Tax Policy

1
Tax Policy

• A broad definition governments attitude,
  objectives, and actions with respect to its tax
  system
• The details of the tax system should be
  consistent with overall tax policy
• Tax policy should reflect the normative standards
  government deems important

2
Criteria for a Good Tax

• Convenient
• Sufficient
• Fair (equitable)
• Efficient

3
Sufficient Revenue Collections

• Recall T r B
• How to increase tax revenues (T)
• Enact a new tax on a base not currently taxed
• Increase the tax rate (r)
• Increase (expand) the tax base (B)
• The politics of tax increases
• Why is it not simple to determine the impact of
  such changes?

4
Behavioral Response to Tax Changes

• Income effect - taxpayers respond to an increase
  in tax burden by earning more before-tax income,
  so is to maintain their pre-change after-tax
  earnings
• Substitution effect - taxpayers respond to an
  increase in tax burden by earning less -
  labor/leisure trade-off
• Both types of responses complicate forecasting
• Static versus dynamic forecasting

5
Tax Fairness/Equity

• T function(ability to pay)
• Horizontal equity - taxpayers with the same
  ability to pay should pay the same amount of tax
• Vertical equity - taxpayers with greater ability
  to pay should pay a greater amount of tax
• Redistribution of wealth

6
Tax Rate Structures and Vertical Equity

• Progressive rates
• Tax rates increase as base increases
• Used to promote vertical equity, based on the
  theory of declining marginal utility of income
• Regressive rates
• Tax rates decrease as base increases
• Regarded as unfair to lower income taxpayers
• Proportional (flat) rates
• Often regarded as implicitly regressive

7
Tax Rate Comparisons

• Average tax rate - the explicit tax paid divided
  by the tax base
• Marginal tax rate - the rate that applies to any
  incremental increase in tax base
• Will the average tax rate be gt, , or lt the
  marginal tax rate when rates are progressive,
  regressive, or proportional?

8
Efficiency

• Tax neutrality
• Taxes as an instrument of fiscal policy
• macroeconomic effects
• behavior modification

9
Evaluating the US Income Tax

• Is the US income tax system
• Convenient?
• Sufficient?
• Fair?
• Efficient?
• Which of these goals might motivate recent
  proposals to change the system?

10
The Source of Federal Tax Law

• Legislative process
• Any new tax bill is first introduced in the House
  of Representatives, and referred to the Ways and
  Means Committee
• A bill approved by Ways and Means is sent back to
  the full House for approval
• A bill approved by the House is sent to the
  Senate, where the Finance Committee has
  jurisdiction

11
Source of Tax Law continued

• The Senate Finance Committee may amend the House
  bill, and send to the full Senate for approval
• If the House and Senate approved versions of the
  bill differ, a Joint Conference Committee must
  resolve differences
• The final bill must be approved by both House and
  Senate, before being sent to the President

12
Structure of the Federal Tax Law

• Primary authority three types
• Statutory authority - Internal Revenue Code of
  1986
• Administrative authority
• Treasury Regulations - have authoritative weight
  similar to the Code
• IRS Rulings
• Revenue Rulings - guidance published by the IRS
  for ambiguous or contentious situations. Not
  binding authority unless the facts are the same.
• Revenue Procedures - explain procedures and other
  taxpayer duties

13
Structure of the Tax Law continued

• IRS Rulings continued
• Private Letter Rulings - the IRS makes an
  advanced ruling on a specific transaction at the
  request of a taxpayer. Represents authority only
  for that transaction and that taxpayer!
• Judicial authority
• Court Decisions - establish precedent on
  interpretation of the tax law
• Trial Courts Tax Court, District Courts, Federal
  Claims Court
• Appeals Courts Circuit Courts of Appeal, US
  Supreme Court

14
Structure of the Tax Law continued

• Congressional intent - Committee reports of
• House Ways and Means Committee
• Senate Finance Committee
• Joint Conference Committee
• Secondary authority
• Textbooks, editorial materials in commercial tax
  services, professional journals
• Useful for understanding primary sources, but not
  authoritative. Should not be cited!

15
The Tax Research Process

• Step 1 Understand the clients transaction and
  ascertain the facts.
• Step 2 Identify the tax issues, problems, or
  opportunities suggested by the facts and
  formulate specific research questions.
• Step 3 Locate relevant tax law authority.
• Step 4 Analyze relevant authority and answer
  the research questions.

16
The Tax Research Process continued

• Step 5 Repeat steps 1 through 4 as many times
  as necessary.
• Step 6 Document your research and communicate
  your conclusions.