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Criteria for Taxation: Equity, Simplicity & Efficiency

Instructor: Kaitlin Oglesby
Few words can cause political differences to seem so alive as the word 'taxation'. However, as this lesson shows, chances are that someone's simple solution isn't so simple after all.

Building a Better Tax System

Listen to a politician or a policy wonk for long enough, and they will inevitably bring up taxation. Some will argue that taxes are too high, while others will say that the system is too complex or is not fair. Still others will ask why it takes an entire government entity just to collect income taxes, and that is not even all the taxes that the government collects! Simply put, taxation is a hot-button issue, and almost everyone has ideas on how to make it better. In this lesson, we'll look at three criteria that must be balanced for a better tax system, as well as seeing instances in which they don't always work.

Simplicity

Many people would prefer to have a tax system that is simple to understand. Few people complain about sales taxes, for example. Sales tax is easy - if you purchase something, you pay a percentage of its price to the state or local government as a tax. In Europe, a national tax known as a value-added tax, or VAT, is in essence a sales tax. In the United States, campaigners for a more simplistic tax code often campaign for a flat tax, in which a flat percentage would be charged on all incomes. With the current system, billions are spent every year to file taxes. People who argue for a simpler tax code see these billions as dollars that could be better spent elsewhere.

Equity

Those who campaign for a flat tax often point to the equity of the system. After all, wouldn't it be more fair if everyone paid the same percentage? However, this is itself a controversial question. Many would agree with that thought, but many others prefer the progressive tax system in use today. This allows those who make more to pay a higher portion of their income in taxes. However, that portion changes depending on what tax bracket an individual ends up in, and only income earned once passing a tax bracket's limits will be taxed at the higher rate.

Here is an example. If you have two people, one making $50,000 a year and the other making $100,000, with tax brackets of 25% up to $60,000 and 30% on everything over $60,000, both people pay $12,500 on the first $50,000 that they make. However, the richer person then pays another $2,500 on the amount up to $60,000, then 30% of the remaining $40,000, or $12,000. As such, the person earning $100,000 pays $27,000 in total taxes, or around 27% of their total income. However, while the person who makes $50,000 has $37,500 in take-home pay, the person making $100,000 gets to keep $73,000.

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