National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
WHAT DOES THE PUBLIC
BELIEVE ABOUT TAX
FAIRNESS?
STEVEN M. SHEFFRIN*
Tax fairness is a normative concept. Economists have spent decades in search of the
elusive social welfare function. Tax policy
specialists ponder the proper manner in
which to present tables about tax burdens.
And politicians try to ascertain or, in some
cases, shape attitudes about desirable tax
burdens. Lurking behind all three activities
is the public itself. It is ultimately public attitudes that must shape a social welfare
function, the public who is the ultimate
consumer of the results of burden tables,
and the public who, as voters, will judge
the politicians on their decisions,
It is appropriate therefore to consider
whether the public has distinct attitudes
and perceptions concerning tax fairness.
Ascertaining public opinion about these issues, however, is fraught with difficulties
for several reasons. First, some issues have
not been discussed seriously in the public
domain and public opinion will be illformed and volatile on these issues.’ Second, some issues, such as alternative
mechanisms for corporate integration, will
ultimately be too complex for public discourse. Neither of these points is intended
as criticism of the public. It is not an economical use of time for the average citizen
*University
of Cahforma at Davis, Dam, CA 95616-8578
30 1 I
to investigate the full range of tax proposals or the complexities of the tax system.
Finally, some important concepts which are
necessary to understand the effects of taxation are not understood by the public.
Tax incidence is a primary example.
There is a large, voluminous, and diffuse
literature on the measurement, interpretation, and significance of the public’s perceptions and attitudes towards tax fairness.’ This paper relates this literature to
two Important Issues currently on the policy agenda: proposed increases in marginal
tax rates for upper-income taxpayers and
the taxation of employer-provided
health
insurance. These two topics also serve to illustrate broader themes-the
desirable degree of progressivity in the tax system and
perceptions about the incidence of taxes.
In addressing both these topics, two questions are paramount. Does the public have
a coherent view on these matters? And do
public attitudes and perceptions effectively
constrain policymakers?
TAXING THE RICH
The simplest way to determine the degree
to which the public desires increased taxes
on high-income individuals is to ask them,
but there are a number of pitfalls in this
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
process. First, increases in revenue are used
for something-deficit
reduction, tax relief
for others, or increased spending. The uses
of additional revenue are likely to affect
the public’s desires for higher taxes on upper-income individuals. Second, the public
may Inot correctly perceive the current levels of taxation with regard to either marginal or average rates. Indeed, there is evidence from a variety of different studies of
a tenldency to underestimate marginal and
averalge rates.3 Third, desires for higher tax
rates on upper-income taxpayers may be
sensitive to time and place. Finally, the
public may not have homogenous views
with regard to a desirable tax burden. Public opinion polls about the general desirability Iof increased taxes for the wealthy are
generally too crude to address these concerns. Fortunately, there have been several
in-depth studies of taxpayer preferences.
None of the studies, however, deal seriously with the issue of the uses or disposition of revenlues from increased taxation.
Three studies provide interesting Insights
and contrasts on taxpayer attitudes toward
progressivity. Lewis (1978) surveyed 200
resideints in Ejath, England, in 1977 and
asked their perceptions of actual marginal
tax rates and desired marginal tax rates. At
that time, marginal tax rates in England
ranged from 35 to 83 percent. The public
underestimated these rates by 11 percent;
their perceptlons of marginal rates for the
same Income classes ranged from 32 to 75
percent. Desired marginal tax rates (the
rneans over the sample for each income
class) began #at 23 percent for the lowest
class and increased 1:o 56 percent. At the
top end, desired rates were 25 percent below the currently perceived marginal rate
and 33 percent below actual marginal
rates. Nonetheless, the British public believed that marginal rates should exceed 50
percent for the top income classes.
Hite and Roberts (1991) conducted an indepth survey of 600 U.S. taxpayers during
a period after the passage of the 1986 Tax
Reform Act. Their respondents corresponded closely to the overall population
of the lJnited States in terms of age and
income. Among the many parts of their
questionnaire, they asked respondents for
their preferred average tax rate for a family
with no children and various levels of Income. The mean responses for preferred
average tax rates ranged from 2.36 perc.ent for the lowest income class to over
27 percent for families with incomes over
$100,000. This top rate is only slightly less
than the top marginal rate that prevailed
In 1987. These mean preferences do disguise considerable underlying heterogeneity, a point to which we return below.
The stark difference between the British
and American preferences for tclp rates is
intriguing and raises the question of
whether this differerlcc is caused by an innate British preference for higher rates or
whether the responses were conditioned
by the tax rates prevailing at the time of
the surveys. According to the latter conjecture, British taxpayers preferred higher
rates than their American counterparts only
because i heir actual current tax structure
featured higher rates than in the United
States at the time of the U.S. survey. Or, in
other words, are preferences for rates
strongly context dependent?
A study by Wahlund (1989) of Swedish
taxpayers provides evidence for this hypothesis. Wahlund surveyed Swedish taxpayers from 1982 to 1984 during a period
of tax refl,rm when there were rleductions
in marginal tax rates. For the average taxpayer in his sample, rnarginal rates fell
from 62.1 to 54.8 percent during this period. Higher Income taxpayers experienced
I
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
TAX FAIRNESS
the decrease in marginal rates. He therefore compared preferences for desired
rates with perceived rates at the respondent’s income and at 70,000 and 150,000
Swedish kroner (lower and higher income
taxpayers, respectively). Wahlund’s striking
finding was that preferred rates fell onefor-one with perceived rates. As an example, perceived marginal tax rates fell 5 percentage points for higher income taxpayers,
while preferred rates at this income level
also fell by nearly 5 points. Similar results
prevailed during the reform period as well
and for both lower income and average
taxpayers.
concerning the fairness of the tax system.
Respondents were asked if, overall, the tax
system was unfair. The pattern of dissatisfaction with the tax system was U-shaped.
Seventy percent of the steep progressives
agreed that the tax system was unfair
compared to 59 percent of the mild progressives and 78 percent of the flatraters.
The mild progressives were distinctly more
satisfied with the current state of affairs
than those groups preferring more or less
progressivity.
The clear lesson from this study is that desired rates tend to move with perceived
rates. It would, of course, be desirable to
have other experiments of this nature; for
example, comparing preferences before
and after the 1981 rate reductions. It also
accords with other psychological evidence
that individuals’ preferences are context
dependent4
A rough characterization of these findings
is that the population is split fairly evenly
between advocates of the status quo and
those preferring higher or lower top rates.
The flatraters are highly dissatisfied with
the current system and perhaps prefer
lower government spending as well. The
steep progressives are also dissatisfied and
perhaps prefer a higher level of government services as well.6 The intensity of
feeling is stronger at both ends of the
spectrum.
Discussions about mean or average preferences for tax rates can disguise significant
heterogeneity in the population. Hite and
Roberts (1991) asked respondents to
choose the most preferred among five different rate structures5 Thirty-eight percent
of the sample chose rate schedules with
the top marginal rate exceeding 45 percent, 28 percent chose a rate schedule
similar to that in effect in 1991, and 34
percent chose a flat rate schedule with an
exemption. In later work, Hite and Roberts
(1992) dubbed these groups Steep Progressives, Mild Progressives, and Flatra ters, respectively.
The survey results suggest that public preferences place relatively loose constraints on
politicians in determining the structure of
tax rates at the upper income levels. First,
preferred rates are context dependent and
would, for example, be likely to increase
along with an actual increase in top rates.
Second, there is already a distinct and numerous group in the population that prefers higher rates. Politicians would face few
risks from tilting toward this group with
regard to preferences over tax rates per se.
However, there still could be disagreements
and pitfalls over the disposition of any additional increase in revenue.
Not only was their sample split between
these distinct options, but the groups also
appeared to differ in some fundamental
ways. Compared to the flatraters, the
steep progressives had lower income and
less education, were more predominantly
female, and were older. Most striking,
however, was their response to a question
TAXATION
303
OF HEALTH BENEFITS
With comprehensive health reform on the
political agenda, it is natural to return to a
perennial issue on the tax reform agenda,
the taxation of employer-provided
health
insurance. From the standpoint of economic efficiency, the exclusion of em-
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
ployer-paid health insurance from employee income distorts the compensation
package toward health benefits and away
from compensation in the form of wages.
Along with other exclusions (particularly,
retirement related), nontaxed fringe benefits have grown at a rapid rate and are
projected to reach 29 percent of total
compensation by the year 2062, thereby
substantialI!/ reducing the payroll tax base
for Social Security and Medicare.7
From the standpoint of reducing health expendlitures, the health tnsurance subsidy
has increased demand by reducing the effective price of health insurance. Any policies that reduce the demand for health tnsurance will also diminish the need to rely
on direct intervention on the supply side in
order to recluce expenditures. The equity of
the subsidy has also come under attack.
Eliminating the exclusion and using the increased revenues for, as an example, a refundable tax credit would redistribute income toward the lower end of the
distribution.”
For these reasons, the ‘Treasury I proposals
recommended including employer-provided
health insurance above a specified floor in
income.g The proposals for managed competition by Enthoven and Kronlck contain a
virtually identical recommendation
in which
the floor is determined by the cost of a
basic health plan.” The Treasury proposal
‘was motivated by the principle of ellminatung the distortion between wage and nonwage compensation, while Enthoven and
Kronick were interested in making individuals face the true costs of additlonal Insurante on the margin. Nonetheless, they
converged tot the identical policy recommendation.
Despite their logic as tax reform proposals,
proposals to tax employer provided health
insurance have not had a glorious past. After Treasury I, the Reagan Administrationin deference to the Chairman of the Senate Finance Committee, Robert Pack-
wood----changed its proposal to taxing the
first dollar of health insurance up to a ceiling. Of course, this proposal removes desirable marginal incentives and has a less favorable distributional impact than the
Treasury I plan. At that time, proposals to
tax benefits were strongly opposed by organized labor and trade groups, including
the American Dental Association and representatives of HMOs ” Organized labor
had arranged collective bargaining arrangements that featurecl generous health plans,
while the trade groiups were worried that,
If benefits became more expensive, their
services would be eliminated.
Taxing health benefits was not popular
among the general public or among some
politicians. Surveys of public opinion in
1985 revealed that, to cut the deficit, 64
percent were in favor of a 10 percent surcharge cJrI taxes paid by corporations,
while only 31 percent favored taxing
health benefits above a specified floor.”
Some politicians, including Packwood, belleved in using the tax system to encourage
the purchase of health insurance and successfully opposed any plans that would effectively rarse the costs of insurance.
The search for revenues to finance universal health insurance coverage has naturally
led to a reiurn to this debate. Opposition
from organized labor and a perception that
the public would still strongly oppose the
taxation of employer-provided
health insurance has led to consideration of a wide
range of proposals. These have included a
VAT, excise taxes on cigarettes and alcohol, and various taxes on health care providers. The proposed taxes on health care
providers have included the following: taxing health insurance companies on their
new premiums, on the theory that employer mandates will create a windfall to
the insurance companies through increased
demand; taxes on new revenues of hospitals, on the theory that universal coverage
will elimirlate uncompensated
care at hospitals and create a windfall; a gross re-
I
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
TAX FAIRNESS
ceipts tax on doctors; and an elaborate
penalty tax on hospitals and doctors in
states in which total health care spending
exceeds some predetermined limits.
The key feature of the proposed taxes on
health providers is that they are not directly imposed on consumers of health
care. As one reporter commented, “Taxing
health providers could be far easier to sell
politically than some other tax options.
That’s because a tax on providers would
be less visible to consumers than, say, taxing workers on some of their employerprovided health benefits.“13 The literature
on public perceptions of taxation supports
this insight. There is considerable evidence
that the public reacts more unfavorably to
visible than to hidden taxes. Recent income
tax legislation has embodied this feature.14
It is important to stress that placing taxes
on health providers is not equivalent to
eliminating the exclusion of employer-provided health benefits when there are taxpayers with different rates. Taxes on providers would lead to health insurance
becoming more expensive, but, on the
margin, the cost of additional health coverage to taxpayers would still vary with their
marginal tax rates. A flat surcharge on the
employer-provided
portion of health care
would not work for those taxpayers with
rates higher or lower than the surcharge.
Higher bracket taxpayers would still face
incentives to purchase additional coverage.
Underlying the political view that taxes on
health care must be hidden and indirect is
the implicit fact that the public does not
understand tax incidence.15 There has been
virtually no research on the public’s understanding of tax incidence and no guarantee that the conventional wisdom on
health taxation is correct. To address this
point, a survey was conducted in which 82
relatively sophisticated individuals were
asked to respond to one of two questionnaires.16 The following is the text of one of
the two questionnaires.
305
Please read the following paragraphs and
then answer the questions below. There
are no “right” answers, so please feel free
to respond as you wish.
The government wishes to tax health insurance as part of a plan to reform the health
system. Consider a single, employed individual who currently has a health insurance
policy that costs $1500. Currently, the employer pays the full cost of this insurance.
The government now wishes to impose a
10 percent tax on the health insurance
($150 In this case). There are two plans.
Under the first plan, the worker pays the
full tax. Under the second plan, the tax is
paid for by the employer.
Questions:
1. Which plan is fairer?
a. The one in which the worker
the tax.
pays
b. The one in which the employer pays
the tax.
c. Both are equally fair.
2. Briefly explain your answer to #l.
A second questionnaire was identical, except that, before the tax was imposed, the
employer and employee each paid $750
for the insurance.
Before discussing the responses, it IS
worthwhile to review how a typical economist would respond. Most would believe
that, in the long run, the two schemes
would have identical effects; the statutory
incidence does not matter. Since labor supply is inelastic, workers would bear the
burden of tax. In the short run, the statutory incidence could matter and there
might be more flexibility if employees were
already directly paying a portion of their
health insurance.
The responses to the questionnaires are
summarized in Table 1. The open-ended
nature of the second question was meant
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
TABLE 1
SUKVEY RESULTS ON THE FAIRNESS OF HEALTH TAXATION
Baseline
Fairest plan
Worker pays tax
Employer pays tax
Equally fair
Total
Addendum
Number mentioning tax incidence
Number advocating equal split
Number indicating “it is for the worker”
Number saying employer already pays full
cost
Employer Pays
All of Insurance
Employer and Employee
Split Cost
17
13
14
44
10
15
13
38
10
4
1
6
3
6
4
NA*
82
--
*NA =- not applicable.
to elicit response and not necessarily represent “true” oublic opinion. First, only 13
out of 82 respondents mentioned anythin<]
relating to tax incidence at all. They typically responded that the two proposals
were equally fair. The rest of the respondents assumed that the statutory and economic incidence were the same. Surprisingly, equal numbers felt that It was
equally fair to levy the tax on the worker
and the employer. However, this division
was sensitivle to the initial situation. When
the employer was paying the full cost initially, six respondents commented that it
was fairer for the worker to pay any additional tax since the employer was bearing
the initial burden. This documents the importance of the initial situation in determining the public’s views of tax fairnessa finding fully in accord with the literature
on economic psychology.‘7
Another result also confirms the importance of the initial ‘situation. Ten individuals
suggested, vvithout any prompting, that tt
would be most fair to split any additional
tax between the worker and the employer.
This rlesponse was Imost pronounced when
the costs were split in the Initial situation.
Two lessons emerge from this preliminary
experiment. First, even relatively sophistl(cated individuals do not really understand
incidence and confuse statutory and eco-
nomic Incidence. Second, initial situations
are very Important in determining judgments about fairnes#s.
Rather than despair over the public’s lack
of economic knowledge, there may be
scope for using their charactenstic biases in
the name of good tax policy.18 Consider,
for example, in the context of health insurance, the followlng strategy. Convince the
public that a comprehensive health reform,
which w11l bring important national benefits, will require equal sacrifice across the
population. One dimension of this shared
sacnfice would be equal sharing of health
insurance costs between employer and employees It may even be possible in the polltical dialogue to raise the posr,ibility that
the sharing percentage may increase
slightly fl3r higher paid employees. The notion of sharing and equal sacrifice could
resonate in the population.
If this pcllitical strategy were to prove successful, the result would be to approximate
a policy of taxing some fraction of employer-provided health insurance above a
certain floor. Of course, this would not be
fully equivalent to the type of proposal advocated In Treasury I or by Enthoven and
Kronick, but it would rnove in the right direction and reduce some of the taxInduced demand pressures on the current
system. The alternative, the pursuit of the
I
National Tax Journal
Vol. 46, no. 3, (September, 1993), pp. 301-08
TAX FAIRNESS
invisible tax, can easily lead to complexity
and distortions without achieving fundamental objectives of tax or health reform.
l4 This point
dlscussed In more detail In Sheffnn (1993)
Failure to understand tax incidence is just
one of the characteristic biases of taxpayers. Taxpayers also have very little understanding of implicit taxation. They also
view direct subsidies and tax preferences
very differently, particularly when tax preferences result in low taxable income for
corporations or wealthy individuals.‘g Given
these biases, there are only two strategies
to achieve reform that are compatible with
the public’s understanding. We could conceivably educate the public on the subtleties of taxation, or we could try to find
ways to restructure the debate so as to
achieve the goals of tax reform by other
means. In the health insurance case, the
idea of “equal sacrifice” is one mechanism
to reframe the debate to achieve desirable
goals.
l6 Two questionnarres
IS
l5 Included In this def’nltron
tax Inca-
were given to 82 students at the be-
glnnrng of an upper-dlvrsron
completed
public finance class All had
a course In Intermediate
m’crotheory
This sur-
vey was not meant to obtain a deflnltrve reflectton
of
publ’c oprnron but simply to explore the range of v’ews
on the matter
”
Statlst’cally, the rnltlal srtuatlon did not matter, except for
the desrrabrlrty of workers payrng the addrtronal tax, and
even this differed
at a srgnrflcance level of 15 percent
However, the written
ent between
responses were qualrtatlvely
drffer-
the two rnrtral s’tuatrons
‘* Thus approach
was suggested
to me In another context
by
Jane Gravelle (see Gravelle, 1993)
”
Evidence for these pornts
provided
IS
In Sheffnn (1993)
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IS
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the government
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It
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”
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