What is a Tax?

by Eric Toder on Wed 30 Sep 2009 04:05 PM EDT |

What is a tax? You would think a senior economist at the Tax Policy Center would have no trouble answering that question. But it is not so simple.

This question has come up in the debate over the proposal to require all Americans to have medical insurance—a provision in all of the major congressional health reform bills. If you must buy insurance, is the payment you make a tax or just a premium for insurance coverage? Is the penalty imposed on those who don’t buy insurance a tax or a fine for failing to comply with the law?

Of course, we know taxes are what we pay to fund the general activities of the government. And for most taxes, including the individual income tax, what we pay bears little relationship to how much we benefit from government services. But not all payments to governments are for broad public services and some levies, such as airline ticket taxes, are associated with direct consumption of a service by the payer.

Payments to governments that are analogous to commercial transactions are counted as user fees, not taxes, and reduce measured spending on the public activity. Examples include the fees I pay when I visit a National Park or for getting my car emissions tested. Getting the emission test gives me a lot less pleasure than hiking in Shenandoah Park, but it is a requirement I must meet for the privilege of driving. And since I am the potential polluter, the state requires me to bear the cost.

So when is a payment to government by users of a service a tax and when is it a fee? A 1993 CBO report cited Malcolm Baldrige, a Commerce Secretary during the Reagan Administration. “I think it is simple,” Baldrige commented. “If it is a Democratic proposal, it is a tax; if it is Republican, it is a user fee.” Of course, Baldrige was joking, but nonetheless user-related taxes are often hard to distinguish from user fees. If my local community funds trash collection out of property tax revenues, total tax collections look higher than if they charge me a separate fee for trash collection (even if the fee is collected when I pay my property tax). Using federal gasoline taxes to finance interstate highways makes the tax burden look higher than if those roads, like some older state highways, were paid for by tolls.

The 1993 CBO report cites four categories of user-related charges: user fees, regulatory fees, beneficiary-based taxes, and liability-based taxes. In general, fees are distinguished from taxes by the degree of connection between the payment and the service received or social cost imposed by the payer. Thus, payments to the black lung fund are considered a liability-based tax because, although payments to miners result from past activities of the coal industry, they are not closely linked to the current actions of any firm on which the impost is based. In contrast, charges for food safety inspections are a regulatory fee, because (assuming the cost is passed forward) food consumers who are the beneficiaries of the inspection activities are paying for it. Often, however, a particular levy can be classified on either side of the tax/fee line.

So what are payments for mandatory health insurance? They are involuntary and not based on something the person chooses to do, which makes them look like a tax. However, the individual gets a benefit –insurance coverage – in exchange for the payment, which sounds like a fee. Because of subsidies, some individuals will pay more than others for the same coverage (tax). And if the individual fails to buy insurance, she must make a payment to the IRS, for which she will get nothing directly in exchange (tax). But the payment can be viewed as a regulatory fine for failing to meet a public responsibility (fee). Finally, because the IRS is administering these payments, it looks very much like (and will likely be scored as) a tax.

As a tax economist, parsing these questions is fascinating. But I’m not sure it is very important to the health debate. Instead, we’d be better off asking a different set of questions: Who would bear the net costs of this mandate by paying more than the value of insurance they receive? Who would benefit by receiving insurance in excess of the amount they pay? Is this income redistribution desirable? Is it the best way to pay for (near) universal coverage? And is that goal worth the cost? If we like the answers, we should support reform and if we don’t we should oppose it, regardless of whether we label the payments “tax” or “fee”.