Principles of taxation
Chapter 1: The fundamental principles of taxation
A tax is a payment in cash or in kind to a public authority
But payments on the basis of a contractual obligation are not taxes
That includes contractual payments between private parties, and contractual obligations
between private parties and public authorities
But payments on the basis of a non-contractual liability of tort vis à vis private parties or
public authorities are not taxes
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 misdemeanours are not taxes)
A tax is:
1. a mandatory contribution
2. in accordance with the rule of law
3. imposed by the public authority on its subjects
4. for the purpose of public spending
5. without any personal compensation
1. mandatory contribution :The taxpayer has no choice but to pay the tax, even when the taxpayer
disagrees with the way the government spends the money
2. In accordance with the rule of law: The tax needs a legitimate legal basis.
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
3. 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
In order to be a taxpayer, one must be subject to a government (central, regional, or local level of
government)
1
,Governments exercise authority in two ways: over persons and over territory (= the two main
nexuses for taxation)
4. For the purpose of public spending
In theory 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 goals is very rare
5. without any 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 tolls and fees?
User fees are payments for services or goods provided by public authorities
They are not taxes, because there is a clear and specific compensation for the payment
However the price of the service is not a market price but a price unilaterally determined by the
public authority
Why do we tax and how do we tax?
• Why: the benefit principle
• Why: the principle of sovereignty
• How: the ability to pay & the equality principle
• How: the principle of legality
• How: efficiency
Why: the benefit principle
• The benefit principle justifies taxation on the basis of the use made or the benefit derived by
the taxpayer from government goods and services
o Those who use (and benefit from) government services should pay taxes
2
, o + those who make more use (and derive most benefit- from government action
should pay more taxes
“Taxes are the price we pay for a civilized society”
However the benefit principle the characteristic of a tax as a unilateral mandatory payment without
any personal compensation
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
Why: the principle of sovereignty
• The sovereignty principle justifies taxation on the basis of the relationship of subordination
between the taxpayer and his government
• The sovereignty principle is a solid basis for taxation in connection with the legality principle:
“No taxation without representation”
o Levying taxes and spending tax revenue is subject to (democratic) consent & control
of the taxpayers
o Otherwise: arbitrary taxation
How: ability to pay & equality
• Benefit principle? Those persons who make most use and benefit of government action
should pay most taxes
• 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
“Equals are taxed as equals and unequals are taxed unequally”
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?
3
, 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
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
How: the principle of legality
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
It is essential that this statute is approved by the representatives of the people who are
subject to the tax (“no taxation without representation”)
It protects tax payers from arbitrary taxation and insures that taxpayers can have their voices
heard when it matters.
General elements of taxation
In modern society the major taxes always have the same basic structure. There may be differences in
the importance, the size and the functioning of the structural elements, but essentially the structural
elements of all major taxes in all countries are the same
1. Personal scope of the tax
Subjects of the tax: rules determining who is the taxpayer
Individuals or family units (either residents or non-residents): PIT, inheritance tax, gift tax,…
Legal entities (either residents or non-residents): CIT, tax on non-profit entities, bank taxes,
insurance taxes, mining taxes,…
4
