Tax Regressivity and the Choice of Tax Base

Abstract

In 1995, Paul Peterson, a professor of government at Harvard University, concluded that the greatest price of the United States (U.S.) federalist system was inter-jurisdictional inequity, but that the federal government’s role in redistributive policy could potentially minimize this cost. While Peterson’s work focused on the expenditure side of the budget, federal governments also facilitate the redistribution of income through the tax code, but some tax bases tend to be inherently more progressive than others.   Given the range of tax bases available to policy makers,  the  role  of  a  tax  base  in  income  distribution  is  fundamental  to  evaluating  the distributional effects of different tax structures.  Using the regressivity of state and local tax systems in the U.S., this study finds that consumption taxes may impose significant equity costs when designed as sales taxes.  More specifically, for each one percent increase in sales tax revenue as a share of the tax base, the system becomes 12 to 17 percent more regressive.  For each one percent increase in income tax revenue as a percent of the revenue base, the system becomes 12 to 13 percent less regressive- despite the fact that United States’ state governments tend to have either flat or only moderately graduated income tax rates.  While this study finds that the choice of tax base can only explain about half the variation in regressivity rates, it does high light the difficulty in designing a consumption tax that achieves redistributive policy goals.