Taxation: Principles and Forms | Accounting

After reading this article you will learn about the principles and forms of taxation.

Principles of Taxation:

Taxation is required to cover Government expenditures such as cost of:

(i) Administration,

(ii) Defence from external aggression,

(iii) Police for the maintenance of law and order,

(iv) Judicial courts for administration of justice,

(v) Schools and colleges for giving education to people, and

(vi) Hospitals for the preservation of health etc.

The study of how the Government obtains its revenue and how it spends it, is known as Public Finance.

The following principles of taxation are, however, generally accepted:

These are four canons of Adam Smith laid down in his Wealth of Nations:

(i) Taxation should be equal.

(ii) Taxation should be certain.

(iii) Taxation should be timely, and

(iv) Taxation should be economical to collect.

Adam Smith was of the view that the amounts people pay in taxes should be equal, by which in fact he meant proportional to their income. The people should be so taxed as to make them feel the burden of tax equally. There should be certainty with regard to the amount to be paid, for it should not be a tax-gatherer’s business to squeeze as much as possible from the taxpayer.

In other words, the form, quantity and manner of payment of the tax should be clear and plain to the contributor. There must be no confusion as to what, why and when he must pay. Tax should be paid in time there should be convenience of payment and collection.

The principle of timeliness or convenience is to the effect that taxes should be so selected and arranged in time and manner of collection as to disturb as little as possible both producer and consumer. Economy should be observed so that taxes should not be imposed of a kind where the cost of collection was excessive.

The principle of economy in lax collection is generally conceded, for the State will benefit little if the tax is expensive to collect. A serious objection to bringing small incomes within the orbit of income tax is the heavy cost of collection. A tax may obstruct industry and cause unemployment, in which case it can hardly be considered economical.

Forms of Taxes:

Taxes may be Direct or Indirect.

1. Direct Tax:

It is borne by the persons on whom it is intended to be levied by the taxing authority. Direct tax is imposed on persons whom it is desired and intended should pay.

Examples of direct tax are:

a. Income Tax.

b. Profits of companies (Corporation tax).

c. Capital gains tax, etc.

These are all taxes on different kinds of income, levied directly on the person receiving the income. Direct taxes are usually collected at the very source and hence the cost of collection is compara­tively very small and the chances of evasion are little. The tax payer knows what to pay, why to pay and when to pay the direct tax.

2. Indirect Tax:

An indirect tax is one, the burden of which is passed on by the person on whom it is imposed, to other persons. For example, import duties levied on foreign vehicles are collected from mer­chants importing them but ultimately this amount is realised (by them) from the customers, i.e., the purchasers of the vehicles in the shape of increased prices of vehicles.

Indirect taxes are on goods and services, and so they are sometimes known as outlay taxes, since they are paid only when certain purchases are made.

How much a person pays indirect taxes depends on the extent to which he uses taxed goods or services.

Examples of indirect tax are:

a. Sales tax,

b. Excise duties etc.

Indirect taxation is the principal form of taxation on low incomes and is levied mainly on articles of wide consumption to ensure wide contribution. At the same time this form of taxation is the least equitable since it falls most heavily, in a relative sense, on the lowest incomes and has no relation to the capacity of the tax payer to bear the burden.

Luxury goods appear to be the things most suitable for indirect taxation but it is often very difficult to draw a sharp line of demarcation between luxuries and other things, and if luxury goods are rigidly defined, the total yield for taxing them is not likely to be very great.

The principle of indirect taxation is to spread taxation over as wide a range of goods and services as possible, so that people of all tastes are brought within the net.

Indirect taxes when levied on clothes, petrol, kerosene oil may agitate the public, but when applied on intoxicating liquors and drugs, do a distinct social service by restricting their consumption.

Indirect taxes make no distinction between rich and poor, and thus poor people have to make a bigger sacrifice. Indirect tax payers do not feel that they are paying tax and thus their civic consciousness remains unstipulated. Indirect taxes (such as custom duty) encourage smuggling of goods.