Characteristics of a Good Tax System

Read the full chapter here: The Government and the Economy – Fiscal Policy

The Canons of Taxation:

1. Equity
Tax rates should be fair: every person should pay according to his/her ability to pay. The more a person earns, the more tax he/she should pay. Note that this also implies that those at the bottom should also pay their fair share – this is not the case in Ireland at present.

2. Certainty
Everyone should be able to work out his/her tax liability.

3. Convenience
The payment of taxes should be convenient for the taxpayer.

4. Economy
The cost of collecting tax should be small in comparison to the amount collected.

Further Characteristics:

1. Redistribution

Taxation should enable the government to redistribute income form the rich to the poor.
A progressive tax: is one that takes a higher percentage of income from the high-income earner than from the low-income earner.
E.g., PAYE

A regressive tax: is one that takes a higher percentage of income from the low- income earner than from the high-income earner.
E.g., VAT

A proportional tax: is one which takes the same percentage in tax from everyone.
E.g., an income tax system with only one rate of tax.

2. Not Discourage Work

A good tax system should not be a disincentive to work. At present in Ireland marginal income tax rates are so high, and social welfare so generous, that there is no incentive to work.

3. Not Discourage Investment

A good tax system should not discourage investment. Ireland’s current corporation tax of 12:5% (and even below) is very important in attracting foreign direct investment.

4. Act as an Automatic Stabiliser

A good tax system should have a stabilising e ffect on national income:

(a) When incomes are rising, the amount collected in taxes should also rise, so that the increase in demand in the economy is curtailed. This will lessen inflationary pressures on the economy.

(b) When incomes are falling, the amount collected in taxes should also fall, so that the decrease in demand in the economy is not as great as it would otherwise be. This will lessen de
ationary pressures on the economy.

Taxes are thus said to be automatic stabilisers in an economy, since they prevent incomes rising too fast in times of high demand, and prevent incomes falling too fast in times of low demand.

In short, taxes can be used to attenuate the highs and lows of the boom-bust cycle.

Types of Taxes

1. Direct Taxes
Taxes on income or wealth.

(a) Income tax:
Every individual who is employed is liable for income tax.

(b) Corporation tax:
A tax on company pro ts. (12:5%)

(c) Capital gains tax:
A tax levied on an individual if he/she sells an asset at a price higher than
he/she purchased it.

(d) Capital acquisitions tax:
A tax on gifts or inheritances.

Advantages of Direct Taxation:

(a) Direct taxation conforms to all four `Canons of Taxation’.
(b) Direct taxes are automatic stabilisers.

Disadvantages of Direct Taxation:

(a) High rates discourage workers from increasing their productive capacity by
doing overtime, working longer hours, etc.
(b) High rates encourage tax avoidance and tax evasion.
(c) High rates encourage citizens to contribute to the black economy.
(d) High rates discourage investment.
(e) High rates penalise the most e fficient companies.

Indirect Taxes

Taxes levied on goods and services.

(a) Value-added tax (VAT):
A tax levied at each point of exchange of goods and services, from primary production to fi nal consumption.
21% standard rate; 12:5% reduced; zero rate on certain items.

(b) Excise duties:
These are taxes levied on goods which are produced for domestic consumption.

(c) Customs duties:
These are taxes on goods which are imported into the country.

(d) Stamp duties:
This is a form of taxation which involves the fixing of pre-paid stamps to legal and commercial documents.

(e) Property tax:
A tax paid to local corporations. Calculated as a percentage of the value of the dwelling.

(f) Water tax:
A tax (or charge) to pay for the provision of water supplies.

Advantages of Indirect Taxation:

(a) Cost of collection is low – economy;

(b) Harder to evade indirect tax than direct tax;

(c) Do not discourage work;

(d) Can be used by the government to encourage or discourage consumotion of
certain goods and services, for instance cigarettes;

(e) Act as an automatic stabiliser;

(f) Convenient for the tax-payer as they are `hidden taxes’.

Disadvantages of Indirect Taxation:

(a) Inflationary;

(b) Levied on goods and services consumed in equal quantities by rich and poor – regressive;

(c) Do not conform to the principle of equity;
(d) It is not possible for the government to predict accurately the yield from indirect taxation – an increase in indirect tax on a particular good may cause consumers to refrain from consumption, or switch to alternative goods.

The impact of a tax: refers to the individual, company, good or service on which the tax was initially levied.

The incidence of a tax: refers to the individual, company, good or service on which the tax eventually rests.

Example: if the government raises VAT by 1%, shopkeepers may raise their prices concomitantly. In this case the impact of the tax is the shopkeeper; the incidence is the consumer.

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