A Justification for Taxation
Taxation is one of the most important parts of any society. Taxes have been collected by governments ever since the beginning of civilization. A tax is defined as a financial charge levied on an individual or legal entity by a state or nation. Failure to pay this charge is punishable by law. According to Black’s Law legal dictionary, a tax is a pecuniary burden laid up an individual or property to support a government. An economist view on taxes is that a tax is a transfer of resources from the private sector to the public sector and without references to any special benefits received.
Though taxes are an often overlooked aspect of society, they have oft created more conflicts than some more controversial societal problems, for example religion. In ancient days, often the largest cause of war was the levying of taxes from kings and aristocrats. In 1215, the Magna Carta was written in order limit the power of King John, who had begun imposing taxes on the Barons. In 1776, the American Revolution was mostly fought over the heavy taxes that the British Empire began to levy, creating the famous slogan “No Taxation without Representation”. Gandhi started the movement against the Salt Tax in 1930, which lead to the eventual removal of the British from the subcontinent. Even today, while many believe that the bickering in Congress is due to partisan politics, the issue of taxes have created some of the most heated ideological battles in this nations history. Taxes have become an integral and decisive part of our everyday lives; but what purpose do they serve and what are the most efficient and fairest forms?
Goal of Taxation
The main goal of taxation has generally been to generate revenue for a government. As society as progressed however, taxes have also been used more to redistribute wealth from the rich to the poor, and have also been used in order to influence the behavior of people. Welfare, food stamps, and subsidized housing would be some examples of redistribution of wealth. Taxes on things like cigarettes and gambling, and also tax deductions on things like owning a house and having a spouse are examples of where taxes are used to influence the personal lives of people.
Direct and Indirect Taxes
Taxes come in two basic forms, direct and indirect. Simply stated, a direct tax is a levy on income, property, or wealth. This includes income tax, corporate tax, payroll taxes (Social Security), poll tax, zakat, jayzah, and more. An indirect tax is one that is levied on goods and services rather than a person or corporation. Examples of an indirect tax would be sales tax, excise duty, and import duty.
The key difference between a direct tax and an indirect tax is that while direct taxes can be adjusted for the individual circumstances of a person, indirect taxes are imposed on the transaction and entirely disregard the circumstances of the taxpayer. This makes all indirect taxes regressive, as they begin to have a larger impact on your total percentage of wealth as you make less money, as the poor tend to spend more on consumer goods relatively to the wealthy.
Indirect taxes are often criticized for displacing the economic theory of equilibrium. It acts as an additional factor in supply and demand and disrupts the balance between the two.
Progressive, Regressive, and Negative Taxes
A progressive tax is a direct tax where the tax percent increases as your income or wealth is higher. Progressive taxes place more tax incidence, or tax burden upon the wealthy, while having less burden on the poor. The concept of a progressive tax is an ancient one; Plato advocated for a progressive tax and so did Adam Smith. Smith writes in his Wealth of Nations “It is not very unreasonable for rich to contribute to public expense, not only to the proportion but more.”
Some arguments against progressive taxation are that its not equitable, there becomes a difficulty in collection in some countries, there is the risk of capital flight, and it can potentially lower economic growth due by creating less incentive. Also, many Libertarians view a progressive tax as a violation of equal rights to citizens.
A regressive tax is generally uniform and the tax rate goes up if disposable income goes down. So because the poor have less disposable income, even though they have the same tax rate on sales tax, relatively they are paying more on the tax than someone who has more disposable income. Advanced countries have attempted to reduce the inherent regressive nature of sales tax by exempting basics like food and clothing.
A negative tax is actually a type of progressive tax because when a person’s income goes down the rate of tax goes lower, even into the negative. This means the government actually pays you money if your income is below a certain point, essentially welfare. This type of tax can eliminate the welfare trap and creates more incentive to work; the progressive nature of the tax discourages people from staying on welfare which is actually currently encouraged in certain circumstances.
Taxation in Religion
No major religion has a detailed or comprehensive tax system, but almost all of them have some command to pay taxes. In Christianity, when Caesar imposed taxes on Jesus, he said “render to Ceasars things that are Ceasars and render to god things that are gods.” (Mark 12:17) Judaism similarly stresses the importance of paying taxes.
Islam, while not having a prescribed system of taxation, the Khalifia’s did impose different kinds of taxes. Zakat is more a redistributive measure of Islam, and while loosely may fit the definition of a tax, since it is not mandatory it shouldn’t be considered a tax. Though some people might consider it mandatory with the punitive aspect coming in the next life. Abu Bakar did actually mandate Zakat, which would make it a tax, but the next Caliph’s did not follow his lead. Currently only Saudi Arabia and Pakistan have a legislatively required Zakat, but other Muslim countries do have a voluntary Zakat which the government issued. Jayzah was a tax that was imposed on non-muslims but was essentially the same as Zakat. Sometimes the Jayzah was kept below the Zakat, in order to discourage conversion to Islam, an example of taxes being used to influence people’s behavior. Khiraj was a tax issued by Umer that was imposed on arable land.
Types of Taxes
Income tax—————————–Progressive and Direct
Capital Gain tax———————-Progressive and Direct
Corporate tax————————-Progressive and Direct
Property Tax————————–Progressive and Direct
Land Tax——————————-Progressive and Direct
Wealth Tax—————————–Progressive and Direct
Sur Tax———————————Progressive and Direct
Gift Tax———————————Progressive and Direct
Customs——————————-Regressive and Indirect
Value Added Tax——————–Regressive and Indirect
Excise Duty—————————Regressive and Indirect
Sales Tax——————————Regressive and Indirect
Taxation History of Pakistan, India, and USA
In ancient times, most taxes in India were regressive except for the land tax which used to be proportional and somewhat progressive. The great Indian philosopher Chanakya (Kautalia) first proposed the concept of a progressive tax in 370 BC, but no significant progress was made until the enactment of the Income Tax Act of 1922 by the British Government and the establishment of the Central Board of Revenue in 1924. The British also created the appellate tribunal in 1939 which was adopted by both Pakistan and India.
India replaced the Indian Income Tax Act of 1922 with the Indian Income Tax Act of 1961 but also added a wealth tax and gift tax in order to place more tax incidence on the rich.
Pakistan also followed India’s example and added a wealth tax as well as a gift tax, as well as replacing the Indian Income Tax Act of 1922 with their own version in 1979.
The United States history of taxation can be best described as pre and post 16th amendment. Article I of the Constitution states that the “Federal government can levy taxes but only to proportion”. This meant that the government couldn’t impose capitation, poll tax, or head tax unless in proportion and must be uniform throughout the United States. From 1861 to 1894, more than 60 bills were presented for an income tax, and a bill was finally passed in 1894 call the Revenue Act of Wilson Forman Tariff. This act imposed a 2% flat tax on income over $2000 (Today it would be about $56,000). This was one of the first reforms from Congress which illustrated a growing concern of some of the wealthiest Americans consolidating too much power in the absence of direct taxes.
This act was overturned by the Supreme Court however as a violation of Article I of the Constitution. Congress responded quickly by passing the 16th amendment on July 1909, and it quickly was passed by enough state legislatures as well. The 16th amendment gave congress to tax from any source and without proportion, finally allowing for a progressive tax.
Ever since the passage of the 16th amendment, the rate and exemptions within the income tax have changed drastically. In 1913, $3000 of income was exempt, ($66,000 in today’s value) and only 10% of people were actually subject to the tax. In 2010, only $9350 was exempt. In 1985, the interest group Americans for Tax Reform (ATR) was founded by Mr. Grover Norquist, who’s main goal was to reduce tax revenue to only 8% of GDP. The mission statement of the ATR is “Government’s power to control one’s life drive’s from its power to tax”. Norquist is a Harvard graduate and married to a Kwaiti Muslim and is a cofounder of Islamic Free market institute with Khalid Saffuri in 1988.
How to Measure Tax Incidence
In recent years, many economists have been developing complex mathematical equations in order to create indexes that measure where the actual tax burden lies. One of these indexes is called the Plato index, developed by professor M. Fitzgerald of the Oxford department of international development, which measures tax burden by combining income distribution and tax pressure. The Plato index is defined as a ratio of direct tax revenue to the gross top quantile household. (Top 20% of households) The worse that the income distribution is the higher the tax yield should be. Plato’s best value would be 21%; UK is the closest with 20%, US at 16%, Argentina is at 2%. Developed countries tend to fall in the 15-20 range, developing in the 10-15, and underdeveloped in the 2-7. the Organization of economic co-operation and development (OECD) encourages poor countries to evolve direct and progressive taxes and reduce indirect and regressive taxes. Keeping the balance between the two will reduce poverty and also reduce dependence on foreign aid.
The Gini coefficient is another model used by economists to determine the income inequality of a country. The higher the coefficient, the higher the inequality of income within the country. Countries in Europe have coefficients around .25-.35, while the US as a coefficient of around .45-.49, and developing countries in Africa have coefficients of over .60.
Taxes aren’t simply numbers and percents that are changed around on whim to generate revenue, they pose philosophical, ideological, and goal oriented questions.
Ultimately in my view, countries must increase the progressive nature of their tax codes, as even most wealthy and developed countries are below the equilibrium. In poor countries, severe inequalities exist in income, and the best way to create a fair tax burden is to have direct progressive taxes which place the burden on the wealthy as opposed to regressive indirect taxes which place more burden on the poor. Furthermore, taxes should not be used as a means to manipulate human behavior; the sole purpose of taxation should be economic, it shouldn’t cross over into the personal realm. Tax incentives such as mortgages, 529 savings accounts, child credit, marriage, sin taxes, luxury taxxes, IRA, 401K, tax holidays, etc should be removed as they attempt to coerce people into certain behavior my providing monetary incentives.