Sunday, August 19, 2012

Horizontal Equity

Given the various incarnations of tax reform on the table, particularly from the Republicans in the Presidential debate, we are going to see a lot of discussion on the issue of tax equity.  Unfortunately, nearly all of this discussion is going to focus on the notion of vertical equity, that is, the equity between people of different incomes.

In some ways, a far more important discussion on the tax side is to be had around the notion of horizontal equity.  Oddly though, there is almost no published data on the topic of horizontal equity.  There are numerous papers on the topic as a conceptual matter but very little in the way of data.

But to illustrate the problem, we can look at the following table from the Tax Policy Center which shows the distribution of households who have zero or negative Federal income tax liability.  What this will show you is a reasonable number (thousands) of people with zero income tax liability who have high levels of income.  This fact is (in part) a result of lack of horizontal equity in the tax code.

There are literally hundreds of drivers of a lack of horizontal equity (mortgage interest deduction, child care credit, alimony income, etc.).  Each of these drivers is designed to fulfill some overriding policy objective that tax writers think they have; however, taken collectively they drive a large amount of horizontal inequity.

And horizontal inequity has effects that seep over into the discussion of vertical equity.  Remember the famous discussion about Warren Buffett versus his assistant.  Leaving aside the fact that Mr. Buffett did the tax calculation incorrectly, it is still a comparison driven by horizontal equity more than vertical equity.  People in Mr. Buffett's income class do in fact pay higher average effective federal taxes than people in his secretary's income class.  It is horizontal equity (and his faulty calculations) that drives this anecdote.

Which brings us to the debate over tax reform.  A smart campaign would push tax reform on the basis of horizontal equity.  Such a campaign would have a whole lot of ammunition to use.  The fact that neither side wants to talk about it is only an example of how much politicians like to be able to use the tax code to try to influence all of us to exhibit the "right" behaviors.

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