The AICPA's 10 guiding principles: any proposed changes to our tax system will require analysis to determine whether they conform to good tax policy.

• Author: Nellen, Annette
• Position: American Institute of Certified Public Accountants

EXECUTIVE SUMMARY

* The 10 guiding principles stem from the AICPA's Tax Legislation and Policy Committee's goal to determine how proposed tax-system changes should be analyzed.

* The guiding principles help determine how proposals to change existing tax rules should be analyzed.

* Incorporating the principles into the analysis and debate on tax law changes should better ensure an effective tax system based on good tax policy.

Should the Federal income tax be replaced with a consumption tax or additional savings incentives added to the income tax system? How should e-commerce be taxed? Should equipment depreciable lives be shortened to help stimulate investment? These and similar questions are often asked by legislators, economists, tax practitioners and taxpayers.

How should proposed changes be analyzed? The AICPA Tax Division's Tax Legislation and Policy Committee (Committee) sought to answer this question. The Committee focused on analyzing fundamental tax-reform proposals (such as a flat tax and a national sales tax); it determined that the proposal debate was missing an analytical framework to determine whether the proposals incorporated principles of "good" tax policy. The Committee created a framework to present the principles of a good tax system; it can be used both to analyze proposals and to modify them (if necessary), so that any changes will strengthen the tax system, rather than weaken it. It can also serve to identify and design improvements to the tax system (to better incorporate good tax policy principles). The framework can be used to analyze tax proposals of any size, degree and at any government level.

The framework outlined in AICPA Tax Policy Concept Statement No. 1 (1) helps analyze proposed changes to existing tax rules. This article explains the framework's 10 guiding principles of good tax policy, followed by examples applying the principles to analyze (1) the Armey flat tax, (2) a proposal to allow nonitemizing individuals a charitable deduction and (3) the application of sales and use taxes to e-commerce.

Ten Guiding Principles

Discussed below are the 10 principles of good tax policy (see Exhibit 1 on pg. 101). They are of equal importance and presented in no particular order (although the first four stem from Adam Smith's tax policy maxims (2)).

One: Equity and Fairness

This precept commands that similarly situated taxpayers be taxed similarly. "Equity" refers to-both horizontal and vertical equity. Horizontal equity means that taxpayers with equal ability to pay should pay the same amount of tax; vertical equity means that taxpayers with a greater ability to pay should pay more tax. The framework does not resolve how much more tax people with higher incomes should pay; it merely serves to note the importance of the principle, not state how to achieve it. The definition and achievement of equity for a tax system is a matter of political, social and economic debate.

The presence of both horizontal and vertical equity in a tax system is thought to create fairness. However, "fair" means different things to different people. For example, some would view an income tax system as "fair" if there were few exclusions and deductions; others might view an income tax as fair if there were only one tax rate.

Equity is likely best measured by considering the range of taxes paid, not just by looking at a single tax.

Two: Certainty

Under this principle, tax rules should clearly specify when and how a tax is to be paid and how the amount to be paid will be determined. There is no certainty if taxpayers have difficulty measuring the tax base or determining a transaction's applicable tax rate or tax consequences. Certainty may be viewed as the level of confidence a person has that a tax is being calculated correctly. For example, if a taxpayer cannot determine whether (1) an expenditure should be capitalized or expensed or (2) a particular transaction will be subject to sales tax, certainty does not exist.

Three: Convenience of Payment

According to this principle, a tax should be due at a time or in a manner most likely to be convenient for the taxpayer. Convenience helps ensure compliance. The appropriate payment mechanism depends on the amount of the liability and ease or difficulty of collection. Discussion of this principle in designing a particular rule or tax system should focus on whether it is best to collect the tax from a manufacturer, wholesaler, retailer or customer, as well as collection frequency.

Four: Economy of Collection

This notion dictates that the costs to collect a tax should be kept to a minimum for both the government and taxpayers. It considers the number of revenue officers needed to administer a tax and taxpayer compliance costs. This principle is closely related to the next.

Five: Simplicity

According to this principle, the tax law should be simple, so that taxpayers can understand the rules and comply with them correctly and cost efficiently. Simplicity in a tax system reduces errors and increases respect for the system, thereby improving compliance. A simple tax system better enables taxpayers to understand the tax consequences of their actual and planned transactions.

Six: Neutrality

This precept mandates that the tax law's effect on a taxpayer's decision as to whether or how to carry out a particular transaction be kept to a minimum. Neutrality stands for the proposition that taxpayers should not be unduly encouraged or discouraged from engaging in certain activities due to the tax law. The tax system's primary purpose is to raise revenue, not change behavior. Of course, a completely neutral tax system is not really possible. For example, an income tax could be said to discourage earning income. However, within the system, the neutrality principle would come into play in determining how to measure income or ability to pay.

Seven: Economic Growth and Efficiency

A tax system should not impede or reduce the economy's productive capacity, but be aligned with the taxing jurisdiction's economic goals (e.g., economic growth, capital formation and international competitiveness). The system should not favor one industry or type of investment at the expense of others. For example, a jurisdiction would probably not design an income tax that imposes a 90% rate on the top 25% of income earners, as this would harm its economic growth.

The principle of economic growth and efficiency might seem to conflict with the neutrality principle, but this is not necessarily the case. The former principle just recognizes that rules to calculate the tax base and rate have economic effects. For example, if an income tax system calls for a 30-year depreciable life for semiconductor manufacturing equipment, the jurisdiction must recognize that such a...