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Tax Neutrality: Balancing Priorities

Key Takeaways

  • There are four principles of sound tax policy: simplicity, transparency, stability, and neutrality.
    • Neutrality means the tax code does not give preferential treatment to certain industries or behaviors.
  • Taxes have one job: to raise revenue to provide government services like infrastructure, education, and more. This is done best when a tax is levied on a wide base at a low rate.
    • Non-neutral tax policies shrink the tax base and prioritize influencing behavior over raising revenue.
    • Though it’s not sound tax policy, governments commonly use the tax code to do this.
  • Examples of non-neutral taxes include excise taxes on gasoline and sugar, lower tax rates for electric vehicles, and tax breaks to attract certain industries to a state.
    • The motive behind these policies can be good, like promoting healthy behavior, protecting the environment, or creating jobs. However, the tax code is not the best avenue for these priorities.
  • When the tax code picks a “winner,” it naturally selects a “loser.” Sometimes this is a competing business or industry, but the “loser” can also be taxpayers themselves.
  • Historically, businesses and individuals have come up with creative ways to avoid non-neutral taxation, like adding flour to candy to skip some sales taxes.
  • These types of policies limit revenue—the opposite of taxes’ main purpose.


Taxes have one job – to raise revenue for the government to provide necessary services.

And when taxes are applied at a low rate, on a wide base, they’re likely to do this job better.

Unfortunately, this hasn’t always stopped governments from trying to use taxes for other purposes besides raising revenue, like influencing behaviors, or favoring certain businesses or punishing entire industries.

These might seem like a great idea on the surface. If we want to protect the environment we can lower tax rates on electric vehicle manufacturing. States that want to grow their economy might offer tax abatements to attract film producers or new sports stadiums.

There is also a long history of hiking taxes on products we want people to consume less of like gasoline, sugar, and even streaming services in some states. But here’s the problem – or problems:

First, preferential tax codes pick “winners.” And when that happens, there’s always a “loser” too. Sometimes, it’s the taxpayers and sometimes, it’s a competing business.

It also encourages businesses to game the system. Turns out that if you add enough flour to a chocolate bar you can call it “food” instead of “candy,” and skip some sales taxes.

Lastly, because preferential tax policies have a narrow base, they don’t actually raise that much revenue – the one thing they’re supposed to do.

This is why neutrality is one of the most important principles of sound tax policy.

Neutral tax codes don’t play favorites or try to influence personal or business decisions.

They stick to what they’re best at – raising sufficient revenue through low rates and a broad base.