59 Pages Posted: 3 Sep 2007
Although there is consensus about the need for equity, academics and policy makers disagree about the best tax system because we have ignored the need to first identify equity goals appropriate for a just government and then to design a tax system to help achieve those goals. This article proposes that the principal equity goal underlying a just government is the creation of equal opportunities for all citizens to achieve self realization, i.e. to maximize their potential. It proposes, therefore, that a tax should be designed to achieve equal opportunity for self realization as one of its principal goals. Viewing equal opportunity for self realization as a design issue leads to the identification of another principle that is foundational - the promotion of democracy. Both political philosophy and empirical literature suggest that equal access to the electoral process and participation in the community has to exist in order for equal opportunity for self realization to exist. Designing a tax system to help achieve these goals will not only increase equity, but also may provide efficiency gains that analysts have previously ignored.
To illustrate the importance of designing a tax system based upon these equity principles, this article revisits the debate about the desirability of an income tax versus a consumption tax. It argues that a progressive income tax, which limits loss deductions, is better than an ideal consumption tax in establishing the conditions for equal opportunity for self realization and democracy. A progressive income tax that limits loss deductions burdens investment income, which is a major source of political power. In contrast, a consumption tax cannot burden the disproportionate political power of the wealthy because it only burdens investment income in narrow situations and wealthy individuals only consume a small percentage of their total income. Although taxpayers can use portfolio adjustments to eliminate the burden on investment income in an ideal income tax, they have not used such adjustments in our actual income tax. This behavior may result from taxpayer concern that portfolio adjustments can decrease the after-tax return below that obtained in a fully taxable situation due to our tax system's limitations on loss deductions and changes in applicable tax rates.
This article also analyzes some other efficiency and equity claims for the two forms of taxes. The efficiency claims for an ideal consumption tax versus our existing income tax are overstated when viewed in the context of real-world systems that take into account taxpayer behavior and transition relief. Given the uncertain efficiency gains of a consumption tax in the real world, there is a strong argument that the equity goals discussed herein should govern the selection of a tax system. Such equity goals favor a progressive income tax that burdens investment income.
Keywords: self realization, tax systems, taxation, income tax, consumption tax
Suggested Citation: Suggested Citation
Repetti, James R., Democracy and Opportunity: A New Paradigm in Tax Equity. Vanderbilt Law Review, Vol. 61, 2008; Boston College Law School Research Paper No. 137. Available at SSRN: https://ssrn.com/abstract=1010987