After reading this article you will learn about the merits and demerits of progressive taxation.
Merits of Progressive Taxation:
Progressive taxation has been universally accepted as the best system of taxation. It is based on the application of principle of diminishing marginal utility of income and ability to pay.
As income increases, marginal utility of income diminishes. Also, the higher the income, the greater the capacity to produce and consume.
The recent popularity of progressive taxation is due to:
(a) The growth of democratic values,
(b) The diffusion of socialist ideas, and
(c) Recent development s in economic theory.
This principle has been advocated by different writers on different grounds. Prof. Hobson, Marshall and Pigou staunchly supported progressive taxation:
(1) Progressive taxation justifies the canon of ability or equality. It secures equality in sacrifice and leads to justice in the distribution of tax burden. Since the marginal utility of money to a rich person is less than a poor person, the rich should be taxed at a higher rate than the poor. In progressive taxation, higher income group contributes more as taxes. Hence it justifies equity in payment and fair distribution of tax burden.
(2) Reduces inequality in the distribution of income. It is considered as a powerful tool to reduce inequality in the distribution of income and wealth. In this type of taxation, the rich contributes more volume of taxation, because of their high ability to pay. Hence, Prof. Kaldor emphasized the role of progressive taxation to reduce the inequality of income.
(3) Satisfies the canon of economy. Progressive taxes are economical because cost of collection does not increase with increase in rate and income.
(4) It is highly elastic, with the slight change in the rate of taxation; the government can increase its revenue collection considerably. Hence, it is elastic in nature.
(5) It satisfies the canon of productivity: The need for resources of the government is on an increase due to increasing functions. Progressive taxation helps the government to mobilize the required revenue for meeting growing public expenditure without much strain and collection cost.
(6) Progressive taxation helps to curb inflationary trend. It by reducing disposable income helps to reduce consumption demand. Thus the revenue mobilized therein may be diverted for productive investment.
(7) Progressive taxation is very convenient from the administrative point of view.
(8) Progressive taxation can act as a check on concentration of economic wealth and power.
(9) Progressive taxation has an in-built mechanism to deal with the undesirable effects of inflation and deflation.
Prof. Taylor justified progressive taxation on the following grounds:
(a) Revenue productivity,
(b) Optimum individual allocation of tax burden,
(c) Promotion of stability and growth, and
(d) Optimum social allocation of resources.
Prof. Hobson tried to justify progressive taxation, from the view point of taxing the surplus. According to him, every individual’s income consists of two elements – an element of cost and an element of surplus.
Hobson argues that we cannot tax the cost element, since it would destroy the source of income itself. Hence, all taxes should be directed towards surplus. Surplus element predominates in higher income.
Hence Hobson concludes that progressive taxation will not affect consumption activities, it affect only surplus element of a persons’ income.
Demerits of Progressive Taxation:
(1) Progressive taxation is arbitrary and uncertain. There is no guiding principle according to which tax rates are fixed. There is uncertainty as to which rates of increase should be adopted. Different countries at different times will probably adopt different ways for assessment.
(2) Based on faulty system of assessment, it is based on the wrong assumption of diminishing marginal utility of money. However, utility is a subjective phenomenon, un-capable of comparison. Hence this is based on the wrong assumption that marginal utility of money declines with increase in income.
(3) It will adversely affect production and discourage capital formation. It will hamper the growth of trade and industry. Prof. J.S. Mill observes “to tax the higher income at higher percentage than smaller, is to lay a tax on industry and economy”.
(4) Progressive taxation punishes prudence and virtues and rewards extravagance and idleness. In this context, William Newmarch observed that “graduation or progression is confiscation, punishing prudence and virtues”.
(5) There is large scope for tax evasion in the case of progressive taxation. Every effort would be put to evade a steeply graduated tax than a proportional tax. This will be done by furnishing false declaration and filing false assessment.
(6) Prof. J.S. Mill condemned graduated taxation as equal to confiscation. To put it in his own words “graduated taxation is graduated robbery”.
An examination of arguments advanced against progression, shows that the objections against progression are far from decisive.
The progression system is not only theoretically just, it is practicable and its administrative difficulties are greatly exaggerated. A moderate degree of progression should be aimed at, whereas very high progression will be perhaps unjust.