Canons of Taxation:
A tax has no connection with the benefit received by the payer. Also, the charge is compulsory.
Hence in distributing the burden of taxation, a person’s share cannot be decided with reference to the benefit derived by him.
Adam Smith laid down four principles to guide the taxing authority.
Adam Smith’s Canons:
The principles or canons of taxation enunciated by Adam Smith were so important that they have become classic.
(1) Canon of Equality:
“The subjects of every State,” Smith asserted, “ought to contribute towards the support of the Government as nearly as possible in proportion to their respective abilities, that is, in proportion to the revenue which they respectively enjoy under the protection of the State. In the observance or neglect of this maxim consists what is called the equality or inequality of taxation.” Equality here does not mean that all tax-payers should pay an equal amount. Equality here means equality or justice. It means that the broadest shoulders must bear the heaviest burden.
This canon has given rise to two theories:
(i) Equality of Sacrifice Theory:
It means that the burden of taxation should involve an equal sacrifice for every individual. This equality, however, though good in theory, is difficult to attain in practice. Sacrifice is subjective, something in the mind and feelings of a person. It is difficult to measure. Besides, it has to take into consideration the number of dependents on the earning member in the family and their standard of living.
(ii) The second principle indicating justice is the Ability or Faculty Theory:
Which hold that the rich should be made to pay something more than proportionate to their income? A man with an income of Rs. 500 per month will not, other things being equal, feel the same pinch in parting with Rs. 50, as a man with an income of only Rs. 50 feels in paying Rs. 5 (though the percentage is the same), because the former’s faculty to pay is greater. On this principle is based progressive taxation, i.e., increasingly higher rates of taxation as incomes – increase. Proportional taxation will not do justice.
(2) Canon of Certainty:
Adam Smith further said, “The tax which each individual has to pay ought to be certain and not arbitrary. The time of payment, the amount to be paid ought all to be clear and plain to the contributor and to every other person.” The individual should know exactly what, when and how he is to pay a tax otherwise it will cause unnecessary suffering. Similarly, the State should also know how much it will receive from a tax.
(3) Canon of Convenience:
Smith wrote, “Every tax ought to be levied at the time or in the manner which it is most likely to be convenient to pay it.” Obviously, there is no sense in fixing a time and method of payment which are not suitable. Land revenue in India is realised after the harvest has been collected. This is the time when cultivators can conveniently pay.
(4) Canon of Economy:
Lastly, Adam Smith held that “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.” This means that the cost of collection should be as small as possible. If the bulk of the tax is spent on its collection, it will take much out of the people’s pockets but bring very little into the State’s pocket. It is not a wise tax.
Other Canons of Taxation:
Economic science has progressed much since the days of Adam Smith. Later writers have added to his canons.
The additions are:
(5) Canon of Productivity:
This canon emphasizes that a tax should bring in a substantial amount of money to the State. After all, the main object of the taxing authority is to secure funds. Therefore, a tax which does not yield a fair income is not of much use. It is much better to have a few taxes which yield good revenue instead of many taxes yielding a little.
(6) Canon of Elasticity:
This canon points out that a tax should automatically bring in more revenue as the country’s population or income increases. There should be an automatic link between the needs of the State and resources of the people. If, in an emergency, an increase in the rate of the tax brings in increased income, the tax is elastic.
(7) Canon of Simplicity:
It argues that the tax system should be simple; otherwise there would be confusion and, worse still, corruption. During the war and after, certain taxes, e.g., on sale of cloth and lather essential supplies in India resulted in corruption mainly because they lacked in simplicity.
(8) Canon of Variety:
It is also necessary that the tax system off a country should be diversified. Reliance on just a few taxes is risky. The revenue will not be sufficient, nor will it be fair, because it will not touch a large number of people. In order to be just, a tax system must be broad-based. In order to be adequate, it must be diversified, having a wide coverage over commodities and persons.
(9) Canon of Flexibility:
‘Flexibility’ in taxes is different from ‘elasticity’ mentioned earlier as a canon. Flexibility connotes the absence of rigidity in the tax system. A flexible tax quickly adjusts to the new conditions; on the other hand, elasticity means that income can be increased. Presence of flexibility is a pre-condition for elasticity. Lack of flexibility in a tax can cause financial troubles to a State.