taxation concepts and principles

TAXATION CONCEPTS AND PRINCIPLES

TAX: DEFINITION

A compulsory contribution from the person to the government to defray the expenses incurred in the common interest of all without reference to special benefits conferred upon taxpayer

Free rider problem Can be considered as a monetized

service to the government

TAXATION: PURPOSES

To finance the government’s public expenditures

Serves as a fiscal instrument to promote the goals of developing countries

TAXES: CLASSIFICATION

As to Purpose – fiscal or regulatory As to Incidence – direct or indirect As to Rate – proportional, progressive or

regressive As to Authority – national or local As to Object – income tax, property tax, excise

tax As to Scope – general or specific (e.g. Special

Education Fund) As to Amount Paid – specific or ad valorem

Principles of a Good Tax System Economic efficiency Administrative simplicity Flexibility Fairness Political responsibility

ECONOMIC EFFICIENCY

Taxes should enhance economic and social efficiency

Market failures Externalities (positive and

negative) Announcement effects

E.g. on real property

DISTORTIONARY TAX

An individual can change his tax liability by simply changing his consumption of a particular good or service

NONDISTORTIONARY TAX

If and only if, there is nothing an individual can do to alter tax liability

CORRECTIVE TAX

Raises the revenue and improves the efficiency of resource allocation

Point to ponder: “Why should society tax productive (“good”) economic activities, like savings and hard work, rather than bad economic activities, like pollution?

ADMINISTRATIVE SIMPLICITY

The tax system should have low costs of administrative compliance.

It ought to be easy and relatively inexpensive to administer

Direct cost: cost of running tax collection agencies

Indirect cost: cost to taxpayers

The tax System should have low costs of administrative compliance.

FLEXIBILITY

The tax system should allow easy (even automatic) adaptation to changed circumstances

Progressive tax (automatic stabilization)

Ad valorem vs. specific tax Political difficulties of adjusting tax

rates

The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance.

FAIRNESS

A good tax system should distribute the tax burden across taxpayers in a manner that is consistent with accepted norms of fairness and equity.

It ought to be fair in its relative treatment of different individuals

The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance.

FAIRNESS

There are two different ways to view fairness, but both are based on tax incidence.

The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance. The tax System should have low costs of administrative compliance.

TAX INCIDENCE

refers to who actually pays the tax Many taxes are paid by one person (gasoline

distributor, landlord, corporation), who has the ability to look to others for reimbursement (consumer of gasoline, renter, consumer).

Tax fairness is judged by a tax’s incidence, rather than who pays the tax.

FAIRNESS

Fairness in the burden of the tax according to one’s ability to pay.

A fair tax is one that is levied according to one’s ability to pay the tax.

TAX TYPES

FLAT TAX A commonly-held principle is that one’s tax

burdens should rise at the same rate as one’s ability to pay

PROGRESSIVE TAX : it should rise at a faster rate

REGRESSIVE TAXES Tax rate falls despite greater ability to pay

FAIRNESS

Fairness in the burden of tax according to benefits received.

A second way fairness may be evaluated is with reference to who benefits from government activities.

POLITICAL RESPONSIBILITY

People should know how much they and others pay Thus, a good tax system is one where the

tax incidence is clear, or transparent.

Transparency is important in a tax system It should improve the democratic

process surrounding taxes

References:

Joseph E. Stiglitz, Economics of the Public Sector, Third Edition (New York: W. W. Norton & Co., 2000), Chapter 17 “Introduction to Taxation.”

Leonor M. Briones, Philippine Public Fiscal Administration, vol. 1, Manila: FAFI, 1996. Chapters 6-7.