In this article, Amber Kotnala discusses Adam Smith’s theory on cannons of Taxation.

INTRODUCTION

Every citizen of a country has some rights and duties. In case of rights, its individual’s wish whether to exercise such right or to waive such right but this is not with the case of duties that are imposed on him. He has to perform his duties or liability imposed on him and if he doesn’t, then he will be subject to the penal provision in respect of such non-performance. One of such duty is to pay tax.

But the question that comes into our mind is why to pay tax? To understand this, the theory of Hens Kelson, a jurist and a philosopher of law, would help us to give an answer to this question. According to him, a system of law is based on Grundnorm or ground rule, from which flows the validity of other statements of law in the system. The ground rule might be that some particular dictates or proposition, such as those of sovereign, are to be obeyed. In India, Grundnorm is the Indian Constitution (Law of Land). The Parliament and legislature of the State has the power to make law but this law making power is not unfettered. The Parliament and State legislature can only make law in conformity with the constitutional provisions, i.e. Article 245 and Article 246 and any law made against, shall be unconstitutional. Power of levying tax is conferred by Article 265 of the Indian Constitution. Article 265 states that only the authority of law has the power to levy and collect the tax and no other. Therefore, it becomes a duty of every citizen to pay tax.

Another way to have a clear understanding is that as we all know, to run a nation, there must be a sovereign authority, i.e., the government. The government must stand on the concept of ‘effectiveness’ and ‘stability’. The government can function effectively only if it has the funds for its operation. The only way to raise such fund is to impose the tax on its citizen. India, being the welfare State requires the funds to implement welfare policies. These funds are the income of the government. The income collected goes to the Consolidated Fund of India i.e. Article 266 of Indian Constitution. Payment of tax (Government’s Income) is not burdened to the citizen. As rightly said by Justice Homes of the US Supreme Court that “Taxes are the price for civilization”. It is time that tax is no longer considered a burden but a price for civilization. For this, the government has to make tax collection so simple that citizen shall not feel harassed or burdensome.

CANONS OF TAXATION

Canons of taxations are the guiding rules and principle to make tax collection system effective and functional. The government has to build the structure that can make tax collection simple and effective. Therefore, certain rules and principles have to be followed in order to do the same. But any principle so framed or proposed would not be exhaustive. This is so, because of the dynamic nature of the society. A progressive society is always subject to the changes and these changes have to be adopted by the government in order to make the tax collection mechanism effective and efficient. Adam Smith gave four canons in his famous book named ‘Wealth of Nation’. These four canons are also called as the Adam Smith’s canons of taxations. Followings are the four canons of taxation:

1. Canon of Equality

Equality means treating everyone equal but here, the term equality is used with regard to the ability to pay. As considering everyone equal would result in payment of the large amount by low-income group or payment of the same amount i.e. less, by the high-income group. 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. Adam Smith had rightly stated as 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. In simple word, we can say that taxing the individual according to his ability to pay results into the equal distribution of wealth in the economy. Because of this principle of Adam Smith, the government has made the different tax slabs so that the sacrifice made by the individual in a monetary term shall be equal.

2.Canon of Certainty

Another important canon given by Adam Smith is ‘Canon of Certainty’. According to him, ‘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. Moreover, lack of certainty in the tax system, as pointed out by Smith, encourages corruption in the tax administration. Therefore in a good tax system, “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.”

In other words, we can say, individual who is paying tax, it has to pay the same, in a complicated manner, shall restrain him in doing so because of the hardship and problems that he has to face while paying tax. Also, if an individual is unaware of the amount of tax to be deducted from his income in advance then he may get demotivated to do investment bearing high risk if he is a businessman. Therefore, the tax system must be certain and not arbitrary. Uncertainty along with arbitrariness would defeat the very purpose of the tax system.

3. Canon of Convenience

Another important canon of taxation is ‘Canon of Convenience’. As the word ‘convenience’ per se means to make easy, simple and comfortable. According to him, “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.

Income tax authority cannot tax the amount which is not earned. It may create an absurd situation, where tax is deducted on the amount, not in existence. Apart from this, another important aspect is, after earning income, how the tax collection must be done so as to make it convenient. The best example of this is Tax Deducted at Source (TDS). TDS means “deduction of tax from the source it has been generated”. It is the obligation of the employer to deduct the tax before crediting the salary of the employee in his/her account and the tax so deducted shall be paid to the government, when due. This relieves the employee from paying the tax. Due to the rapid growth of technology, the internet has gained more popularity and is easily accessible nowadays. This gave rise to e-payment of direct taxes.

For making e-payment of taxes one should have only two things, an internet connection and a net banking enabled account in an authorized bank. If the taxpayer does not have a net banking enabled account, then he can make e-payment using a net banking enabled account of any other person but the tax should be paid in his name. What a contributor has to do is just to follow the procedure by logging onto the website www.tin-nsdl.com. All these things have made tax collection mechanism convenient.

4. 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. To quote 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. As stated earlier, due to technological advancement payment of tax has become an easy task. From the point of the government, technology has reduced the expenses that would be incurred in case of absentia. Without technological advancement in a tax system, we cannot imagine how much hefty amount may government has incurred in the collection of tax.

OTHER CANONS OF TAXATION

These are the four canons that were given by Sir Adam Smith but these four are not square, confining the principle of taxation. There can be others canons also and some of them are as follows:

• 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 i.e. production in the economy. 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 i.e. yielding sufficient revenue.

• 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. This is best applicable in case of indirect taxes. For example, the imposition of the high tax in high-end goods or luxury goods and services. 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. Another advantage of the rule of diversity is that imposing several low rated taxes will bring others, having low income, within the purview of taxation system thereby leading to the contribution to the State treasury by a low-income group.

Commending diversity in the tax system Arthur Young writes, “If I were to define a good system of taxation, it should be that of bearing lightly on an infinite number of points, heavily on none”. Similarly, another expert of public finance writes, “Excessive reliance on any one base may produce adverse economic effects because the rates may become too high. Therefore, a tax system may do less economic damage if it raises moderate amounts from several bases rather than large amounts from one or two.”

CONCLUSION

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.