Tax equity principles and applications

Taxes

An evaluation of two types of taxes: Sales vs. income

Sales taxes are invariably regressive taxes. Poorer people use a larger percentage of their taxes for consumption-related expenses, so they pay proportionately more of their income in sales taxes. For the wealthy, more of their spending is concentrated in savings and investments, since they can save a larger proportion of their income and still meet basic expenses. Of course, given that they often buy more items and more expensive items than the poor, the wealthy may pay more in total sum value than the poor in sales taxes. But as a proportion of their income, it is usually lower. Also, the poor spend a higher percentage of their income on necessities such as food which they cannot cut back on, even when the sales tax increases. Often, items like food and clothing are exempt from the sales tax to reflect this fact. But poor people may buy food items that are prepared, such a simple rotisserie chicken in the supermarket (which is taxed as a restaurant item for the service of cooking) and depending on where the state where one lives, relatively basic everyday goods may still be taxed.

The regressive nature of sales taxes has caused many people to advocate for their abolition. Sales taxes are primarily used to fund state operations. Sales taxes vary on a state-by-state basis and some states do not have sales taxes, while others do. Some states have both income and sales taxes; others only one or the other. The argument in favor of an income tax is that it is more progressive: people who have more income pay a higher rate of taxes. "A tax system is considered progressive if, on average, households with higher incomes pay taxes that are a larger share of that income. Thus, in a progressive tax system, the average effective tax rate-tax paid as a percentage of income-rises as income rises" (Distribution, 2012, Brookings Institute).

But some dispute whether income taxes are truly progressive, even when the rich pay a higher rate of taxes as a percentage of their income. First of all, the rich often have access to more loopholes than the poor. They derive a smaller proportion of their wealth from salaries and more from investment income, capital gains, and inheritance. Therefore, they may actually pay less in income taxes than a middle-income person who derives most of his or her income from a salary. "At very high incomes, the average effective individual income tax rate actually declines, primarily because much of these taxpayers' income is in the form of capital gains, which are lightly taxed" (Are federal taxes progressive, 2012, Brookings Institute). For example, "Barack and Michelle Obama's effective tax rate for 2011 was 20.5%. They had adjusted gross income of $789,674. We also learned that their tax rate was slightly lower than President Obama's secretary, who had about $95,000 of income... [While] Mitt and Ann Romney have a projected effective tax rate of 15% for 2011" (Brown 2012).