Public Finance, 2nd Edition

REFLECTIONS ON THE HAIG±SIMONS CRITERION IN

PRACTICE: THE FEDERAL PERSONAL INCOME TAX

Despite its appeal to many public-sector economists, the Haig±Simons

income measure has not fared well in the United States. Only the federal

and state personal income taxes pay so much as lip service to the Haig±

Simons criterion. State governments rely heavily on sales taxes and local

governments rely primarily on the property taxes, neither of which is valid

according to the Haig±Simons criterion.

State sales taxes may appear to be consistent with the view that con-

sumption is the ideal tax base. In practice, however, sales taxes are far

removed from an ideal consumption tax. Sales taxes often exclude broad

classes of expenditures from taxation, they usually tax all included items at

one Wxed rate, and they are levied on businesses. What expenditures tax

proponents have in mind is a tax levied on individuals exactly as the federal

income tax is, except that it would exclude saving from the tax base. A

graduated rate schedule could easily be applied to individual expenditures,

removing the stigma from sales taxes that they may be regressive.

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The federal personal income tax is the single largest tax in the United

States. Of all the broad-based taxes, it comes closest to the Haig±Simons

income measure as its tax base, but not really all that close. Recall that,

according to the Haig±Simons criterion, the federal income tax base should

include personal income and capital gains on assets held from the beginning

of the tax year, without regard to the sources or uses of income. The only

permitted deductions from Haig±Simons income are legitimate business

expenses, meaning expenses required to earn the income. The actual tax

base falls far short of the Haig±Simons ideal, both the personal income and

capital gains components.

Personal Income

Taxable income is only about half of personal income. The main discrep-

ancies between taxable income and personal fall into three categories: exemp-

tions, exclusions, and deductions.

An exemption is income that is recognized as taxable income by the

Internal Revenue Service (IRS) but is simply not taxed. The main example

is the personal exemption given to the taxpayer and all the taxpayer's depen-

dents. The exemption was $2800 per person in 2000, and it is adjusted each

year for increases in the consumer price index (CPI).

Exclusions are sources of income that are counted as personal income by

the U.S. Department of Commerce in the National Income and Product

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This stigma may be more myth than reality. See the discussion in Chapter 17 on the

incidence (burden) of the sales tax.

362 REFLECTIONS ON THE HAIG±SIMONS CRITERION IN PRACTICE