Cannons of Taxation

Cannons of Taxation

The noted 18th century English economist, Adam Smith, had enunciated the cannons of taxation in his much acclaimed book “An Inquiry into the Nature and Causes of the Wealth of Nations” which was popularly called as “Wealth of Nations”. According to Smith there are four basic cannons of taxation, which are based on the concepts of equality, certainty, convenience and economy.

1. Is should be Equitable – It means equal treatment of similarly situated taxpayers. The equity is horizontal and vertical. Horizontal equity - all purchasers of the same equity pay the same tax. Vertical equity: unequally situated taxpayers being taxed on their ability to pay as per progressive taxation philosophies.

He says: 'The subjects of every state 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.' This canon embodies the principle of equity or justice and lays down the moral foundation of the tax system. 'It is not unreasonable that the rich should contribute to the public expense not only in proportion to their revenue but something more than that proportion,' Smith had written in his Wealth of Nations. Thus, tax should in proportion to the ability to pay.

2. It should be Convenient – a tax should be readily and easily assessed, collected, and administered.

The cannon of convenience states that every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.

3. It should be Certain – the consistency & stability in the prediction of taxpayers' bills and the amount of revenue collected over time.

The canon of certainty is highlighted in the following statement by Smith: "The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought all to be clear and plain to the contributor and to every other person. Where it is otherwise, every person subject to tax is put, more or less, in the power of tax-gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of each aggravation, some present or perquisite to himself." Certainty is needed not only from the point of view of the tax payer but also from that of state.

4. It should be Economical – compliance and administration of a tax should be minimal in terms of cost.

Finally the cannon of economy dictates that every tax ought to be so contrived as both to take out and to keep out of the pocket of the people as little as possible, over and above what it brings into the public treasury of the state.

He also propagated three additional criteria:

1. Adequacy - a tax should have the ability to produce a sufficient and desired amount of revenue to the taxing authority.

2. Achievement of social and economic effects - the use of taxes to reallocate resources to achieve various specific social and economic objectives.

3. Neutrality - a tax should not encourage inefficient allocation of resources by being so extreme that taxpayers make counterproductive economic decisions.

Some later economists subsequently added a few more canons to Smith's four described above. Among these are: elasticity, flexibility, simplicity and diversity.

If we try to weigh the taxation practices in India in the balance of Adam Smith’s above cannons, we may perhaps see we are moving in the opposite direction of Adam Smith. In India, where rich escape from paying taxes by hook or crook, the les privileged is forced to shoulder the burden of nation building. In many cases, the ability to pay taxes is inversely proportional to the tax they actually pay!

The convenience, consistency, stability, certainty etc. are words unknown to the authorities. Taxation statutes are seemed to be high school laboratories where the mandarins of the south blocks learn the art of ‘Tinkering’.

If you look at the economy, we see crores spend to collect lakhs. On the other side, Government is collecting easy money in the form of taxes like FBT, Dividend Tax etc.

Our ancient Economist and Philosopher “Kautilya” wrote in ‘Arthasasthra’ that the collection of taxes from the people should be like a bee collecting honey from a flower without disturbing the flower.

Wishful thinking in India, isn’t it?