After reading this article you will learn about:- 1. Definition and Characteristics of Tax 2. Objectives of Taxation 3. Principles.
Definition of Tax:
In every country major part of the revenue is raised through taxation. According to Prof. Taylor “Taxes are compulsory payments to governments without expectations of direct return or benefit to the tax payer”.
Prof. Bastable “defined a tax is a compulsory contribution of the wealth of a person for the service of public power”. According to Taussing “the essence of a tax as distinguished from other charges by government is the absence of a direct ‘quid-pro-quo’ between the tax payer and the public authority”.
Dr. Dalton opines that “a tax is a compulsory contribution imposed by the public authority irrespective of the exact amount of service to the tax payer in return and not imposed as a penalty for any legal offence”.
Prof. Adams gave a Comprehensive definition of a tax stressing the various aspects of tax. He say “from the standpoint of view of the state, a tax is a source of derivative revenue, from the angle of the citizen a tax is a coerced payment, from the administrative point of view it is a demand for money by state in conformity to established rules from the point of view of theory a tax is a contribution from individuals for common expenditure.
Another acceptable definition was given by Prof. Seligman; “tax is a compulsory contribution from the person to the government, to defray the expenses incurred in the common interest of all without reference to special benefit conferred”.
A tax is a leakage from the circular flow of income into the public sector. It is paid by individuals, corporations and other associations of individuals. It represents a payment out of the income of the people.
Characteristics of Tax:
1. Basic Characteristics of a Tax:
From the above definitions we can meaningfully derive some basic characteristics of a tax.
1. It is a compulsory contribution. Even though a tax is paid willingly, in a sense it is a compulsory contribution. It only means that no one can refuse to pay a tax, on the general ground that he doesn’t derive any benefit from certain state services. A tax is levied on the basis of same predetermined criteria such as equity. Seligman emphasizes that compulsory contribution is enforced without reference to special benefits conferred.
2. The fact that tax is a contribution implies the notion of a sacrifice involved on the part of the contributor.
3. Tax payment is a personal obligation. Prof. Lutz rightly point out that the obligation to pay tax is a personal responsibility of the taxpayer. This personal obligation to contribute to the states support is universal and applies to all. This does not mean that all taxes must be levied on persons or objects of taxation.
As a matter of fact, taxes are actually based on a great variety of material things as well as non-material and intangible form of wealth. The meaning is that the primary obligation to pay the tax is a personal obligation.
4. A tax is levied according to certain legal requirements.
5. The amount of tax is not fixed with reference to the exact benefit which a taxpayer receives from public service. In other words there is no element of quid-pro-quo in the payment of tax.
6. A tax is paid out of the income of the taxpayer.
7. The power of taxation is mainly to be used for collecting revenue to the state. Writers like Prof. Lutz are of the opinion that the modern concept of taxation emphasizes positively that it should be used for the purpose of providing public revenue and that it apparently does not give a positive sanction to the use of the taxing power for the accomplishment of ulterior objects.
2. Commercial Revenue and Income from Public Domain:
In the words of Prof. P. E. Taylor “the revenue which we call commercial are received in the form of prices paid for government produced commodities and services”.
It includes payment for postage, tolls, interest on funds borrowed form government credit corporations, prices for liquor in government stores, surplus war materials, electricity distributed by publically owned utilities etc.
The basic characteristic of commercial revenue is that in return for payment, the person concerned receives a consumable commodity or service.
Profit from public undertakings run on a monopoly basis also can be included in the category of commercial revenue. According to-Dalton monopoly profit of a public enterprise resemble very much of a tax.
Dalton argues that there is no substantial distinction between the British government revenue from export duties imposed on private traders and the French government monopoly profit from the sale of Tobacco; so long as the government uses its monopoly power in a public enterprises to charge high prices with a view to get large profits as a form of revenue.
Income from public domain is also included in the commercial revenue. This income is received from public property in land, building, mine etc. income from this source consist of the receipts from lease or sale of these properties or the sale of products in public properties.
It includes only that part of public property which is reserved or used by the state or is leased to private persons basically for fiscal purposes. However revenue from public domain is not a major source of income in many countries in modern times. The income from this source is steadily tending to decrease.
3. Administrative Revenue:
Those receipts placed in the category of administrative revenue include fees, licenses, fines, forfeitures, escheats and special assessments. They generally arise as a by-product of the administrative function of the government. Hence they are called administrative revenues.
Fees are payments for services rendered by the governments such as registration of births and deaths etc. Prof. Seligman defined fee as “a payment to defray the cost of each recurring service undertaken by the government primarily in the public interest but conferring a measurable special advantage on the fee payers”.
Thus a fee is a payment charged by the government to bear the cost of administrative service rendered by the government.
It is paid by the people to avail such services. In charging the fee certain principles should be followed. The fee levied must be equal to the cost of production. It may also resemble a monopoly price, since it is charged by the public authority to prohibit rendering the same service by any other than itself.
The fee can be distinguished from price. The fees are charged for government services. Whereas price are charged for materials or services of business character e.g. sale of fertilizer manufactured by a government factory.
An element of tax is present in fee. But it is absent in price. In a sense fee is a compulsory contribution, but price is a voluntary payment.
(b) License Fee:
It is a special type of fee, it is charged for granting a permission or privilege. License fee are charged for keeping a gun, or a motor vehicle.
Hence a license fee is paid in those instances in which the government authority involved; simply confer permission or a privilege to a particular person.
The best examples are the registration fee for motor vehicles, the payment for permit to operate automobile.
A distinction can be drawn between tax and fees. Prof. Seligman point out how fee differs from a tax in several important points.
1. A tax is levied as a part of a common burden. Whereas a fee is assessed as a payment for a special privilege. The basis of taxation is the ability or Faculty of the taxpayer. The basis of a fee is the special benefit accruing to the individual. In the case of a tax, the benefit is not susceptible of direct measurement. In the case of a fee the benefit is measurable
2. The payment of fee legalizes some action. If the fee is not paid, the base of the fee or the source or purpose of the fee becomes illegal. This is not the case with a tax. If the income tax is not paid, the defaulter is made to pay a penalty, but the income itself is not made illegal. But if the automobile driver does not pay the registration fee, driving of the car is made illegal.
3. A third distinction between taxes and fees may be found in the conditions attached to the service which the government performs in the case of a fee the government does some particular thing in return. In the case of tax, it gives no equal service. There is quid-pro-quo in fees, but quid-pro-quo is absent in tax.
(c) Special Assessment:
Certain public improvements, such as the construction of streets and sewers, confer specific benefit upon particular property owners in addition to their general community benefits.
Special assessments are charges imposed upon property benefited by such improvements. It is imposed by the government, whenever certain specific improvements have been made as a result of public expenditure. For instance, provision of irrigation facilities in a particular area may call for a special assessment on all beneficiaries.
This is compulsory contribution levied in proportion to the special benefits derived, towards the cost of the improvement of property. This assessment is known in England as ‘betterment tax’ and in America as ‘special assessment’.
In India betterment levy is imposed on certain properties, especially land, whose capital value has been enhanced by the introduction of casual irrigation.
Prof. Seligman defined special assessment as “a compulsory contribution, levied in proportion to the special benefit derived to defray the cost of a specific improvement to property, undertaken in the public interest”.
Prof. Seligman point out the following characteristics of special assessment:
(a) The special benefit is measurable,
(b) There is an element of special purpose,
(c) These assessments are not progressive but proportional to the benefit received,
(d) It is a payment for specific local improvement, and
(e) Through this charge the government claims a part of the unearned increment in the value of property, which arises from specific improvement programme of the government.
Three practical bases are used in making special assessments:
(1) If the public authority improves a street, the suitable method of fixing the rate of the beneficiaries is to make it vary according to the length of the frontage facing the street.
(2) In the case of irrigation and drainage projects, the area is used to assess the special benefit received.
(3) If the improvements results in appreciation of the value of the properties, the assessment will take into account, the new value of the property as a ratio of the original value.
(d) Fine and Penalty:
A fine is a punishment or penalty imposed on an individual for any violation of law. For example, violation of traffic rules, payment of income tax after the stipulated time etc. A public authority imposes penalty mainly to defer from certain acts.
If refers to the penalty imposed by competent authority like courts, for the failure of individuals to appear in the courts to complete contracts as stipulated or to safeguard valuable assets.
Forfeitures of bail or of bond are similar to fines. As source of revenue, fines and forfeitures have little significance. They are almost entirely unpredictable. In revenue sense they are pure by-products of the administration of government machinery.
It refers to the claim of the state to the property of persons who die without legal heirs or documented will. It is the duty of the state to guarantee distribution of the estates of deceased persons to heirs specified in wills, or to persons declared to be lawful heirs by courts, if no such heirs exist, the property reverts to the state.
Under the rights of escheat, the government may also acquire unclaimed property of dissolved educational institutions or other trusts. This is not an important source of revenue to modern government.
4. Grants and Gifts:
Gifts are voluntary contribution from private individual or non-governmental organizations to the government funds for specific purpose, such as relief fund or defence fund during a war or an emergency.
Such contributions are made by patriotic, charitability minded persons during war, flood or natural calamities to overcome deficiency in government revenue position. Gifts have no significant place in modern revenue system, except during national emergencies like war.
Grants or grants-in-aid are a method by which one government provides financial assistance to another. In a federation the central government provides grants to state governments, usually in the performance of a specified function.
Sometimes the government of one country receives a grant from another country which is commonly called foreign aid. It may be military aid, economic aid etc. Many advanced countries and international funding agencies like World Bank, IMF, etc. gives grants-in-aid to developing and poor countries for economic development programmes.
5. Public Borrowing:
In the modern world every government use the method of raising revenue by public loans. Just as individuals or business firms may borrow in anticipation of other revenues, the government also borrows.
The government can borrow loans within the country and from outside the country. The government can borrow from individual institutions, banks etc. From outside sources it can borrow from international lending institutions.
6. Printing of Paper Money:
The government may resort to printing of paper money as a means of paying their bills. Governments, unlike individuals, have the power to create money. However, the printing of paper money is normally avoided as a source of revenue because its use is too easily abused. Once this method of financing is started, it is difficult to stop and runaway inflation can easily result.
Thus there are different sources of income of a government. Some of them like taxes are compulsory payments, others like fees and prices are voluntary. Special assessments etc. are partly compulsory and partly voluntary.
Each source has its own importance in the revenue base of a government. However, among these various sources, tax revenue constitutes the major source in modern times.
Objectives of Taxation:
In a modern democratic society ‘tax tool’ is an important ingredient of the fiscal system, to achieve certain important objectives.
Today tax tool is not only the traditional type of revenue raiser, but also it is a multi-edged tool, which can be used for influencing the national economy. The war and post war period have proved that a good deal of economic effect can be generated by taxation.
Now it has been widely accepted that taxation is a powerful fiscal tool, which can be effectively used to achieve certain objectives such as increased production, better distribution of wealth, to control cyclical fluctuation in income and employment etc. in a country.
Hence taxation should be governed by certain well defined objectives.
The major objectives of taxation held in the past and pursued today are detailed below:
1. Revenue Aspect:
The time honored objective of taxation is to raise revenue. The introduction of new tax measures or the strengthening of existing measures means an increase in government income to finance normal expansion of governmental activity. This objective means that the structure of taxes and tax rates ought to be devised to generate more revenue.
This doesn’t mean that non-revenue consideration have no place in the formulation of tax policy. This only means that when government has to meet increased expenditure, it is on taxes that it primarily relies.
However, revenue objective of taxation is subject to certain criticism. It is commonly argued that, taxation may be used as an instrument for obtaining certain social objectives like redistribution of wealth and reduction of inequality.
2. Regulatory Objective:
A second objective of taxation is that of regulation or control. This is ‘sumptuary taxation’. Technically the term sumptuary refers to the regulation or control of private expenditures. In public finance it came to represent all extra revenue objective of taxation.
There are some taxes where primary objective is to control and regulate consumption. For example, restrictions on the consumption of alcoholic liquors are effected by means of restrictive excise duties.
In the case of such taxes, primary aim is one of regulation and not of revenue. For instance, the policy of high cigarette excise enforced by some state governments in India seeks to attain certain social and economic objectives at the cost of revenue yield.
Likewise customs duties can be levied on imported articles with a view to encourage internal production of the same. However, this method of combining regulation with revenue collection is criticized on the ground that it achieves neither purposefully.
Nowadays taxation is advocated as a measure to regulate the flow of income. This is an extension of the regulative aspect of taxation. Taxes transfer income from individuals to government. This in turn will alter the pattern of private consumption and investment and thus influence the level of national income.
Similarly those taxes, which are taken from surplus income, reduce funds available for private consumption and investment. When the level of income is low, the revenue objective of taxation will have to be subordinated to sumptuary objectives,
4. Functional Finance Objective:
This was advocated by A.P. Lerner, an American Economist. He holds the view that, the chief objectives of public finance is to maintain an adequate level of national income. Lerner observes “taxation should never be imposed merely as a means of raising money for the government, but to leave less in the hands of the tax payer”.
According to this view, public finance must be functional finance in which revenue motives and other motives must be subordinated to that of maintaining an adequate level of income. Taxation should be used as a means of cutting down total spending, when it becomes necessary so as to prevent excessive total demand and inflation.
5. Incentive Objective:
In recent years a good deal of emphasis has been given on ‘incentive taxation’. It includes a variety of proposals, designed to provide preferential treatment for income from business enterprises and establishing rewards and penalties to stimulate output.
Its purpose is to stimulate the larger flow of investment activities in the desired channel and to prevent its flow into undesired channels. Several types of incentives are provided under incentive taxation to stimulate investment activity.
For example, ‘tax holiday’ given to investors who establish investment units in a backward area, for a certain number of years. Another example is export subsidy given to export industries to boost our export to foreign countries.
6. Reduction of Inequalities:
It is now generally accepted that taxation ought to be used as a means of regulating the socio-economic life of the community, it is an effective tool to reduce the glaring inequalities of income and wealth existing in the modern society. Democratic governments aim at securing social justice. Progressive tax system is designed to achieve this objective.
7. Growth, Equity and Stabilization:
In the case of developing countries, the objective of taxation is to promote economic growth with stability. Tax policy should judiciously be framed to promote saving, investment and capital formation activities.
Growth may sometimes generate inflationary pressure in the economy. Hence, tax policy should aim at bringing about stability in the economy.
The discussed objectives may change from time to time depending on the prevailing economic condition in an economy. The changing political scenario of a democratic country also exerts influence in the tax policy pursued by the government.
However, revenue objective is the prime motto behind any tax policy. All other objectives are supplementary to these basic objectives. In a sense socioeconomic objectives cling around the revenue objective of tax policy.
Hence, it is very difficult to frame a comprehensive tax policy, which will help to realize the manifold objectives discussed above.
Principles or Canons of Taxation:
Taxation by definition involves compulsion. Taxpayers are required to make certain payments regardless of their individual disposition in the matter.
In a democracy, taxes will not be imposed unless they meet with the approval of the majority of the representatives of the people. But once taxes are levied, no individual has the choice of paying or not paying.
Owing to this compulsory nature, tax collections have significant effects upon the behavior of individuals and the functioning of the economy. This aspect must be taken into consideration, in the framing of appropriate tax structure.
Tax revenue has occupied the most important place in the revenue system of all the governments in modern days. Principles of taxation mean the framing and employment of appropriate criteria in the development of tax structure. This aspect has received attention from earlier days.
Mercantilists and physiocrats advanced doctrines of tax principles. Adam Smith developed his famous canons of taxation, widely quoted down even in the present day. Mc Culloch, J.B. Say and John Stuart Mill dealt with the question at length. Principles of taxation focused the attention in the studies of Edgeworth, Dalton and Pigou. Recent decades witnessed little progress in the development of principles of taxation.
Recently, most studies in public finance, merely repeat the older doctrines. The development of the principles of taxation is essentially an application of the theory of economic welfare.
The principles of taxation can be selected only in terms of the goals which are accepted as the appropriate objectives of the economic system. Adam Smith was probably the first writer to attempt a general statement of the principles or canons which should govern any sound system of taxation.
The celebrated Canon of taxation as prescribed by Adam Smith is explained below;
1. Canon of equality or Ability:
According to this canon, taxes imposed should be in accordance with an individual’s ability to pay. In this context, Adam Smith observes “the subjects of every state ought to contribute towards the support of the government as nearly as possible, in proportion to their respective abilities that is in proportion to the revenue which they enjoy under the protection of the state”.
It implies that in absolute terms the richer should pay more taxes, because without the protection of the state, they could not have earned and enjoyed that extra income. In this case Smith observes “it is not very unreasonable that the rich should contribute to the public expense not only in proportion to their revenue, but something more than that proportion”.
2. Canon of Certainty:
This canon is meant to protect tax payers from unnecessary harassment by the tax officials. The amount to be paid, the time and method of payment should be clear and certain for the tax payers to adjust his income and expenditure accordingly.
“The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought all to be clear and plain to the contributors and to every other person”.
Adam Smith further point out that if a scope for arbitrariness exists, then under such circumstances, even honest tax machinery will become unpopular. Certainty also implies that the state should know how much revenue it could expect and when it could get it.
According to Adam Smith uncertainty in taxation encourages corruption. All attempts at equality will be a myth, without the tax being certain.
3. Canon of Convenience:
This canon states that “every tax ought to be levied at the time or on the manner in which it is most likely to be convenient for the contributor to pay it. A tax imposes burden on the taxpayer.
Hence a tax should be imposed at a time and in such a manner that the taxpayer feels minimum of inconvenience. For example, agricultural tax should be collected soon after harvest, since the farmers are in a better position to pay it. Income tax should be deducted monthly on installment basis from salaried taxpayers.
The canon of certainty implies that the time and manner of payment should be certain. But the canon of convenience says that the time of payment and manner of payment should be convenient.
4. Canon of Economy:
Every tax involves a collection cost. It is important that the cost of collection should be the minimum possible. Smith says that “every tax ought to be contrived as both to take out and to keep out of pockets of the people as little as possible over and above what it brings to the public treasury of the state”.
The tax is economical, in the sense that the cost of collection is very small. Moreover, a tax will violate the canon of economy, if hinders the development of trade and industry in any manner.
Taxes on harmful drugs and intoxicants are regarded as economical because they not only bring income but also discourage unproductive expenditure. This rule requires that taxes be established, in such a manner as to minimize the real costs of collection, in terms of resources required to collect the taxes and to comply with the tax laws on the part of the taxpayers.
The above canons of taxation are still considered as fundamental principles of taxation. However, owing to the needs of the modern complex state and the problem involved in them, the canons of Adam Smith needs to be supplemented, by certain rules, most of which should be treated as corollaries to the canons of taxation.
It is true that the canons of Adam Smith are excellent. Yet it is generally recognized that they must be completed, to suit the needs of modern complex society, by the addition of a few other general principles.
Hence later writers on public finance like Bastable, Shirras, and Mrs. Hicks etc. have added a few more canons of taxation, which are given below.
5. Canon of Productivity:
Productivity or physical adequacy means that, the tax system should sufficiently yield the revenue needed to meet the requirements of the state.
Productivity again means that the government should not depend upon deficits. One tax bringing a large income is not better than many taxes, each bringing very small revenue. However, multiplicity of taxes should be avoided. Another meaning of productivity is that the tax should not discourage production.
6. Canon of Elasticity:
Elasticity is closely connected with fiscal adequacy. This canon implies that yield from taxation should grow along with increase in population and development of economy.
When the state is in need of larger revenues in an emergent situation, it should be possible to raise them by pushing up the rate of the tax.
Elasticity demands that there should be in the system, a capacity to respond quickly to the changes in the demand for revenue. For example, in India income tax is elastic. By raising the rate a bid or imposing surcharge the government is able to collect more revenue.
The tax system should be simple, plain and intelligible to the common man. As far as the underdeveloped countries are concerned, this is a very important characteristic of good tax system; since the common taxpayers are illiterate.
In any country the system of taxes and the laws governing them should be simple. A complex tax system may even prompt an honest taxpayer, to indulge in involuntary tax evasion.
Flexibility means that there should be no rigidity in the tax system, so that it can be quickly adjusted to new conditions. Under a flexible system, a new tax can be imposed or an old tax can be withdrawn to adjust to the changed situation.
There should be a variety of taxes properly co-ordinated, so as to form a united and consistent system. The tax system should be broad based. This canon requires that the tax system should not rely on a few taxes. There should be a large number and variety of taxes, so that it can touch all sections of the people in the society.
The tax system should not distort the working of the market mechanism. Taxes should not produce any adverse effect in the economy. This canon means that taxes should be able to avoid undesirable effect upon the economic system of the country.
11. Canon of Co-Ordination:
In a federal system of government, taxes are imposed by the central, state and local governments.
Hence there must be a well stitched co-ordination between the taxes imposed by different taxing authorities.
12. Canon of Expediency:
This canon insists that taxes should not be covered in controversy. Taxpayers should have no doubt about its desirability.
The canons of taxation have a sound philosophy behind them and exhibit an insight into the practical experience of tax administration and its effects. Since the days of Adam Smith many other principles have been added.
Supplementing Smith’s four canons, Bastable adds the maxims of productivity and elasticity and holds productivity to be the most important principle. In this context, Prof. Cannan observes “the ultimate object of every system of public finance, so far as the distribution of taxation is concerned must be of course to secure the best result on the whole and in the long run”.
In this context, equity and economy is considered as the two guiding principle of taxation. However, in general, the tax structure is considered as a part of the economic organization of a society and should therefore fit in its overall economic policy.