ACCY 312 Chap.3 Evaluating a Tax System
Evaluating a Tax System
Sufficiency: will it raise enough
A tax system is judged first on whether it raises the revenue the government needs. The difficulty is forecasting. A static forecast assumes taxpayers do not change behaviour when the law changes, so a higher rate is simply multiplied by today's base. A dynamic forecast allows the base itself to respond. Two responses pull in opposite directions.
Under the income effect a taxpayer works more after a rate increase to keep the same after-tax income, which enlarges the base. Under the substitution effect the taxpayer shifts toward untaxed activity such as leisure, which shrinks it.
Which effect dominates depends on the taxpayer: someone who needs every dollar tends to follow the income effect, someone comfortably above their needs tends to substitute.
Equity: how the burden is shared
Equity asks how the tax burden should be distributed. Horizontal equity means people in comparable circumstances owe equal tax: two people with the same taxable income should owe the same amount.
Vertical equity means taxpayers with a greater ability to pay bear more of the burden, which in the class example requires the richer taxpayer to pay at a higher rate than the poorer one, not merely more dollars. Equity debates also cover double taxation of the same income and whether provisions keep pace with inflation.
Administrative feasibility
A system also has to be workable.
Certainty means taxpayers can tell when, where and how to pay. Convenience means the tax is collected without undue hardship, which is why wages are taxed through withholding. Economy means compliance and administration costs are kept low for both taxpayers and government.
The course adds economic growth as a further objective, encouraging activity that expands the economy.
Indexing and sunsets
Two design features show how the criteria play out. An indexed provision is adjusted for inflation so its value does not erode, as the standard deduction is.
A sunset provision is scheduled to expire, so a deduction available in one year may not exist the next; the slides point to clean energy credits for solar and wind that expire during 2026. Sunsets help a bill's budget score but work against certainty.
Using the criteria in an answer
No tax scores well on every criterion, so an evaluation is a trade-off.
A strong answer names the criterion, shows how the proposal performs on it with a figure or an example, and states which other criterion pays for that gain.
What this chapter covers
- 01
Sufficiency of revenue
- 02
Static and dynamic forecasting
- 03
Income and substitution effects
- 04
Horizontal equity
- 05
Vertical equity
- 06
Certainty, convenience and economy
- 07
Indexed and sunset provisions
Worked example · free
Test a rate rise for sufficiency and equity
- 2Static: 6% of $1,000,000 is $60,000, an increase of $10,000.
- 2Dynamic: 6% of $900,000 is $54,000, an increase of only $4,000 once the base shrinks.
- 2Equity: the $160,000 resident must pay above 10%, so at least $16,001; the other $40,000 resident pays $4,000.
Key terms
- Sufficiency
- The criterion that a tax system raises the revenue the government requires.
- Static Forecasting
- A revenue projection that assumes taxpayers do not change behaviour after a tax change.
- Dynamic Forecasting
- A revenue projection that allows the tax base to respond to a change in the law.
- Income Effect
- The response of working harder after a tax increase to preserve after-tax income.
- Substitution Effect
- The response of shifting from taxed activity to untaxed activity, such as leisure, after a tax increase.
- Horizontal Equity
- The principle that people in comparable circumstances owe equal tax.
- Vertical Equity
- The principle that taxpayers with greater ability to pay bear a greater share of the burden.
Evaluating a Tax System FAQ
Why do static revenue forecasts often overshoot?
They ignore how people react. If a higher rate pushes activity toward untaxed alternatives, the base shrinks and actual collections fall short of the rate multiplied by today's base.
Does a flat tax satisfy vertical equity?
Under the definition used in class it does not. A richer taxpayer pays more dollars under a flat rate but not a higher rate, and vertical equity as the course applies it asks for a higher rate as ability to pay rises.
What is a sunset provision and why does it matter for planning?
It is a rule written to expire on a set date. Planning that relies on it can fail when the provision lapses, which is why sunsets weaken the certainty criterion even when they reduce a bill's cost.
Exam move
For each criterion, write one sentence defining it and one real provision that helps or hurts it. Then rehearse a short evaluation that names a gain on one criterion and the cost on another.
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