A nation’s tax system is often a reflection of its communal values or the values of those in power. To create a system of taxation, a nation must make choices regarding the distribution of the tax burden—who will pay taxes and how much they will pay—and how the taxes collected will be spent.
In democratic nations where the public elects those in charge of establishing the tax system, these choices reflect the type of community that the public wishes to create. In countries where the public does not have a significant amount of influence over the system of taxation, that system may be more of a reflection on the values of those in power.
That is, in order to hasten the development of their societies, a big portion of the income and savings of the rich and high-earning people should be confiscated through high income tax rates, and the money be distributed to the poor and the weak, including the lazy and irresponsible, so that there will be more equality and more social progress. The wave of globalisation in the 80s made many politicians and their respective technocrats realise that they need to relax a bit their level of income confiscation as there was an emerging “income tax competition” among countries.
This thinking has pervaded until the early 80s, so that by 1980, the vast majority of countries have top marginal income tax rate of 50 per cent or more. Exceptions were HK in Asia, Switzerland in Europe, and Argentina in South America, among others. A lot of tax cheating also happened in many countries where income tax rates are very high, resulting in lower tax collection by governments.
Taxation has four main purposes or effects: Revenue, Redistribution, Re-pricing, and Representation. The main purpose is revenue taxes raise money to spend on roads, schools and hospitals, and on more indirect government functions like market regulation or legal systems. 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 re-pricing. 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.
Re-framing the tax revenue regulations should deserve a very close review of existing rules and regulations one by one, if not word by word in fitting with present day demand of social norms and business practices. If these regulations have to be effectively enforceable, prudently practiced, impartially implemented in a free and democratic environment unlike past colonial regime, it has to be such a public law framed by the lawmakers who should also be within its jurisdiction. Appropriate ownership has to be established for each item of law equally on every footing. Rules should not be framed only for the ruled, to twist the innocents and ignorant, should not be a tool for applying discretionary power by the enforcement officials, but be applicable for all indiscriminately. Cannons of tax law should be digestible and implementable across the board and be applied without fear and favour. It has to be simple, comprehendible, non duality in meaning and interpretation, delegable, assertive but with adequate relieving and remedial provisions. Stakeholders’ views at large should be taken into consideration to make it more user-friendly.
To be sound, a tax system must be economically efficient, inflicting as little damage as possible on the economy. Every tax system distorts economic decisions and leads to less economic activity than otherwise would occur, resulting in what economists call “deadweight loss.”
These are the costs caused by distortion to working, investment, entrepreneurship, and other productive activities. It has been argued that typical estimates of the economic cost of a taka of tax revenue range from 20 paisa to 60 paisa over and above the revenue raised.” Harvard’s Martin Feldstein has gone so far as to conclude that the deadweight burden caused by incremental taxation “may exceed one dollar per dollar of revenue raised, making the cost of incremental government spending more than two dollars for each dollar of government spending.” (National Tax Journal, June 1997)
What is more, applying different tax rates to different activities or to different producers exacerbates the distortion of economic decisions and increases the deadweight losses due to the tax system. A sound tax system should be designed to minimise these losses. There should be none to deny the fact a sound tax system should be logistically economical. It should impose the smallest possible compliance costs on taxpayers, otherwise people will not be encouraged to pay tax; rather they will be inclined to evade tax.
It should not be reflected that there is no fairness in taxation. No one is going to say that taxes are unfair, but on the contrary, it is often observed that fairness does not enter into the matter. There is a theory that all wealth is fortuitous, or “lucky”. There is the extreme case of the people who win the lottery, or inherit wealth, but that is a small fraction. There are also gifted people; luck in one’s genetics is also luck. However, most wealthy people became rich through a lifetime of hard work. Then you must ask why people work hard. Is it their character, their psyche, their upbringing? All of these are determined by circumstance.
Every tax system imposes direct costs on taxpayers in terms of time devoted to tax preparation or money to buy the services of CPA’s.
Ultimately, every tax system diverts a portion of tax revenues raised by the tax to pay the cost of administering and collecting the tax and enforcing its provisions. A sound tax system would minimise these costs.
To be sure, the most visible, fluid tax systems are the most neutral and simple. Just a little bit effort by the citizens should be required in paying taxes. This is a necessary evil. Otherwise, the government could do and take whatever it wanted. Citizen-voters have a minimal responsibility, if not civic duty, to participate in this, a fundamental component of democratic society.
Debates about taxes usually devolve into “the wealthy can afford it” or “it is unfair to be taxed so harshly”. Neither argument has merit. Tax the wealthy too harshly, and they will stop creating wealth. Tax them too leniently, and either society will be unable to govern itself, or the rest of society will be so harshly taxed that it will rebel. It is entirely a matter of practicality. Fairness never enters into it. As pundits of the past have put it “If you know the position a person takes on taxes, you can tell their whole philosophy. The tax code, once you get to know it, embodies all the essence of life: greed, politics, power, goodness and charity.”
The writer is a former Secretary to the Government of Bangladesh and former Chairman, NBR.