The notes and textbook this week touch on the role of politics in budgeting, both internal to organizations and partisan politics (see pp. 120-121 of the textbook). Thinking about the internal portions of this discussion (focused on bureaucrats inside organizations), is it acceptable for appointed officials to engage in internal politics during budgeting processes? Why might this be a necessary and fundamental to budgeting processes? To what extent is it acceptable?

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There are two general principles of tax equity. The first is the ability to pay principle, which says that the taxpaying capacity of different taxpayers should be taken into account in designing the tax system. The second is the benefit principle, which says there should be some relationship between the benefits received by the taxpayer and taxes paid.

Ability to Pay

Different taxpayers have different levels of income and wealth and, therefore, may have different capacities to bear the cost of financing government.4 One sense of equity relates to the "ability to pay" principle. A tax should be related to the taxpayer's income or wealth or, more generally, to the taxpayer's ability to pay the tax. A taxpayer who can afford to pay more should pay more. Some consider that equitable. This principle implies that a tax imposes the same loss of utility for each taxpayer or, as economists refer to it, the equal absolute sacrifice. Equity has both horizontal and vertical dimensions.

Horizontal Equity

Horizontal equity refers to charging the same amount to different taxpayers whose ability to pay (usually measured by income levels) is the same. If two taxpayers living in the same jurisdiction are the same on relevant dimensions, and they pay different levels of tax, that tax would violate the principle of horizontal equity. That can occur, for example, because the way a tax is administered may erroneously identify two taxpayers as being the same, when in fact they are different. This can be a particular problem for the property tax, because the level of tax paid is usually a direct function of assessed values of property. If two parcels are erroneously valued the same, when in fact one could sell for more on the market, then these two taxpayers are being treated as if they are the same, when they in fact may be quite different. It is important to note that whether two taxpayers are "the same" is frequently in the eye of the beholder. If two taxpayers have the same level of income, for example, but one is supporting a family of five on that income while the other is a single taxpayer, simply differentiating tax paid on the basis of income fails to account for real differences in ability to pay. In this case, a tax that appears to be horizontally equitable may not be at all.

Vertical Equity

While there is nearly universal agreement that horizontal equity should be adhered to, vertical equity is a somewhat harder principle on which to obtain consensus. Put simply, vertical equity has to do with "treating different taxpayers differently." Normally, this implies knowledge of how a given tax affects different people, or income groups, in the society. Vertical equity is normally measured by computing the effective tax rate, which is computed by dividing the tax paid by a given individual by some measure of wealth or income. The computation of the effective tax rate can yield conclusions that a given tax, or tax system, is one of the following:

Progressive, if effective tax rates are higher for higher-income taxpayers than for lower-income taxpayers;

Proportional, if effective tax rates are essentially the same across different income categories; or

Regressive, if lower-income taxpayers experience higher effective tax rates than higher-income taxpayers. Knowing whether a tax is progressive, proportional, or regressive involves knowing more than just the tax rate.

For example, a flat rate sales tax on purchases seems to treat all taxpayers equally, but is often actually regressive in that low-income families may spend a greater proportion of their incomes on taxed items than wealthier families do. Most people would argue for tax systems that are either proportional or progressive. However, even if there is general agreement that a tax system should be progressive (as is generally true for the federal income tax), this does not mean that there is agreement concerning how progressive the tax should be.

Because debates about progressivity are actually debates about the portion of the tax burden to be borne by different taxpaying groups, the debates are important and can create substantial controversy. In addition to the direct tax burden borne by different taxpayers, some Republicans in Congress have wanted to make the income tax less progressive, arguing that many upper-income taxpayers are "job creators" and that lower tax rates therefore have a positive effect on employment.5 Overall, the entire U.S. system of revenue, at the national level, is progressive, but that masks some variation by revenue source.

While the federal income tax is quite progressive, the payroll tax (for Social Security and Medicare) is actually regressive, because there is an income ceiling above which Social Security taxes are not paid. In 2019, taxpayers and employers were assessed the payroll tax only on the first $132,900 of payroll income.6 The revenue system cannot be judged independently of certain government expenditure programs. Transfer payments, such as various forms of aid to low-income families, are somewhat like "negative" taxes in their effect and increase the progressivity of the tax and transfer system considered together.

A Congressional Budget Office (CBO) study compared the average tax rate paid for all federal taxesindividual income, social insurance, corporate income, and excise taxesin 2016 (before the Tax Cuts and Jobs Act) and projected for 2021 (after that law took effect). It found that the top 1% of income earners paid an overall effective tax rate of 33.3% in 2016, but that this would fall to 30.4% by 2021. Similarly, the average tax rate would fall from 26.8% in 2016 for the group in the 96th through 99th percentiles to 24.8% by 2021, from 23.6% to 22.5% for those in the 91st to 95th percentiles, and from 21.2% to 20.2% for households in the 81st to 90th percentiles. Effective tax rates continue to drop as incomes decline.

The average tax rate declined from 17.9% in 2016 to 16.9% in 2021 in the fourth quintile, and from 1.7% in 2016 to less than 1% in 2021 for the lowest quintile.7 A separate study found that, for the first time in history, the 400 richest families (all billionaires) paid a lower effective tax rate than the bottom 50 percent of taxpayers (what might largely be considered to be the "working class").