The effective amount of taxes paid by each category of income is explained by the following chart.
This chart shows the percentage of income that is paid on average by members of each income group. The chart shows the impact of the progressive tax system with brackets, with the tax rate increasing along with income. This type of tax structure follows the principle of vertical equity , which states that individuals in different economic conditions should have different tax burdens based on ability to pay. At the same time, there are no severe jumps in the effective tax rate between one income group and the next; the increases are mostly steady. Thus, at the same time that there is a substantial differential between the highest income group and the lowest income group, the amount of increase for the highest earners is relatively small, compared to the nominal rates for the top tax brackets in the past. For example, before 1986 the top income bracket had a tax rate of 50%.
The difference between the yearS₂004 and 2014 also show that the tax rates have increased for each group, but the increases have been larger for the lower income groups than the higher groups. While, overall, the pattern has not been changed very much from the 2004 levels, it might be compared against the tax brackets from before 1986 which had the lowest income group with a rate of 0%. If the trend toward "flattening" of the distribution continues in the long run, the principle of vertical equity also would be gradually abandoned.
Tax efficiency refers to the amount of effort required for administering taxes and ensuring compliance. The burden of a tax refers to the amount of effort required by taxpayers to pay tax; this includes such things as record keeping and form processing needed to pay a tax. Efficient tax collection avoids causing "excess burden" for taxpayers. Of course, the notion of what constitutes an "excessive" burden differs according to opinion. However, the general principle is that tax administration adds to the cost experienced by taxpayers and should be minimized as much as possible.
Tax equity refers to the concept of equal treatment by a tax system. There are different definitions of equity that can be applied under this concept.
• Horizontal equity means that taxpayers with similar economic conditions should pay equal amounts of taxes. This principle is referred to as the equal tax treatment doctrine.
• Vertical equity means that taxpayers with different economic conditions should pay different amounts of taxes, varying based on either their ability to pay or by the benefits received. This principle is referred to as the relative tax treatment doctrine.
Therefore, an efficient tax system should be as easy to administer as possible, while an equitable tax system should extract a similar amount of payment from groups of taxpayers at similar levels of income or wealth (horizontal equity), but also have some differential treatment for those who are more or less able to pay (vertical equity).
The bracketing system used in the current US federal income tax attempts to achieve vertical equity by allowing taxpayers with smaller incomes to pay a smaller amount of tax. Within each tax bracket, horizontal equity is at least nominally achieved by having the same rate within that group. Some have argued that a "flat tax" which is not bracketed would be more fair. It also would reduce the tax burden by simplifying the calculation of taxes owed. While this is true in terms of horizontal equity, this proposal would do away with an ability to pay concept, so vertical equity is not achieved. A simplified bracket system is a compromise between the two ideas.
Lessening the tax burden by simplifying the forms and procedures would also be recommended. However, the reason why forms are so complicated is mostly because of the numerous exemptions and deductions given to taxpayers for many different reasons, as matters of government policy. While the tax burden would be reduced by such a simplification, each one of those line items represents a benefit to a certain group of taxpayers, and its removal is therefore politically difficult. Therefore, although it's certainly possible to recommend simplification, it is much more difficult to politically achieve it.
Shifting of a tax occurs when the amount of that tax is paid by another individual. The burden can be shifted forward to consumers, or backward to owners of resources. The incidence of a tax refers to the amount of the tax that ends up being paid by each party.
For example, in a typical sales tax, retailers will add tax at the end of the sale to the final amount paid by the consumer. Thus, a 10% tax on a $1.00 purchase leads to a final cost of $1.10 being paid by the consumer. In this case, the incidence of the tax is entirely on the consumer; the tax shifts forward.
On the other hand, the retailer could also pay the tax on behalf of the consumer. The consumer would pay only $1.00, but the retailer would pay the $0.10 tax on the purchase. In this case, the incidence of the tax is on the retailer; the tax shifts backward.
Another possibility would be that the $0.10 tax would be divided evenly between the two parties: the consumer pays $1.05 and the retailer pays the remaining $0.05. Now, the incidence of the tax is on both retailer and consumer and there is some shifting forward and backward.
Shifting applies to output taxes, which are charged on units of output. Sales taxes fall within this category. An income tax is said to be "independent of output" because it does not change supply. When the supply is not changed, the tax cannot be shifted; the incidence is always on the original taxpayer. Thus, shifting and incidence is applicable to output taxes but not to income taxes.