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General Tax Principles. June 6, 2008. Principles. Why Tax Principles?. To help “… identify and recommend changes to align the revenue system with economic activity” (DOR Strategic Plan, June 2004) To constrain the tax debate—a framework for discussion

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Why tax principles l.jpg

Principles

Why Tax Principles?

  • To help “…identify and recommend changes to align the

  • revenue system with economic activity”

  • (DOR Strategic Plan, June 2004)

  • To constrain the tax debate—a framework for discussion

  • To set standards for measuring progress

  • To improve our ability to influence tax proposals and law

  • changes


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Principles

Why Tax Principles?

  • To minimize unguided, conflict-creating, incremental

  • law changes

  • To provide an agenda for periodic review and evaluation

  • To assist the Department’s internal planning for tax

  • administration

  • To evaluate each tax in the context of the whole tax system


Tax principles l.jpg

Principles

Tax Principles…

Taxes should be:

  • Simple and understandable

  • Stable, predictable, adequate

  • Efficient

  • Fair

  • Competitive

  • Visible


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Principles

Simple and understandable

  • Critical for voluntary compliance

  • Simplicity breeds a sense of fairness

  • Minimizes administrative costs

    Strategies

  • Broad bases, low rates—minimize “tax expenditures”

  • Maximize federal income tax conformity

  • Clear statutory language (minimize rule-making)

  • Uniform, convenient administrative procedures

  • Balance costs of enforcement with desired level of compliance


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Principles

Stable, Predictable, Adequate

  • Taxes raise sufficient revenue to cover spending commitments

  • Facilitates tax planning, aids in forecasting

  • Avoids disruption of unexpected, non-optimal changes in tax laws

    Strategies

  • Broad bases, low rates, minimize tax expenditures

  • Law changes with long-term focus vs. quick fixes (steady, purposeful, aimed at the ideal end-state

  • Approximate 3-legged stool balance (personal Income, sales, and property taxes)

  • Budget reserves, rainy day funds


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The Three-legged Stool

The Fiscal Balancing Act

“Three-legged Stool” (FY2007)

“Ideal” MN Actual

  • Income tax 33.3% 38.7%

  • Sales tax/MVST 33.3% 27.8%

  • Property tax* 33.3% 33.5%

    100.0% 100.0%

*before PTR Source: DOR Tax Research Division


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Principles

Efficient – Two Definitions

  • Administrative Efficiency

    • Low admin cost (ease of understanding, low compliance costs, etc)

  • Allocative Efficiency

    • Tax policy does not distort private economic decisions—what to produce, how to produce it, to save or invest, types of investments (unless distortion is a goal)

      Strategies

  • Broad bases, low rates

  • Minimize use of the revenue system as a tool of social policy

  • Taxes should not impede productivity

  • Tax policy should preserve relative prices


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Principles

Fairness (equity)

  • Use “benefits-received” theory/fees if appropriate

  • Otherwise—use “ability-to-pay” theory

    a. Horizontal equity –Treat equals equally (see allocative

    efficiency)

    b. Vertical equity – meet some politically acceptable standard

    of tax incidence

    Strategies

  • Tax those who benefit from specific, identifiable expenditures in proportion to benefit received,

  • Broad bases, low rates, minimize tax expenditures, avoid boutique rates

  • Clear statutory language

  • Minimize tax shelters


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Principles

Fairness (equity)

Strategies

  • Publish and publicize tax expenditures--monitor trends, review and sunset

  • Assess system-wide tax incidence

  • Shield subsistence income from taxation

  • Avoid regressivity

  • Use income tax rates, , low income credits, PTR to achieve desired level of system progressivity


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Principles

More on Fairness…

  • It’s not who writes the checks that matter…

  • …It’s who bears the burden of taxes

  • Fact: only people bear the burden of taxes

  • Businesses pass taxes on to people (workers, customers, investors)

  • Analysis of the “tax incidence” of taxation must recognize this

  • DOR’s biennial Tax Incidence Study does this


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Principles

Taxes: Progressive, Proportional, Regressive

Tax Rate

5% 4% 3% 2% 1%

progressive

proportional

Regressive

Income


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DOR Tax Incidence Study, March 2007 (TY2004 data)


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Principles

Competitive

  • Maintain a competitive business climate

  • Tax system should recognize the necessity of competing in the global economy

    Strategies

  • Recognize the growing insignificance of “place” and invisibility of tax transactions in tax administration

  • Recognize changes in competitive regimes (eg. Electric utility deregulation)

  • Tax burdens should not get too far ahead of other states

  • Focus on long-run competitiveness

  • Use direct appropriations for incentive, rather than tax expenditures


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Minnesota State and Local Tax Ranking, FY 2006

Per $1,000 PI Per Capita

Rank % of US

Rank % of US

Ind. Income Tax

8th 122.2

8th 114.3

Corp. Franchise Tax

10th 116.3

13th 108.6

Sales and Use Tax

23th 90.4

35th 84.3

Property Tax

28th 86.2

35th 80.3

Total State and Local Taxes

14th 109.1

20th 101.6

Source: Minnesota Taxpayers Association, June, 2008


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Principles

Visible

  • Often overlooked principle

  • Encourage transparency – critical to healthy democracy

  • Avoid hidden taxes (eg. Pyramiding sales taxes)

  • Avoid creating a “fiscal illusion” (prices less than cost)

    Strategies

  • Make taxpayers aware of linkage of taxes to spending

  • Report on tax incidence

  • Small tax payments are less visible than large ones

  • Avoid automatic tax increases (triggers, indexed rates)

  • Keep Truth-in-Taxation meetings

  • Codify differential property assessments in statute


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Principles

If broad bases and low rates are so good, why do we have so many exemptions, and such high rates?


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Principles

Simplicity-Fairness Tradeoff

Tax all income, Flat Rate

Simple

Exemptions, Progressive Rates

Fairness


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