Underlying the provisions of any tax law is a policy consideration that is the product of our political process. Consequently, the malodorous scent of politics is an unavoidable hazard when discussing tax policy.
Yet understanding the components of our tax policy and their implications is important for understanding our system of taxation.
Tax policy is basically the measures and methods used by our national, state and local governments to collect the money used to fund their activities. Historically, these measures and methods have varied.
Until the 16th Amendment to the Constitution was ratified, income taxes were held to be unconstitutional and the federal government’s revenues were limited to excise taxes and tariffs. Today, the list of the methods used to collect government revenues includes sales, property, estate, gift, excise, payroll, employment and income taxes as well as fees and licenses.
Currently, governments’ major source of revenue is from taxes collected on income and earnings. According to The Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution, for the fiscal year 2008, individual and corporate income taxes constituted 57 percent and payroll taxes 36 percent of the federal revenue dollars collected. Of state governments’ 2006 general revenues, nearly 51 percent came as transfers from the federal government or individual and corporate income taxes.
An increasingly important aspect of tax policy is to use it to encourage behavior believed to benefit society. For instance, if you own a home, the presumption is that you are more invested in the community in which it is located. Accordingly, tax policy includes developing provisions in the tax law to promote home ownership such as the deductibility of interest paid on a primary residence.
Permitting business to accelerate the tax benefits cost of an asset normally spread over several years into the year it is purchased in an example of tax policy promoting business activity.
Probably the most controversial component of our tax policy, however, is its use to bring about economic fairness or vertical equity (addressing social inequality through taxation). As the income tax evolved, our tax policy has become more progressive, i.e. requiring those who earn more income within a given period to pay a relatively larger percent of their income in taxes.
As evidence of the progressive nature of income taxes, the Tax Policy Center estimates that about 40 percent of tax units will pay no individual income tax or will receive a net subsidy for 2008 and that the 1 percent with the highest incomes will pay 18.3 percent of their income in individual income tax on average.
And while it is generally recognized that payroll taxes are regressive, claiming a relatively larger share of the income of lower-income than from higher-income households, The Tax Policy Center correctly points out in its 2008 estimates that individuals in the bottom 20 percent of earners do not pay any income tax but receive subsidies, i.e. payments, from the government totaling 8.1 percent of their income. So a portion of the regressive nature of payroll taxes is offset by the subsidies lower income households receive in conjunction with their earnings.
A consequence of a progressive tax policy is that the cost of government is increasingly borne by fewer taxpayers. Understandably, these taxpayers are advocates for narrow or limited tax saving provisions to reduce their income taxes, adding to the tax code’s complexity and the perception of unfairness.
In effect then, what the advocates for vertical equity in tax policy have fostered is an environment in which taxpayers justify inflating or embellishing facts to meet the requirements of specially designed stipulations in the law to reduce taxes, because most taxpayers have a vague notion that locked in the recesses of the tax code are rare and illusive tax saving provisions.
Occasionally, we will ask clients whose tax returns we are preparing to describe the facts surrounding a reportable transaction; their response in many instances is some variation of, “What do they need to be?” as if facts were so malleable they could be transformed, reminiscent of the legal contortions associated with questioning what the meaning of the word “is” is.
Abraham Lincoln once said, “Most folks are about as happy as they make up their minds to be.” A similar sentiment might capture the outlook many of us have regarding taxes. Be assured, however, that the appropriate place for redress of tax or economic inequities is not in a CPA’s office.
John D. Blair Sr. is a managing partner at Blair, Bohlé & Whitsitt, PLLC, a CPA firm that provides accounting, assurance, tax compliance and planning services in addition to strategic planning and tax minimization strategies to privately held businesses. Contact him at 704-841-9800 or visit www.bbwpllc.com.