No discussion on the principles of taxation can be complete without a reference to the canons of taxation laid down by Adam Smith.
Although the theory and practice of taxation has been considerably extended since his days, yet his propositions are still fundamentally true and they remain the starting point of sound public finance:
(i) “The subjects of every State ought to contribute towards the support of the government, as nearly as possible in proportion to their respective ability; that is in proportion to the revenue which they respectively enjoy under the protection of the State. In the observation and neglect of this maxim consists what is called the equality or inequality of taxation.”
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Equality here involves equality of sacrifice, and not equality of the amount paid. The poor and the rich both should pay what they can pay and equality and justice demand that no one should pay more than what he is able to pay.
(ii) “The tax which each individual is bound to pay, ought to be certain, and not arbitrary. The time of payment, manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person.”
A tax should not be arbitrary. Everyone must know well in advance what he has to pay, when he has to pay, and where he has to pay. When he knows all this, a tax-payer can adjust his expenditure with the least inconvenience. The government, too, becomes certain, as far as possible, of its receipts.
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(iii) “Every tax ought to be levied at the time or in a manner, in which it is most likely to be convenient for the contributor to pay it.”
A tax should be collected at the time when the tax-payer has the means to pay. If public authorities demand payment when it is not convenient for the tax-payer, it becomes burdensome and there is probability that it may not be paid at all.
A convenient tax is justified on the grounds of productivity and good government, and also from the point of the tax-payer, particularly when he belongs to the poor class in the community. The greater the convenience the less waste of time and of resources involved in collection and payment.
(iv) “Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the State.”
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The machinery required for collecting taxes should be simple and economical so that the cost of collection and the loss to the individual and the community should be small in proportion to the proceeds.
It is, therefore, necessary that an able Finance Minister should always see that the cost of collection does not exhaust the major portion of the receipts. Similarly, a sound system of taxation should scrupulously avoid all taxes which discourage saving and hamper the growth of capital.
Following are a few more principles for a good system of taxation which may be added to Adam Smith’s canons enumerated above:
(v) From the point of view of the government a tax should be productive of revenue. But no tax should be imposed which may tend to diminish the economic resources of the community. A tax may be immediately productive of large revenue, yet under certain conditions it may ultimately result in a reduction in the nation’s income.
(vi) It is better to have a few productive taxes than many less productive ones. It is always cheaper to collect a few remunerative taxes than a large number of smaller amounts spread over a wide field.
(vii) The tax should permit of an automatic growth as wealth and population increase.
(viii) The tax should be elastic and it should be responsive. The system of taxation should contain at least some taxes which permit of an increase in the rate and yield in order to meet emergencies without necessitating an increase in expenditure on administration or collection.
(ix) The system of taxation should be as simple and intelligible as possible. If it is complex and difficult to understand, it may create doubt and friction between the government and the tax-payer.
A simple and intelligible system of taxation creates confidence, a better appreciation of the needs of government and, at the same time, it injects political consciousness into a citizen.