Tax reform - Introduction to the new series

After demonetisation, it is widely expected that next step will be tax reform. So I wanted to examine and recommend the possible taxation reforms we can expect.

But this time, I want to open the research process to you all. So this post will be the beginning of a series of posts on this topic. Each post will be ideas under exploration and may end with some questions too. At the end of the series, I will convert it into a proper research paper and an explanatory article. 

So to start off, let us begin by asking basic questions.

What is Tax?

Tax is essentially a levy charged, on the people, by the government, to fund its activities.

You can find equivalent definitions in Wikipedia and Investopedia. Let us examine the crucial aspects of this definition and the question it raises. 

Tax is a levy. It is a charge on something such as a transaction or an asset. It implies that there exist transactions or assets that are visible to the government.

Government or its equivalent implies some authority that can bear the force of law on the person. The person may be a citizen or foreigners (including friendly aliens or enemy aliens).

Activities of the government include all the activities taken by the government upon itself. Initially, it included mere protection from enemies (army). Then expanded to provide safe internal law and order (police). It was further expanded to include dispute resolution (Judiciary). It further expanded to infrastructure for citizens (markets and city infrastructure). And now includes education, social security, health, etc. 

Distinction of tax

In purely communist countries there is ideally nothing like taxes. Everything belongs to the government and the citizens only get what they need for living.

In capitalist societies, a tax is something government takes from the people in return for the services it provides. It envisages a government to charge fairly for the services it provides even though the government can impose itself by authority of law.

Capitalist societies want to restrict the scope of government so that only a minimum amount needs to be taken from the person. The individual himself is best placed to spend the rest of the amount. So better to tax him less and leave him enough resources to achieve her own potential. This is the republican position on government.

The left-wing position on government is somewhat contrary. Their view is that government should provide the common services that could enable the individuals to achieve their full potential. They are for expanding government role in activities that involve common good. So they are happy to pay higher taxes.

In either case, taxes are a reality only the extent differs. We discuss this distinction because it has a bearing on HOW the individual is taxed not just WHAT he is taxed.

Power to tax
The constitution of the country grants power to the government to tax the citizens. The constitution decides what level of government can tax what activity. These powers are then refined by relevant laws and hence collection or even benefit from the taxes collected can be allocated to other government (usually lower).

Notice that power to tax is embedded in the constitution and hence amending it is a considerably expensive legislative exercise.

Types of Taxes
If you search for types of taxes, you will end up with taxes at the level of various governments. Local taxes, state taxes, central or federal taxes etc. But when designing tax policy the relevant classification is a bit different.

1. So one way to differentiate taxes is - income taxes v/s expenditure taxes. Expenditure taxes means sales tax, VAT or GST type taxes. Income taxes are fairly well understood. But people forget that income for individuals is salary and for corporates is the profit.   So in accounting terminology, individuals get taxed on revenues and corporates get taxed on profits. 
2. Another way is to look at is flow taxes v/s stock taxes. Flow taxes include income or expenditure taxes while stock taxes include property taxes or estate taxes, inheritance taxes etc.
3. Some taxes are mixed taxes - capital gains. It is partly income and partly stock tax. Experts have intuitively suggested that short-term capital gains are like income and therefore it is closer to income tax. Long-term Capital gains is an investment gain, therefore has second and third order effects hence taxed at lower rates.
4. Transaction Taxes are another type. They are incurred only when a transaction occurs. Banking Transaction tax being discussed currently is part of this.
5. Policy taxes like import taxes, sin taxes and environmental taxes, carbon taxes etc. These are not essentially taxes but instruments designed to influence the markets. So if extremely low costs imports are threatening the domestic industry some import taxes may be charged. The objective of these taxes is not to create fund for government activities but to influence the markets or policy. The fund created from them may be used selectively but the aim is different.

Tax Collection
Taxes are collected from taxpayers (different from citizens) either by direct deductions (Tax deducted at source) or by seeking payment of taxes.

Tax payment is accompanied by a statement by the taxpayers that details her assessment of taxes and proof of payment. It is generally called Tax Returns.

Tax inquiry and approval
If you note, taxes are self-assessed. Hence, by definition, the government will create an oversight mechanism to ensure your assessment is correct or not. This is done by tax scrutiny, wherein an officer or a computer checks for correctness of your statement. Your statement or return is examined against the data generated by your banks and other agencies and tallied with your return. If it is correct, your return in approved and tax liability is extinguished.

In every country, there is a limit as to how long the tax liability stays active. In India it is presently 5 years. In other countries the years varies depending upon how efficient the tax department is. Once this period is passed you are no longer required to pay for liabilities that may be discovered for prior period.

In sum
These are the very basic things about taxes. Next we will dive into the main topic.

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