commentary

(Wall Street Journal )

April 17, 2001

Tax Fairness Is in the Eye Of the Beholder

by Charles Wolf, Jr.

Reprinted with permission of The Wall Street Journal, © 2001 Dow Jones & Company, Inc.

Critics of George W. Bush's tax-reduction plan fault it on two principal counts: It is too large, and it is "unfair" because the resulting benefits accrue disproportionately to high-income earners.

According to the critics, tax cuts should be more targeted -- hence "fairer" -- and smaller, allowing more of the estimated future budget surpluses to be used to pay down the federal government's $3.4 trillion of publicly held debt over the next 10 years. The implication is that accelerated debt reduction would be "fairer" than would the larger, across-the-board cuts in tax rates and tax revenues envisaged by the Bush plan.

On the issue of whether accelerated debt reduction is fairer, the critics are plainly wrong. The benefits of debt reduction are no less concentrated on high-income earners than are the benefits of tax reduction. The underlying issue of how fairness should be judged is more debatable, more difficult, and probably unresolvable because it is inherently subjective.

To be sure, cutting marginal tax rates by equivalent percentages across the board will disproportionately reduce the gross tax liabilities of high-income earners. A 5% reduction in the marginal tax liability of a taxpayer whose tax rate is 39% reduces tax obligations by much larger dollar amounts than does the same 5% reduction for a taxpayer whose marginal tax rate is 15%; the 39% taxpayer has more dollars exposed to the higher tax rate.

But, the same disproportion arises in the relative dollar benefits that would accrue to high-income earners (high-tax payers) as a result of paying down the federal debt. Reducing federal debt relieves future taxpayers of the burden of servicing and redeeming the debt. Hence, high-income earners -- who bear a disproportionate share of this burden through the higher tax rates they pay -- would realize the same disproportionate benefits from this relief as those they would realize from across-the-board tax reduction.

About 200 years ago, economist David Ricardo made essentially this same point when he analyzed the distributional effects of the comparable, although opposite, choice between incurring government debt now to be serviced in the future or increasing tax revenues now to avoid budget deficits and future debt service. Paying down the debt is no less skewed in favor of high-income earners, than is ratcheting marginal tax rates downward. It doesn't make sense to criticize the latter as "unfair" without attaching the same label to the former.

While the issue of tax reduction versus debt reduction can be dealt with and disposed of in economic terms, this isn't true of the fairness issue. Fairness is complex, multifaceted and highly subjective. It depends on which among many plausible but conflicting concepts and criteria one adopts for judging, let alone measuring, it. For example, is it "fair" that Vice President Cheney has just paid a higher tax rate (39.6%) on his entire income for last year ($39 million) than is required by law, as well as more than the maximum marginal tax rate of 39.5%?

According to Harvard legal philosopher John Rawls, fairness requires that priority and precedence be given to providing benefits to the less-fortunate (low-income) public before according any distributional benefits to the more-fortunate (high-income) public. A similar inference follows from the familiar Marxist precept: "From each according to ability, to each according to needs."

Economic theory suggests a very different view of fairness. Here, the touchstone is productivity. A fair distribution of benefits (from wages, or profits, or any distributive share), is one that recognizes the recipient's productivity and rewards it accordingly. Since high taxes paid by high-income earners typically reflect relatively high productivity, so too should the benefits from tax reduction recognize this and reward it accordingly. In this view, it is entirely fair that a high share of tax remissions should go to high-tax payers.

This view corresponds closely to what is sometimes referred to as vertical equity: Namely, treating unequally situated taxpayers (both high- and low-tax payers) in appropriately different ways. This might involve, for example, tax reductions that provide differing amounts of dollar recompense to taxpayers in accord with the differing amounts of taxes they have paid.

Finally, it is worth noting that when marginal tax rates are reduced by about the same number of percentage points across the board, the proportional reduction in the lowest tax bracket is much larger than the corresponding reduction in the highest bracket. In the case of the Bush plan, rates are reduced 33% and 14%, respectively.

This isn't to say that any distribution of tax cuts is as fair as any other, but rather that there are many reasonable criteria for judging fairness. To argue that the only "fair" distribution of benefits from tax reductions is one that denies high-tax payers an equivalently high share of the tax-cut benefits is unconvincing.

Whether this argument may nonetheless have appeal on political grounds is a separate question.


Charles Wolf Jr. is senior economic advisor and corporate fellow in international economics at RAND and a senior research fellow at the Hoover Institution.

This commentary originally appeared in Wall Street Journal on April 17, 2001. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.