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Commentary: Trump's tax dodge -- what's fair got to do with it?

10/03: MoneyWatch

Commentary

The news over the weekend -- as reported by the New York Times -- that “Donald J. Trump declared a $916 million loss on his 1995 income tax returns, a tax deduction so substantial it could have allowed him to legally avoid paying any federal income taxes for up to 18 years,” prompted many people to say, “That’s not fair!” Why should wealthy people like Donald Trump be able to pay less taxes as a share of their income than the typical household? Why don’t the wealthy pay their fair share?

What is fair when it comes to distributing the tax burden? That is not a question that economics can answer. Economists can estimate how the burden of a particular tax will be distributed across the population, or measure the impact that particular types of taxes will have on the economy, but there is no way to determine what is fair. That requires a value judgment. 

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For example, if the taxes of one person are reduced by $1,000, and the taxes of someone else increased by the same amount, is the tax burden more equitable or less equitable? One person is better off, the other worse off, and economists have no way of weighing the loss against the gain without some assumption about how taxes ought to be distributed.

In economics, assumptions about how taxes should be distributed are known as “principles of distributive equity.” The first principle is absolute equity. With this form of taxation, the tax bill is determined by dividing total government expenditures by the number of people so that everyone pays an equal share. 

But is it fair for the poor to have the same tax burden as the rich? 

The second principle of taxation is based on the idea that everyone should be required to give up the same amount of “happiness” when paying taxes.

The most popular variant of the ability-to-pay principle, one I endorse, is called the equal marginal sacrifice principle. It is often used to justify progressive taxation. The idea is that when a poor person pays the last $100 in taxes it may mean giving up the consumption of food, clothing, or other necessities with a high value. However, when a wealthy person pays $100 it doesn’t mean giving up the consumption of goods that are essential for the household’s well-being. To equalize the sacrifice, taxes should be increased for the wealthy and decreased for those with lower incomes until both sacrifice the same amount of happiness when the last dollar of taxes is paid.

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The third principle of distributive equity is called the benefit principle. In this case, people pay for the government services they consume individually. If people with higher incomes also consume more government-provided resources - such as airports, police protection of businesses and homes, museums and performing arts centers, and so on - then the benefit principle justifies a progressive tax structure. 

But if lower income groups consume more government goods and services than higher income groups, then this could also support a regressive structure. This principle rules out redistribution of taxes, and it also makes it difficult to justify social insurance programs where some people – the unlucky – receive more than they contribute and others receive less. (Just as with fire insurance, when people whose homes burn down receive much more from the insurance than those whose do not, people who experience, say, unemployment will consume a higher share of social insurance programs than those who do not.) It also requires some way of evaluating government services, many of which are not sold in private markets and hence do not have a market determined price.

Depending on one’s choice of a principle of distributive equity, it’s possible to argue for progressive, flat, regressive or equal taxes. I think most of us believe in some version of the equal marginal sacrifice principle, and hence that progressive taxation to some degree is fair, but this is a question that must be resolved in the political arena. 

Economics can assess the consequences of the choice society makes -- who will gain, who will lose, and how it will affect the economy. But it cannot tell us which choice to make.

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