • It doesn't have any loopholes. There are no deductions except for one personal deduction, which is the same for everyone.
  • It doesn't have any hidden tax rates. One of the reasons the rich pay less in taxes is that most of their income tends to be capital gains, which is currently taxed at only 15%.
  • It applies the same tax rate to everyone because the rate is flat. The rich pay more, but they don't pay disproportionately more.
Does the flat tax exhibit results fairness? I think it does, but you have to make sure you're asking the right question. The right question on that topic is "Does flat tax demonstrate results fairness compared to our current tax system?" Compared to our current system, it is more fair. The poor don't get taxed via social security, and the rich don't get a tax break via a lower capital gains rate.

Does the flat tax exhibit process fairness? Yes, that is its strength. The process is simple, easy to understand, and applied without exception. If you earn more, you pay more. But you don't get punished for being rich, which I think should be anathema to anyone who believes in America as The Land of Opportunity.

1 comment:

  1. I am always amused by people who think that a flat tax benefits people of lower income. They can't come to terms that, under the current system they get far more than they contribute and a flat tax would change that. If America ever impliments a flat tax, there will be one huge case of buyers remorse as people who thought that if taxes were more "fair" they would pay less only to find out that in a "fair" system, they pay more.