How Is Our Income Tax Unfair?

July 17, 2007

In the New York Times’s Economic View column July 15, Professor Gregory Mankiw graded the U.S.’s income tax on fairness. He didn’t assign a letter grade, but it sounded as if our federal tax code would have gotten a B from the Harvard prof.

At first he seemed willing to give the code an A, citing Congressional Budget Office data that proves Americans pay much more in tax the more they earn. That makes our federal tax steeply progressive, which is what people generally refer to as fairness. But then Mankiw pulled back, citing fairness guru and scholar John Rawls as someone who would have wanted even steeper progressivity.

What I regret about the column is the missed opportunity to explain the other type of fairness, which our code deserves a D on, or maybe an F.

This second type of fairness answers the question: If two people earn the same amount, do they pay the same amount? Alas, the answer is emphatically no. As Patrick Fleenor showed in a recent paper on the AMT, a family of four earning $130,000 might pay 5.4 percent in tax, or it might pay 14.4 percent.

Large streams of income are taxed at zero percent each year, largely due to Congress’s constant micromanaging: Let’s forgive the tax if the money is spent on housing; let’s forgive the tax if the money is spent on education; let’s forgive the tax if the money is spent on state-local taxes; and on and on. Books with titles like “Deduct It!” are filled with tips on how to whittle down your taxable income to nothing, all courtesy of favor-granting congressional tax writers.

Our income tax is unfair, but not in the way Prof. Mankiw was explaining. He’s correct that the 2008 presidential race will be all about progressivity, but that’s a shame because the unfairness that really undermines American faith in the tax system is the pockmarked tax code that permits clever tax minimizers to pay much less than the family next door who earns the same income.

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