In modern economies taxes are the most important source of governmental revenue. A tax is a compulsory payment to the government by the subjects without expectation of definite return or benefit to the tax payer. As per Adam Smith, “The taxes which, it is intended, should fall indifferently upon every different species of revenue, are capitation taxes and taxes upon consumable commodities. These must be paid indifferently from whatever revenue the contributors may possess, from the rent of their land, from the profits of their stock, or from the wages of their labour”. Every taxation system needs to be effective by incorporating certain canons. Canon of taxation states the characteristics that should be possessed by a good taxation system. It is related to the administrative part of a tax. The first principle of canon of taxation was devised in 77 by Adam Smith.
CANON OF TAXATION
- Canon of Equality
The term equality refers to the ability to pay. While taxing the person, the government must know which person belongs to which income group and then the individual must be taxed. Adam Smith argued that the taxes should be proportional to income, i.e. citizen should pay the taxes in proportion to the revenue which they respectively enjoy under the protection of the State. This would reduce the gap between the rich and poor. If there would be no such principle, the gap between the rich and poor would only increase with the time.
- Canon of Certainty
According to Adam Smith, “the tax which individual is bound to pay ought to be certain, and arbitrary”. The amount of tax, the manner of payment, and the person to whom it is to be paid shall be certain so that the individual shall be informed well in advance about the amount that is to be levied as a tax. If the tax system is not certain, it may lead to harassment of an individual. This principle of certainty states that tax should not be arbitrarily fixed or imposed by the income tax authorities. Lack of certainty in the tax system encourages corruption in the tax administration. Therefore in a good tax system, an individuals should be secure against unpredictable taxes levied on their wages or other incomes; the law should be clear and specific; tax collectors should have little discretion about how much to assess taxpayers; for this is a very great power and subject to abuse.
- Canon of Convenience
According to Adam Smith, “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”. The payment and manner of payment of taxable amount must be convenient to the person paying the same. If the tax collection mechanism is complex, it would lead to frustration and dissatisfaction to the contributor. A good taxation system is one, which is convenient to the contributor. Income tax is always collected on the preceding year of the assessment year. That means the tax is deducted only when the income is earned by the individual. If this would not be the case then the situation may arise, where the burden of paying the tax would be on the contributor, not having earned the income.
- Canon of Economy
A good tax system is where the cost of collecting the tax is minuscule to that of the amount collected. The government shall always endeavour to lower down the expense incurred on the tax collection so as to have the larger amount to its treasury. The very purpose of tax collection is to generate revenue for the government but the same is defeated when the expense gets increased. According to Adam Smith “Every tax ought to be contrived as both to take out and keep out of pockets of the people as little as possible over and above what it brings, into the public treasury of the State”. Therefore, this canon of taxation is significant in adopting the method of collection.
- Canon of Simplicity
A simple tax structure must fetch or generate more revenue for the government. Where the whole of the tax structure is simple, it doesn’t create the confusion and is easy to understand. Tax rates must be simple. Where it is complex, it may lead to confusion and thereby the contributor may abstain from paying such tax. Canon of Simplicity along with the other canon plays a significant role in the effective and efficient functioning of the tax system. Goods and Service tax is one such example to encourage people to pay the tax without getting stuck into the technicalities of different tax. Goods and service tax has made the tax structure simple and productive.
- Canon of Productivity
Imposition of tax must not bypass the rule of productivity. Tax amount of tax shall not be arbitrarily fixed and imposed on the individual so as to discourage him to make further investment. But this does not mean to the imposition of the tax in favour of the big shots of the country. The government shall impose the tax in such a way to make it productive.
- Canon of Flexibility
Tax structure must be flexible enough that it moves along with the economic growth. When there is an increase in the people income, the revenue of the government shall increase. Similarly, when there is a decrease in the income of people, the tax shall also be decreased accordingly.
- Canon of Diversity
Canon of Diversity states that there shall not be a single tax which has too high rates but shall have several taxes with lesser rates. This is so because an individual paying higher tax would lead to evasion of tax. Canon of Diversity also encourages the investments and lead to economic growth. Understanding better, in terms of human psychology, a person may abstain himself from paying a single high rated tax rather than from paying several lesser rated tax.
These canons of taxation are the real secret of the successful tax system. Non- fulfilment of these may demolish the whole structure and would create problems having only one solution i.e. following these aforesaid canons. But, we have to keep in mind that these canons are not exhaustive. With the passage of time, there may be an evolution of new canons which would be best suited to the circumstances of that time. Indian has a growing economy, therefore, new canons are obvious to evolve.
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