Taxation

… a core concept in Economic Analysis and Atlas102

TaxationConcept description

Merriam-Webster defined taxation as the action, process, or system of taxing people or things.

Types of tax

The Economist includes the following in its Economics A-Z

“Income tax, the biggest source of government funds today in most countries, is a comparatively recent invention, probably because the notion of annual income is itself a modern concept. Governments preferred to tax things that were easy to measure and on which it was thus easy to calculate the liability. This is why early taxes concentrated on tangible items such as land and property, physical goods, commodities and ships, as well as things such as the number of windows or fireplaces in a building.”

“… Arguably, any tax is a bad tax. But public goods and other government activities have to be paid for somehow, and economists often have strong views on which methods of taxation are more or less efficient. Most economists agree that the best tax is one that has as little impact as possible on people’s decisions about whether to undertake a productive economic activity.

  • High rates of tax on labour may discourage people from working, and so result in lower tax revenue than there would be if the tax rate were lower
  • Land tax is regarded as the most efficient by some economists
  • [Tax] on expenditure by others, as it does all the taking after the wealth creation is done.

“Some economists favour a neutral tax system that does not influence the sorts of economic activities that take place. Others favour using tax, and tax breaks, to guide economic activity in ways they favour, such as to minimise pollution and to increase the attractiveness of employing people rather than capital. Some economists argue that the tax system should be characterised by both horizontal equity and vertical equity because this is fair, and because when the tax system is fair people may find it harder to justify tax avoidance and tax evasion. However, who ultimately pays (the tax incidence) may be different from who is initially charged, if that person can pass it on, say by adding the tax to the price he charges for his output. Taxes on companies, for example, are always paid in the end by humans, be they workers, customers or shareholders.”

Tax policy objectives

Joseph Minarik (reference below) describes attributes:

“Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them.

  • Simplicity means that compliance by the taxpayer and enforcement by the revenue authorities should be as easy as possible. Further, the ultimate tax liability should be certain. A tax whose amount is easily manipulated through decisions in the private marketplace (by investing in “tax shelters,” for example) can cause tremendous complexity for taxpayers, who attempt to reduce what they owe, and for revenue authorities, who attempt to maintain government receipts.
  • Efficiency means that taxation interferes as little as possible in the choices people make in the private marketplace. The tax law should not induce a businessman to invest in real estate instead of research and development – or vice versa. Further, tax policy should, as little as possible, discourage work or investment, as opposed to leisure or consumption. Issues of efficiency arise from the fact that taxes always affect behavior. Taxing an activity (such as earning a living) is similar to a price increase. With the tax in place, people will typically buy less of a good – or partake in less of an activity – than they would in the absence of the tax. … [T]he goal of efficiency is to minimize the ways in which taxes affect people’s choices.
  • Fairness, to most people, requires that equally situated taxpayers pay equal taxes (“horizontal equity”) and that better-off taxpayers pay more tax (“vertical equity”). Although these objectives seem clear enough, fairness is very much in the eye of the beholder. There is little agreement over how to judge whether two taxpayers are equally situated. For example, one taxpayer might receive income from working while another receives the same income from inherited wealth. And even if one taxpayer is clearly better off than another, there is little agreement about how much more the better-off person should pay. Most people believe that fairness dictates that taxes be “progressive,” meaning that higher-income taxpayers pay not only more, but also proportionately more. However, a significant minority takes the position that tax rates should be flat, with everyone paying the same proportion of their taxable income. Moreover, the idea of vertical equity (i.e., the “proper” amount of progressivity) often directly contradicts another notion of fairness, the “benefit principle.” According to this principle, those who benefit more from the operations of government should pay more tax.
  • Revenue sufficiency might seem a fairly obvious criterion of tax policy. Yet the federal government’s budget has gone from enormous deficit to large surplus, and back again, in just ten years. Part of the reason for the deficit is that revenue sufficiency may conflict with efficiency and fairness. Economists who believe that income taxes strongly reduce incentives to work or save, and economists who believe that typical families already are unfairly burdened by heavy taxes, might resist tax increases that would move the federal budget toward balance.

“Likewise, other objectives of tax policy conflict with one another. High tax rates for upper-income households are inefficient but are judged by some to make the tax system fairer. Intricate legal provisions to prevent tax sheltering – and thus make taxes fairer – would also make the tax code more complex. Such conflicts among policy objectives are a constant constraint on the making of tax policy.”

Source

The Economist, Taxation, Economics A-Z, at http://www.economist.com/economics-a-to-z/t#node-21529301, accessed 11 May 2016.

Joseph J. Minarik, Taxation, The Concise Encyclopedia of Economics, at http://www.econlib.org/library/Enc/Taxation.html, accessed 11 May 2016.

Atlas topic and subject

Taxes and Subsidies (core topic) in Economic Analysis.

Page created by: Ian Clark, last modified on 11 May 2016.

Image: New Business Creator, at http://newbusinesscreator.com/how-a-c-corp-can-avoid-double-taxation-when-selling-a-business/, accessed 11 May 2016.