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A good tax system should meet five basic conditions: fairness, adequacy, simplicity, transparency, and administrative ease.
Although opinions about what makes a good tax system will vary, there is general consensus that these five basic conditions should be maximized to the greatest extent possible.
1. Fairness, or equity, means that everybody should pay a fair share of taxes. There are two important concepts of equity: horizontal equity and vertical equity.
- Horizontal equity means that taxpayers in similar financial condition should pay similar amounts in taxes.
- Vertical equity is just as important, however. Vertical equity means that taxpayers who are better off should pay at least the same proportion of income in taxes as those who are less well off. Vertical equity involves classifying taxes as regressive, proportional, or progressive.
- Regressive tax: A tax is regressive if those with low incomes pay a larger share of income in taxes than those with higher incomes. Almost any tax on necessities, such as food purchased at a grocery store, is regressive because lower income people must spend a larger share of their income on these necessities. Oklahoma’s sales tax is one example.
- Proportional tax: A tax is proportional if all taxpayers pay the same share of income in taxes. No taxes are truly proportional. Property taxes often come closest since there is typically a close relationship between a household’s income and the value of the property in which they live. Corporate income taxes often approach proportional because one rate applies to most corporate income.
- Progressive tax: A progressive tax requires higher-income individuals to pay a higher share of their income in taxes. The philosophy behind progressive taxes is that higher income people can afford and should be expected to provide a bigger share of public services than those who are less able to pay. The federal income tax is the best example of a progressive tax; the Internal Revenue Service reports that the top one percent of taxpayers by income paid 37 percent of federal income taxes in 2016.
While no system of taxes is perfect, it is important to seek horizontal equity because taxpayers must believe they are treated equally. It is just as important to seek vertical equity so government does not become a burden to low-income residents.
2. Adequacy means that taxes must provide enough revenue to meet the basic needs of society. A tax system meets the test of adequacy if it provides enough revenue to meet the demand for public services, if revenue growth each year is enough to fund the growth in cost of services, and if there is enough economic activity of the type being taxed so rates can be kept relatively low.
3. Simplicity means that taxpayers can avoid a maze of taxes, forms and filing requirements. A simpler tax system helps taxpayers better understand the system and reduces the costs of compliance.
4. Transparency means that taxpayers and leaders can easily find information about the tax system and how tax money is used. With a transparent tax system, we know who is being taxed, how much they are paying, and what is being done with the money. We also can find out who (in broad terms) pays the tax and who benefits from tax exemptions, deductions, and credits.
5. Administrative ease means that the tax system is not too complicated or costly for either taxpayers or tax collectors. Rules are well known and fairly simple; forms are not too complicated; the state can tell if taxes are paid on time and correctly, and the state can conduct audits in a fair and efficient manner. The cost of collecting a tax should be very small in relation to the amount collected.
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FAQs
A good tax system should meet five basic conditions: fairness, adequacy, simplicity, transparency, and administrative ease.
What are the criteria for an effective tax system? ›
The criteria of effective taxes are equity, simplicity and efficiency. 1- Equity: This criteria of equity includes two concepts, vertical equity and horizontal equity. Vertical equity means that the taxation system should distinguish between taxpayers according to their financial capacity.
What are the four characteristics of a good tax system? ›
Four characteristics make tax a good tax and they are: certainty, equity, simplicity and efficiency. Certainty is characteristics by which every tax payer must be certain how much tax does he or she own, when payment of tax is due and how it should be paid.
What are characteristics of an effective tax exhibit? ›
Explanation: An effective tax is one that exhibits one or more of the following characteristics: equity, efficiency, and simplicity. Equity refers to a tax system that is fair and just, where individuals or entities with higher incomes pay a higher proportion of taxes.
What makes a tax effective quizlet? ›
Three criteria for effective taxes: Equity, simplicity, and efficiency.
What is an efficient tax system? ›
An efficient tax system raises revenue while minimizing unintended consequences, and an equitable tax system imposes obligations on taxpayers in proportion to their resources.
What are effective taxes? ›
The term effective tax rate refers to the percent of income that an individual or corporation pays in taxes. The effective tax rate for individuals is the average rate at which their earned income, such as wages, and unearned income, such as stock dividends, are taxed.
What are the 4 tax systems? ›
Approximately 85 percent of the state's own-source revenue comes from four sources: the personal income tax (PIT), the sales and use tax (SUT), the corporation tax (CT), and major motor vehicle-related levies.
What are the three most important types of tax systems? ›
progressive tax—A tax that takes a larger percentage of income from high-income groups than from low-income groups. proportional tax—A tax that takes the same percentage of income from all income groups. regressive tax—A tax that takes a larger percentage of income from low-income groups than from high-income groups.
What is the best tax system? ›
2023 Rankings. For the tenth year in a row, Estonia has the best tax code in the OECD. Its top score is driven by four positive features of its tax system.
These are: (1) the belief that taxes should be based on the individual's ability to pay, known as the ability-to-pay principle, and (2) the benefit principle, the idea that there should be some equivalence between what the individual pays and the benefits he subsequently receives from governmental activities.
Why is it important that taxes be efficient? ›
Reducing tax rates can lower the marginal efficiency cost of taxation. Lower tax rates will thus lower the disincentives created by taxation and lower the deadweight loss allowing higher investment and economic activity.
Which of the following criteria are often used to evaluate a good tax system? ›
The criteria often used to evaluate a good tax system are certainty, equity, economy, sufficiency, convenience, and punctuality. The criteria that are often used to evaluate a good tax system include: Certainty: Taxes should be clear and predictable, so that taxpayers know how much they owe and when it is due.
What are the key characteristics of a tax system? ›
A good tax system should meet five basic conditions: fairness, adequacy, simplicity, transparency, and administrative ease. Although opinions about what makes a good tax system will vary, there is general consensus that these five basic conditions should be maximized to the greatest extent possible.
What are the three criteria of effective taxes? ›
Criteria for Taxation: Equity, Simplicity & Efficiency.
Which of the following is not a characteristic of an effective tax? ›
Longevity is not one of the three characteristics of an effective tax system. The major characteristics of an effective system include equity, efficiency, and simplicity.
What are the 3 criteria used to evaluate taxes explain? ›
The answers matter because various combinations of tax bases and rates can raise the same amount of revenue. Three long-standing criteria—equity; economic efficiency; and a combination of simplicity, transparency, and administrability—are typically used to evaluate tax policy.
What is another criteria for effective taxes means that tax laws should be written so? ›
Simplicity is when tax laws should be written so that both taxpayers and tax collectors can understand them. People seem more willing to tolerate taxes when they understand them. Efficiency is when a tax should be relatively easy to administer and reasonably successful at generating revenue.
