Substantive Tax Equity and Adjusting the Income Tax for Regional Cost of Living Differences

Abstract

Substantial variations in the cost of living among regions in the United States are a major impediment to achieving a fair and equitable income tax system. Geographic cost of living differences arise because of disparities in the consumption power of income in different regions. Although the current Federal income tax system sometimes reflects and adjusts for changes in the cost of living over time (by indexing for inflation), it does not account for geographic cost of living variations - the Internal Revenue Code treats each dollar of income the same no matter where it is earned. The underlying premise of this paper is that fairness is a goal of an income tax system. A system of taxation based upon fairness - i.e., ability to pay - must be apportioned based upon a taxpayer's power to consume. The presence of liquidity and ease of transferability does not mean that money a uniform value. It is inequitable to apply a uniform system of taxation in different regions across the United States when money does not have uniform consumption power. Taxpayers whose consumption power differs have different abilities to pay (regardless of whether these taxpayers have the same nominal dollars of income). Money income, therefore, must be adjusted for regional cost of living differences to ensure that it represents the taxpayer's power to consume. Therefore, in order to achieve horizontal equity, taxpayers with similar power to consume should be taxed the same, regardless of where they live.