An ad valorem tax / A unit of specific tax

TAXATION

Taxation is a system of raising money to finance government. All governments require payments of money — taxes — from people. Governments use tax revenues to pay soldiers and police, to build dams and roads, to operate schools and hospitals, to provide food to the poor and medical care to the elderly, and for hundreds of other pur­poses. Without taxes to fund its activities, government could not exist.

Throughout history, people have debated the amount and kinds of taxes that a government should impose, as well as how it should distribute the burden of those taxes across society. Unpopular taxes have caused public protests, riots, and even revolutions. In political campaigns, candidates' views on taxation may partly determine their popularity with voters.

Taxation has four main purposes or effects (4Rs): Revenue, Redistribution, Repricing, and Representation.

Taxation is the most important source of revenues for modern governments, typically accounting for 90 per cent or more of their in­come. The remainder of government revenue comes from borrowing and from charging fees for services. Countries differ considerably in the amount of taxes they collect. In the United States, 26,9 % of the gross domestic product goes for tax payments, in China – 17%, in Canada – 32,2 %, in Belgium- 46,8, and in Ukraine – 28,1%. This is the most widely known function. A second is redistribution. Normally, this means transferring wealth from the richer sections of society to poorer sections. A third purpose of taxation is repricing. Taxes are levied to address externalities: tobacco is taxed, for example, to discourage smoking, and many people advocate policies such as implementing a carbon tax. A fourth, consequential effect of taxation in its historical setting has been representation. The American revolutionary slogan "no taxation without representation" implied this: rulers tax citizens, and citizens demand accountability from their rulers as the other part of this bargain. Several studies have shown that direct taxation (such as income taxes) generates the greatest degree of accountability and better governance, while indirect taxation tends to have smaller effects.

Taxes be classified in the following ways:

By tax base

Taxes have to be levied on some basis or other, and a convenient way of classifying a tax is to do so according to what is being taxed.

An ad valorem tax / A unit of specific tax

An ad valorem taxis one where the tax base is the value of a good, service, or property. Sales taxes, tariffs, property taxes, inheritance taxes, and value added taxes are different types of ad valorem tax. An ad valorem tax is typically imposed at the time of a transaction (sales tax or value added tax (VAT)) but it may be imposed on an annual basis (property tax) or in connection with another significant event (inheritance tax or tariffs). A unit of specific taxis levied on the volume of what is being taxed; many excise duties are specific taxes.

Three main tax bases are used in the present tax system. In most developed countries individuals pay income taxes when they earn money, consumption taxes when they spend it, property taxeswhen they own a home or land and in some cases estate taxes when they die. Using the tax base is a convenient

classification for economic analysis for example, in examining what exactly bears the burden of a tax, known as the incidence of taxation.

Income taxes

An income tax is a tax levied on the financial income of persons, corporations, or other legal entities. Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or corporation tax. Individual income taxes often tax the total income of the individual (with some deductions permitted), while corporate income taxes often tax net income (the difference between gross receipts, expenses, and additional write-offs).

The "tax net" refers to the types of payment that are taxed, which included personal earnings (wages), capital gains, and business income. The rates for different types of income may vary and some may not be taxed at all. Capital gains may be taxed when realized (e.g. when shares are sold) or when incurred (e.g. when shares appreciate in value). Business income may only be taxed if it is significant or based on the manner in which it is paid. Some types of income, such as interest on bank savings, may be considered as personal earnings (similar to wages) or as a realized property gain (similar to selling shares). In some tax systems, personal earnings may be strictly defined where labor, skill, or investment is required (e.g. wages); in others, they may be defined broadly to include windfalls (e.g. gambling wins).

Personal income tax is often collected on a pay-as-you-earn basis, with small corrections made soon after the end of the tax year. These corrections take one of two forms: payments to the government, for taxpayers who have not paid enough during the tax year; and tax refunds from the government for those who have overpaid. Income tax systems will often have deductions available that lessen the total tax liability by reducing total taxable income. They may allow losses from one type of income to be counted against another. For example, a loss on the stock market may be deducted against taxes paid on wages. Other tax systems may isolate the loss, such that business losses can only be deducted against business tax by carrying forward the loss to later tax years.

Corporate tax refers to a direct tax levied by various jurisdictions on the profits made by companies or associations and often includes capital gains of a company. Earnings are generally considered gross revenue less expenses. Corporate expenses that relate to capital expenditures are usually deducted in full. They are often deducted over the useful life of the asset purchase. Notably, accounting rules about deductible expenses and tax rules about deductible expense will differ at times, giving rise to book-tax differences. If the book-tax difference is carried over more than a year, it is referred to as a temporary difference, which then creates deferred tax assets and liabilities for the corporation, which are carried on the balance sheet.

A capital gains tax is the tax levied on the profit released upon the sale of a capital asset. In many cases, the amount of a capital gain is treated as income and subject to the marginal rate of income tax. However, in an inflationary environment, capital gains may be to some extent illusory: if prices in general have doubled in five years, then selling an asset for twice the price it was purchased for five years earlier represents no gain at all. If such a tax is levied on inherited property, it can act as a de facto probate or inheritance tax.

Wealth tax

Some countries' governments will require declaration of the taxpayers’ balance sheet (assets and liabilities), and from that exact a tax on net worth (assets minus liabilities), as a percentage of the net worth, or a percentage of the net worth exceeding a certain level. The tax is in place for both "natural" and in some cases legal "persons".

A poll tax, also called a per capita tax, or capitation tax, is a tax that levies a set amount per individual. It is an example of the concept of fixed tax. Poll taxes are administratively cheap because they are easy to compute and collect and difficult to cheat. Economists have considered poll taxes economically efficient because people are presumed to be in fixed supply. However, poll taxes are very unpopular because poorer people pay a higher proportion of their income than richer people. In addition, the supply of people is in fact not fixed over time: on average, couples will choose to have fewer children if a poll tax is imposed.

Retirement tax

Some countries with social security systems, which provide income to retired workers, fund those systems with specific dedicated taxes. These often differ from comprehensive income taxes in that they are levied only on specific sources of income, generally wages and salary (in which case they are called payroll taxes). A further difference is that the total amount of the taxes paid by or on behalf of a worker is typically considered in the calculation of the retirement benefits to which that worker is entitled. Examples of retirement taxes include the FICA tax, a payroll tax that is collected from employers and employees in the United States to fund the country's Social Security system; and the National Insurance Contributions (NIC) collected from employers and employees in the United Kingdom to fund the country's national insurance system.

These taxes are sometimes regressive in their immediate effect. A further regressive feature is that such taxes often exclude investment earnings and other forms of income that are more likely to be received by the wealthy. The regressive effect is somewhat offset, however, by the eventual benefit payments, which typically replace a higher percentage of a lower-paid worker's pre-retirement income.

Consumption taxes

A consumption tax is a tax levied on sales of goods or services. The most important kinds of consumption taxes are:

General sales taxes that are levied when a commodity is sold to its final consumer. Retail organizations contend that such taxes discourage retail sales. The question of whether they are generally progressive or regressive is a subject of much current debate. People with higher incomes spend a lower proportion of them, so a flat-rate sales tax will tend to be regressive. It is therefore common to exempt food, utilities and other necessities from sales taxes, since poor people spend a higher proportion of their incomes on these commodities, so such exemptions would make the tax more progressive. This is the classic "You pay for what you spend" tax, as only those who spend money on non-exempt (i.e. luxury) items pay the tax.

Excise taxes thatare based on the quantity, not the value, of product purchased. Excises on particular commodities are frequently hypothecated. For example, a fuel excise (use tax) is often used to pay for public transportation, especially roads and bridges and for the protection of the environment. A special form of hypothecation arises where an excise is used to compensate a party to a transaction for alleged uncontrollable abuse; for example, a blank media tax is a tax on recordable media such as CD-R’s, whose proceeds are typically allocated to copyright holders. Critics charge that such taxes blindly tax those who make legitimate and illegitimate usages of the products; for instance, a person or corporation using CD-R's for data archival should not have to subsidize the producers of popular music.

Excises (or exemptions from them) are also used to modify consumption patterns (social engineering). For example, a high excise is used to discourage alcohol consumption, relative to other goods. This may be combined with hypothecation if the proceeds are then used to pay for the costs of treating illness caused by alcohol abuse. Similar taxes may exist on tobacco, pornography, etc., and they may be collectively referred to as "sin taxes". A carbon tax is a tax on the consumption of carbon-based non-renewable fuels, such as petrol, diesel-fuel, jet fuels, and natural gas. The object is to reduce the release of carbon into the atmosphere.

A value added tax (VAT), also known as 'Goods and Services Tax' (G.S.T), Single Business Tax, or Turnover Tax in some countries, applies the equivalent of a sales tax to every operation that creates value.

VAT is usually administrated by requiring the company to complete a VAT return, giving details of VAT it has been charged (referred to as input tax) and VAT it has charged to others (referred to as output tax). The difference between output tax and input tax is payable to the Local Tax Authority. If input tax is greater than output tax the company can claim back money from the Local Tax Authority. VAT was historically used to counter evasion in a sales tax or excise. By collecting the tax at each production level, the theory is that the entire economy helps in the enforcement. However, forged invoices and similar evasion methods have demonstrated that there are always those who will attempt to evade taxation.

Tariffs

An import or export tariff (also called customs duty or impost) is a charge for the movement of goods through a political border. Tariffs discourage trade, and they may be used by governments to protect domestic industries. A proportion of tariff revenues is often hypothecated to pay government to maintain

a navy or border police. The classic ways of cheating a tariff are smuggling or declaring a false value of goods. Tax, tariff and trade rules in modern times are usually set together because of their common impact on industrial policy, investment policy, and agricultural policy. A trade bloc is a group of allied countries agreeing to minimize or eliminate tariffs against trade with each other, and possibly to impose protective tariffs on imports from outside the bloc. A customs union has a common external tariff, and, according to an agreed formula, the participating countries share the revenues from tariffs on goods entering the customs union.

Environment affecting tax includes natural resources consumption tax, Greenhouse gas tax (Carbon tax), "sulfuric tax", and others. The stated purpose is to reduce the environmental impact by repricing.

A toll is a tax or fee charged to travel via a road, bridge, tunnel, canal, waterway or other transportation facilities. Historically tolls have been used to pay for public bridge, road and tunnel projects. They have

also been used in privately constructed transport links. The toll is likely to be a fixed charge, possibly graduated for vehicle type, or for distance on long routes.

An inflation tax is the economic disadvantage suffered by holders of cash and cash equivalents in one denomination of currency due to the effects of Expansionary monetary policy, which acts as a hidden tax that subtracts value from those assets. Many economists hold that the inflation tax affects the lower and middle classes more than the rich, as they hold a larger fraction of their income in cash, they are much less likely to receive the newly created monies before the market has adjusted with inflated prices, and more often have fixed incomes, wages or pensions. Some argue that inflation is a regressive consumption tax.

An expatriation tax is a tax on some who renounce their citizenship of some governments.

Property taxes

A property tax is a tax put on property by reason of its ownership. Property tax can be defined as "generally, tax imposed by municipalities upon owners of property within their jurisdiction based on the value of such property." There are three species of property: land, improvements to land (immovable man-made things, e.g. buildings) and personal property (movable things). Real estate or realty is the combination of land and improvements to land. Property taxes are usually charged on a recurrent basis (e.g., yearly). A common type of property tax is an annual charge on the ownership of real estate, where the tax base is the estimated value of the property. The two most common type of event driven property taxes are stamp duty, charged upon change of ownership, and inheritance tax, which is imposed in many countries on the estates of the deceased. When a person dies, the property he/she leaves for others may be subject to tax. An estate tax is a tax on the deceased person’s estate, which includes everything the person owned at the time of death – money, real estate, stock, bonds, proceeds from insurance policies and material possessions. An inheritance tax also taxes the value of the deceased person’s estate, but after the estate passes to heirs. The inheritors pay the tax.

In contrast with a tax on real estate (land and buildings), a land value tax is levied only on the unimproved value of the land ("land" in this instance may mean either the economic term, i.e., all natural resources, or the natural resources associated with specific areas of the Earth's surface: "lots" or "land parcels"). Proponents of land value tax argue that it is economically justified, as it will not deter production, distort market mechanisms or otherwise create deadweight losses the way other taxes do.

When real estate is held by a higher government unit or some other entity not subject to taxation by the local government, the taxing authority may receive a payment in lieu of taxes to compensate it for some or all of the foregone tax revenue.

In many jurisdictions, there is a general tax levied periodically on residents who own personal property within the jurisdiction. Vehicle and boat registration fees are subsets of this kind of tax. The tax is often designed with blanket coverage and large exceptions for things like food and clothing. Household goods are often exempt when kept or used within the household. Any otherwise non-exempt object can lose its exemption if regularly kept outside the household.

A gift taxis a tax on transfers and conveyances of property by gift.

Most economists believe that a tax system should follow two main principles: fairness and efficiency. British economist Adam Smith laid out these principles in his treatise "The Wealth of Nations". Economists consider two principles of fairness to determine whether the burden of a tax is distributed fairly: the ability-to-pay principle and the benefits principle.

The ability-to-pay principle holds that people's taxes should be based upon their ability to pay, usually as measured by income or wealth. One implication of this principle is horizontal equity,which states that people in equal positions should pay the same amount of tax. If two people both have incomes of $50,000, then horizontal equity requires that they pay the same amount of tax. Suppose, however, that two individuals both have incomes of $50,000, but one has a lot of medi­cal bills and the other is healthy. Are they in equal positions? If not, then perhaps the tax burden of the person with medical bills should be re­duced. But by how much? And how does a person document to tax authorities that he or she is truly paying medical costs, and not just pre­tending in order to lower the tax bill?This example illustrates a funda­mental dilemma in tax design: Fairness is often the enemy of simplicity. A second requirement of the ability-to-pay principle is vertical equity,the idea that a tax system should distribute the burden fairly across people with different abilities to pay. This idea implies that a person with higher income should pay more in taxes than one with less income. But how much more? Should families with different in­comes be taxed at the same rate or at different rates?

2. Taxes may be proportional, progressive, or regressive.

A proportional tax takes the same percentage of income from all people. A progressive tax takes a higher percentage of income as income rises — rich people not only pay a larger amount of money than poor people, but a larger fraction of their incomes. A regressive tax takes a smaller percentage of in­come as income rises — poor people pay a larger fraction of their in­comes in taxes than rich people.

Which is fairest — a proportional, progressive, or regressive system? There is no scientific way to resolve this question. The an­swer depends on ethical and philosophical judgments, such as whether a society has the right to take income from one group of people and give it to another. A progressive, proportional, or even slightly regres­sive system all can achieve vertical equity's requirement that a richer person should pay more in taxes than a poorer person. Most industri­alized nations have progressive income tax systems, which impose a heavier tax burden as one's income increases. In the United States, the individual income tax system divides taxable incomeinto different tax brackets— ranges of income with different tax rates.

Some economists consider sales taxes regressive because indi­viduals with higher incomes spend a smaller proportion of their in­comes on sales taxes than those with lower incomes. A poor person and a rich person who spend the same amount on groceries each year will pay the same amount in sales taxes, even though the rich person earns more money. However, rich people consume more than poor people, and studies of people's spending patterns reveal that, over the course of a lifetime, the rich person will pay roughly the same pro­portion of his or her income in sales taxes as the poor person.

The benefits principle of taxation states that only the beneficia­ries of a particular government spending programmeshould have to pay for it. The benefits principle regards public services as similar to private goods and sees taxes as the price people must pay for these services. The practical application of the benefits principle is ex­tremely limited, because most government services are consumed by the community as a whole. For example, one cannot estimate the benefit received by a particular individual for general public services such as national defense and local police protection. One can make a case that, for some taxes, there is a relation­ship between taxes paid and benefits received. Gasoline taxes, for ex­ample, are used to finance highway construction. But even here, the link between taxes and benefits is weak. Some drivers have more fuel-efficient cars than others. They may use the roads as much as other drivers, but buy less gasoline and thus pay less tax. Merchants who operate stores along the sides of highways benefit from the presence of the roads, but the benefit has nothing to do with the merchants' gasoline consumption. Despite its intuitive appeal, the benefits principle is not im­portant in practice, and it plays little role in the design of tax systems.

In addition to being fair, a good tax system should beefficient, wasting as little money and resources as possible. Three measures of effi­ciency are administration costs, compliance costs, and excess burden.

Running a tax collection authority costs money. The govern­ment must hire tax collectorsto gather revenue, data entry clerks to process tax returns,auditors to inspect questionable returns, law­yers to handle disputes, and accountants to track the flow of money. No tax system is perfectly efficient, but government should strive to minimize the costs of administration. Complying with the system — paying taxes — costs taxpay­ers money above and beyond the actual tax bill. These costs include the money that people spend on accountants, tax lawyers, and tax preparers, as well as the value of taxpayers' time spent filling out tax returns and keeping records. The compliance costs of the US tax system are high. One reason for high compliance costs is the complexity of the tax system. Some complexity, however, is necessary to ensure fair taxation. A third measure of a tax system's efficiency takes into ac­countthe fact that when the government levies a tax on goods, it distorts consumer behaviour — people buy less of the taxed goods and more of other goods. Instead of choosing what goods to buy solely on the basis of their intrinsic merits, consumers are influenced by taxes. This tax-induced change in behaviour is called an excess burden. The larger the excess burden of a tax, the worse it is for efficiency. Taxes on labour can also lead to excess burdens. When the government taxes people's labour (through an income tax), people may decide to change the number of hours that they work. The tax distorts their choice between working and leisure. Not every tax gen­erates an excess burden. Consider a lump-sum tax — a fixed amount of money that all taxpayers must pay regardless of their circum­stances. If the government levies a tax of $1000 on each citizen, re­gardless of what he or she buys or earns, the only way to avoid paying the tax is to leave the country or die. Citizens cannot avoid the tax by changing their behaviour. Because it does not distort behaviour, a lump-sum tax has no excess burden — it is perfectly efficient. How­ever, most people would perceive such a tax as extremely unfair be­cause it disregards individual circumstances such as a person's ability to pay. Thus, the principles of fairness and efficiency conflict: fairness comes at the cost of efficiency. Each society must find the best tradeoff between fairness and efficiency, given the ethical beliefs of its citizens.

Date: 2015-12-11; view: 2068