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Summary Principles of Taxation
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Part 1: The fundamental principles of taxationWhat is a tax?
There is no real one definition to what a tax is. In some country, the law dictates what a tax is. Other
countries leave it up to the courts to decide what a tax is. The definition of a law is a tax or not has
his important implementations. Despite this difference across countries, the course will try to
identify a number of features that are most relevant.
Does it matter if we call it a tax or not? It matters a great deal; we will look into the fundamental
questions/principles of taxation. Those fundamental principles are only relevant to taxes.
General definition: A tax is a payment in cash or in kind to a public authority. However, it is not that
simple.
Example: You need a new passport. You pay this to the local government, but this is not a tax. But
payments based on a contractual obligation are not taxes.
o That includes contractual payments between private parties, and contractual obligations between
private parties and public authorities. Example: You pay the public energy provider for the service
of providing electricity.
- But payments based on a non-contractual liability of tort vis à vis private parties or public authorities
are not taxes. Example: you damaged government property.
- But gifts, donations, or voluntary payments to public authorities are not taxes.
A tax is a mandatory, non-contractual and non-tort payment to public authorities.
- But: a tax must have a legal basis.
And: some mandatory, non-contractual, non-tort payments are fines (e.g. financial sanctions for
crimes or misdemeanors are not taxes). Example: You have to pay a speeding ticket.
A tax is a payment without consideration, i.e. without quid pro quo. The payer does not get an
immediate compensation for the payment of the taxes.
- Tax is a unilateral 1contribution to the budget of the public authority, which is entitled to spend it for
any public purpose.
- Important characteristic (1): The taxpayer has no right to claim some form of personal compensation
for tax paid. Example: Citizen that needs a new passport and needs to pay the price. This is not a tax
due to the fact that it is paid as consideration for specific service.
- Important characteristic (2): The taxpayer has no right to decide how the payment of his tax is spent
by public authorities.
- The public authority is sovereign in spending the taxes collected from the taxpayer.
o Control on spending by the public authority is exercised by parliament. There is a certain degree
of control/input of how this money is spent but this indirect mostly (elections/protests/…).
A tax is…
Mandatory Contribution
A tax is a mandatory contribution which can be enforced by the public authority.
- The taxpayer has no choice but to pay the tax, even when the taxpayer disagrees with the way the
government spends the money.
- From the moment a taxpayer falls within the legal scope of application of the tax, the tax can be
imposed by force.
- The only way to avoid the tax from being due is to place oneself in a factual or legal situation in
which the tax is not due.
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performed by or affecting only one person, group, or country involved in a situation, without the agreement
of another or the others.
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, Accordance with the rule of law
- A tax can only be levied in accordance with the rule of law, i.e. the tax needs a legitimate legal basis.
This is done to avoid abuse of power (taking away your home without legit basis, …).
- No taxation without representation: It is only allowed to tax if you allow taxpayers to be represented
on a government level.
o Magna Charta: Charters of right Agreed by King as his children saw him abusing his authority to
an extent. In order to gain peace, he had to agree to limit his power (including taxes) (1215).
o UK Bill of rights (1689)
o Déclaration des Droits de l’Homme: due to the fact that the government need more money to
spend, the government also had to give more to the people in order to keep peace (France
revolution) (1789).
Principle of legality
- The “essential elements” of a tax must be governed by law, i.e. scope, tax base, tax rate,
administration & procedure on those matters, all taxpayers must give their (collective) consent.
- Part of the history of taxation is the history of how to give this collective consent (= the history of
democracy).
Levy imposed by the public authority on its subjects
- The ultimate foundation of imposing a tax is the authority which a government exercises over its
subjects. Taxes can only be implied by government, not by companies, people, …
o In order to be a taxpayer, one must be subject to a government (central, regional, or local level of
government).
- Governments exercise authority in two ways: over persons and over territory (= the two main
nexuses 2 for taxation).
o Person: residents live/residents in the country. Due to this, the country can implement the
Worldwide Tax Liability: can tax all the income all over the world, not only the country. Example:
A residence in France gets income from France but also rents out a property in Spain (another
income). Due to the Worldwide Tax Liability, France can also tax the income from the property in
Spain.
o Territory: income has its source, does not matter where the resident lives. Hereby, the
government cannot implement the Worldwide Tax Liability. That is limited to the items of income
that are sourced in the country of question. Example: A residence in Spain rents out a property in
France. France is not entitled to tax that income that he gets in Spain but it is entitled to tax the
income from the building in France.
Most countries do both at the same time.
For the purpose of public spending
In principle taxes cannot be reserved for particular expenses.
o Subject to parliamentary control on expenses, the government is free to determine for which
public purposes taxes are to be spent.
o The spending of taxes is a discretionary decision, subject to political arbitrage in parliament.
- In practice some taxes (climate, health taxes) are often motivated by specific goals, but equality
between a tax and the amount spent on a specific goal is very rare.
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Connection between the taxpayer and the government.
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, Mandatory payment without personal compensation
- A tax is a unilateral payment based on the relationship of (personally or territorially) being subject to
a government authority.
- That government does not owe the taxpayer anything on the basis of the payment of tax.
- The government in charge does provide law and order, administration, and other public services. But
that is not in function of the amount of taxes paid; it is because it has authority on all citizens and
persons on its territory.
What about social security contributions?
- Like taxes, public social contributions are generally mandatory payments imposed by law.
- In most EU countries, social protection (unemployment, illness & accidents, old age & retirement,
childcare) is provided by semi-public institutions, based on mandatory social contributions.
- But unlike taxes, social contributions are subject to spending for specific social purposes.
o Social contributions are not unilateral, but the taxpayer is entitled to the contribution of specific
social benefits (i.e. there is some form of compensation: only contributors have access to
benefits).
o However, there is no direct proportional link between contributions and benefits: benefits are
distributed on the basis of need (principle of solidarity). Meaning if you pay more to the social
protection, does not mean that you get more.
What about tolls and fees?
- User fees are payments for services or goods provided by public authorities.
- First difference with tax: They are not taxes, because there is a clear and specific compensation for
the payment.
- Second difference: The price of the service is not a market price, but a price unilaterally determined
by the public authority.
Why do we tax?
1) The Benefit Principle
a. The benefit principle justifies taxation on the basis of the use made or the benefit derived by the
taxpayer from government goods and services.
i. Those who use (and benefit from government services) should pay taxes.
ii. Those who make use (and derive most benefit from government action) should pay more
taxes.
b. However, the benefit principle the characteristic of a tax as a unilateral mandatory payment
without any personal compensation.
i. The citizen is entitled to government services like general administration, police protection,
national education, health service and roads because he is a citizen of that government, not
because he pays taxes to that government. A tax is a unilateral payment, no pro quo.
2) Principle of Sovereignty
a. The sovereignty principle justifies taxation based on the relationship of subordination between
the taxpayer and his government social contract which gives the government authority.
b. The sovereignty principle is a solid basis for taxation in connection with the legality principle: “No
taxation without representation”.
i. Levying taxes and spending tax revenue is subject to consent & control of the taxpayers.
ii. Otherwise: arbitrary taxation.
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, How do we tax?
1) Ability to pay & the equality principle.
a. Benefit principle? Those persons who make most use and benefit of government action should
pay most taxes. (Problem: How do you measure this? Distribution of wealth?)
b. The ability to pay principle is the expression of an equitable distribution of the tax burdens in
accordance with a person’s economic capacity to bear a tax burden (relative to other taxpayers).
Since all taxes in the end must be paid out of income or wealth, those two bases of taxation are
generally considered the best measures of a person’s ability to pay. The ability to pay principle
should be considered together with the equality principle.
There are two types of equitable distribution of charges:
- Horizontal equity: persons who are in a comparable situation (with respect to income and/or wealth)
should pay the same tax. Absolute amount of tax or proportional tax rate?
- Vertical equity: persons who are not in a comparable situation (with respect to income and wealth)
should not pay the same tax.
Implementing vertical equity: how differently should incomparable taxpayers (i.e. taxpayers with
different ability to pay) be treated? Law of diminishing marginal utility: the loss in utility of a tax
payment on extra income or wealth diminishes with the increase in income or wealth the
higher the income/wealth, the higher the tax should be progressive tax.
From theory to practice: pragmatic compromises in taxation
Most taxes in democratic societies have adopted a pragmatic solution:
- When public services at national or local level are for the peculiar benefit of identifiable groups,
without specific characteristics as to income or wealth, governments rely on taxes in function of the
benefit principle.
- When public services are generally provided, and beneficiaries are not clearly identifiable
governments levy taxes in accordance with the ability to pay (income, wealth, consumption) the
principles are not absolute, so you have to implement them.
2) Principle of legality
a. The principle of legality means that a tax is only due when the essential elements of the tax
(scope, base, rate and procedural rules of collection and sanction) are determined by statute.
b. It is essential that this statute is approved by the representatives of the people who are subject
to the tax (“no taxation without representation”).
c. The history of taxation is the history of democracy (see supra).
3) Legality
a. It is impossible however to provide all details necessary for taxation in the statute. (time
consuming matter)
b. Therefore, a tax system also contains executive decrees, rulings, and administrative regulations
(all originating with the executive power / tax administration) supplementing the statute.
i. But in how much detail can the tax administration determine regulations (and change the
statute) without approval in parliament? It depends on countries laws/rules.
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