Introduction to taxation: Ignorance about tax issues can kill your business (part 2)

Introduction to taxation: Ignorance about tax issues can kill your business (part 2)

Introduction to taxation: Ignorance about tax issues can kill your business (part 2)

Principles of Taxation

Adam Smith, an 18th century philosopher tried to organizet the rules that should guide a nation’s system of taxation. He laid down four general principles, as follows:

  1. The people of every state ought to contribute towards the support of the government, as nearly as possible, in respect to their various abilities; that is, in respect to the revenue they enjoy from the state.
  2. The tax every individual is supposed to pay is to be certain, not random. The time, manner of payment, amount to be paid are to be clear to each person, and to the government.
  3. Tax is supposed to be charged at a time that it is convenient for taxpayers to pay.
  4. Every tax is supposed to be arranged in a way that it takes little from the pockets of taxpayers, and brings much to the treasury of the state.

These principles have remained relevant over the years, though they have to be explained from time to time. The principles laid out what is fair in the distribution of tax payments among taxpayers. It holds the belief that tax payments should be based on an individual’s capacity to pay. It also says that the tax paid by taxpayers should be correspondent with the benefits enjoyed by the individual from the government. The emphasis placed on a tax system by the government shouldn’t infringe with market decision making.

Distribution of tax burdens

According to Adam Smith in his principles of taxation, it can be inferred that distribution of tax to each individual should be according to their ability to pay, and at a convenient time. Different principles, and goals affect the government’s tax policy from state to state.

  1. Horizontal Equity

This principle says that people in the same positions are liable to pay the same tax. However, this principle is often neglected consciously or unconsciously. Intentional violations are encouraged by politics, not by sound economic policy. The argument has been whether it is right to lay the same tax burden on people in the same positions, as far as tax issues are concerned.

Introduction to taxation: Ignorance about tax issues can kill your business (part 2)

  1. Ability-to-pay principle

This principle says that tax burden should be distributed among taxpayers with respect to their ability to be about to pay, taking all personal characteristics into consideration. Income taxes from individuals fall under this principle. It is obvious, as it is an individual’s income that determines his ability to pay the tax burden levied to him. There have also been disputes about this principle, by John Locke and Thomes Hobbes, and other tax specialists. They argued that tax burden should be based on what is spent, not on what is earned by individuals.

However, present day tax specialists emphasized income over consumption. They believe that large income provides a good measure of people’s ability to pay, because much assets bring about some degree of satisfaction and tax capacity. The ability-to-pay principle is often hinged on the fact that personal taxes should increase as income increases. Although, this is not always steady because the increase of individual income cannot be ascertained over a period of time.

Some tax specialists believe that this principle can only be accomplished when taxes are supported by direct income transfers or negative refundable credits. Some others believe that the low income families should be taxed less, as this will serve as a means of achieving the equal distribution of tax principle. 

  1. Benefit principle

Under this principle, taxes serve a function that is the same as that of prices in personal transactions. This principle helps to determine the activities that should be carried out by the government, and those that will find them. The allocation of benefits responds directly to every individual’s goals. It is, however, difficult to enforce this principle for public sectors, because individuals have no motivation to pay for a public service, except they benefit directly from it.

The benefit principle is mostly used to fund roads and highways projects, through car fuels tax, and tolls tax. Payroll taxes are also used to fund social security, as this is beneficial for all citizens. Benefit principle serve as a link between contributions and what is enjoyed, but this link is weak, as the contributions do not go into individual accounts.

  1. Economic efficiency

Economic efficiency of a tax system depends on the nature of a market economy. Economists believe that markets do a good job in making economic effective decisions on choices like production, consumption and financing. Hence, they believe that tax policy should desist from meddling with the market’s allocation of resources. This means that the interference of taxation should be minimal on individuals’ decisions.

This priprinviple says that there should be no discrimination about consumption expenses, means and ways of production, forms of organization, or industries. This does not mean that primary economic goals cannot prevail over these principles, as there might be a need to impose taxes on different things, to protect the economy. For instance, there might be a red to impose taxes on pollution, to protect the environment.

  1. Ease of administration and compliance

In addressing the issue of taxation, it shouldn’t be forgotten that there has to be administration by accountable authority. There are four requirements that allows for ease of administration of tax principles. These requirements include: Clarity, Stability, Cost effectiveness, and Convenience. These requirements are necessary, especially in countries where lack of commercial markets, absence of books of accounts, and ineffective resources can impede administration and compliance.


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  • Clarity

Tax principles and regulations should be clear to taxpayers. The regulations must be simple enough for them to be carried out. Clear and certainty in principles help them to be easily carried out in this 21st century. When a nation has tax regulations that are not understood by taxpayers, it results in error, and reduces their respect for the law and government. And when this happens, discrimination against the poor and ignorant comes to play, and the rich and affluent are favored the most. Tax rules and principles shouldn’t be complex, but simple enough to be understood.

Introduction to taxation: Ignorance about tax issues can kill your business (part 2)

  • Stability

Tax rules and laws should be stable. Changes should be minimal, and when they have to be made, they should be in the context of a general tax reform, with provisions for proper transitions. Repeated changes to tax laws can result in confusion, and reduced compliance from taxpayers. Changes to tax laws are not to be often, but just when extremely necessary.

  • Cost effectiveness

The costs of collecting and controlling taxes should be to the least level in accordance with the goals of taxation. This principle is of utmost importance in developing and underdeveloped countries, where administrative resources are few. As much as tax laws are to be clear and stable, they should also be cost effective. The minimal costs should not only include government’s expenses, but also those of taxpayers.

  • Convenience

The payment of taxes should be convenient for taxpayers as much as possible. For instance, large taxes should be allowed to be paid in installments over a period of time. This is just to make it easier on the taxpayers to pay the tax.

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