The Sensitivity of Common Horizontal Equity Measures to Variations in Omitted Income

This paper examines the sensitivity of horizontal equity measures (coefficient of variation (CV) and coefficient of residual variation (CRV)) to a common assumption in horizontal equity studies – that changes in level of omitted income do not change horizontal equity experienced by taxpayers in similarly situated income groups. It have been assumed in many prior studies that certain income exclusions or deductions allowed from taxable income have no effect on the resulting horizontal equity measurements. This paper examines whether the CV and CRV remain low within each income group when the mortgage interest deduction and the charitable contribution deduction are disallowed. In general, the omission of certain income does create a wider variation of effective tax rates within income groups. The results of this study indicate that future horizontal equity studies should consider that omitted income, either through income exclusions or deductions allowed, may affect horizontal equity measures. In addition, for policy makers, taking steps to decrease the tax gap also increases horizontal equity