From the first civilized societies, taxation has been a controversial problem for both the taxpayers and government. Tax is not an easy issue, as it is often accompanied by political issues and as it has widely let to severe political conflicts in the human history. According to its importance, several economic theories have been proposed to run an effective tax system.
The truth is that none of the existing tax theories is perfect, and no perfect tax system has been launched up to date. Of course, it might be due to the involvement of many factors and taxpayers; thus, perfection is meaningless for taxation systems.
Ability-to-Pay Principle
Originating from the sixteenth century, the ability-to-pay principle was scientifically extended by the Swiss philosopher Jean Jacques Rousseau (1712-1778), the French political economist Jean-Baptiste Say (1767-1832) and the English economist John Stuart Mill (1806-1873). As suggested by the principle title, it says that the taxation should be levied according to an individual’s ability to pay.
This is indeed the basis of ‘progressive tax,’ as the tax rate increases by the increase of the taxable amount. This principle is indeed the most equitable tax system, and has been widely used in industrialized economics. However, there is no solid approach for the measurement of the equity of sacrifice in this theory, as it can be measured in absolute, proportional or marginal terms.
Thus, equal sacrifice can be measured as (i) each taxpayer surrenders the same absolute degree of utility that s/he obtains from her/his income, or (ii) each sacrifices the same proportion of utility s/he obtains from her/his income, or (iii) each gives up the same utility for the last unit of income; respectively.
Benefit Approach Principle
Contrary to the ability-to-pay principle, the benefit approach principle was developed in the seventeenth century by English philosophers Thomas Hobbes (1588-1679) and John Locke (1632-1704), and Dutch jurist Hugo Grotius (1583-1645). In this principle, taxation is levied broadly in relation to the benefits that people receive in public services.
The major problem associated with this tax system is that taxes are paid individually but public services are provided collectively. Thus, the public service a taxpayer uses is not necessarily equal to the tax s/he pays. For instance, it is difficult (if not impossible) to allocate the costs for national health, defense or foreign policy to taxpayers in proportion to their consumption.
Tax Incident
As initially proposed by the French Physiocrats, a major duty of a tax system is to analyze the effect of a particular tax on the distribution of tax welfare. For instance, if a government increases tax on petrol, it is not limited to oil companies, and they pass it on to the oil consumers; then, a taxi driver passes it on to the passengers, or a food distributor passes it on to a supermarket, which in turn passes it on to the customers.
This is indeed the complicated nature of tax systems. According to this structure, the term ‘tax incident’ also refers to the ultimate payers of a tax.
References and Further Readings
R. A. Musgrave, and P. B. Musgrave, Public Finance in Theory and Practice, McGraw Hill Higher Education, New York, 1989.
R. A. Musgrave, and A. T. Peacecock (Eds.), Classics in the Theory of Public Finance, MacMillan, London, 1958.
J. A. Pechman, Who Paid the Taxes 1966-85?, Brookings Inst Press, Washington D.C., 1985.
