Principles of Taxation
Part 1: The fundamental principles of taxation
1. What is a tax?
2. What are the fundamental questions of taxation?
3. What are the essential elements of taxation?
1. What is a tax?
Mandatory payment in cash or in kind to a public authority
- Tax No contractual obligation
- Payments on a contractual basis are not taxes
- Gifts, donations, or voluntary payments to public authority are not taxes
- Financial sanctions are not taxes ( Fines)
- Taxes are determined by law ( Legal basis is required)
A tax is a payment without consideration or compensation
- No quid pro quo You get nothing in return ( No individual compensation to taxpayer)
- Unilateral contribution to the budget of a public authority
- This governmental budget is used to finance any public purpose
- Taxpayer has no control over the use of this budget ( Public authority has control)
- Control over spending of public authority is exercised by parliament
- This parliament is elected by citizens/taxpayers ( Indirect control)
What is a tax? ( Summarized)
- Mandatory contribution ( In cash or in kind)
- In accordance with rule of law ( Legal basis is required)
- Imposed by public authority ( Paid by taxpayers/citizens)
- Without any personal compensation ( Individual taxpayers get nothing in return)
- Used by public authority for public spending
Mandatory contribution
- Taxpayers/citizens have no choice and must comply
- Can be imposed by force by the public authority (Fines, seizing of private property, …)
- Only way to legitimately avoid payment of tax Tax avoidance
- Tax avoidance Placing yourself outside the legal scope of application of a certain tax
- Tax laws are not internationally harmonized ( E.g., No individual taxation in UAE)
- More international organizations can engage in more complex tax planning
In accordance with rule of law
- “No taxation without representation” Legislation is required for application of taxes
- Taxation needs a legitimate legal basis Principle of legality
- Legal scope of application is determined individually ( Constitutional organization)
- Any governmental body of any country can levy taxes
- All essential elements of must be laid down in the tax codes
- Tax statutes (or tax codes) What is taxed + who pays + tax rate (+ set of rules)
- National parliaments vote, amend, etc. tax statutes or (tax codes)
- E.g., Magna Charta (1215), UK Bill of Rights (1689), …
, Imposed by the public authority on its subjects
- Taxable subjects are individuals and legal persons
- Only taxpayers/civilians vote ( Legal persons don’t vote)
- Governments exercise authority in 2 ways Over persons + over territory
For purpose of public spending (in the public interest)
- In principle taxes can’t be reserved for only certain expenses
- Government is free to determine for which public purposes tax money is used
- The spending of governments is subject to parliamentary control ( Not directly)
- Dissuasive taxes Taxes are created + motivated by specific goals ( Climate, health, …)
- E.g., environmental taxes are mostly introduced to reduce emission gasses ( CO2)
- Direct link between tax rate and governmental spending is very rare in practice
Mandatory payment with no personal compensation
- Tax Unilateral payment for all subjects of a governmental authority
- No quid pro quo Government doesn’t owe taxpayer anything in return for payment
- Government has authority on all citizens and persons on its territory
What about social security contributions?
- Not taxes ( Legal perspective)
- Social security contributions are also mandatory payments imposed by law
- Paying SSC entitles contributor to specific social benefits ( Unlike taxes)
- Social protection against unemployment, illness, accidents, retirement, childcare, …
- Subjects Cut from the wages of the working population
- No direct proportional link between size of contributions and individual benefits
- Based on principle of solidarity and insurance ( You pay now & receive benefits later)
What about toll charges and fees?
- User fees and toll charges Payments for specific goods/services provided by government
- E.g., toll for driving on certain roads, tunnels, bridges, …
- Not taxes Clear and specific compensation for payment ( Quid pro quo)
- Price is unilaterally fixed by the public authority ( Public has no say)
- You can avoid them by not making use of the specific goods or services
2. Fundamental questions of taxation
Why do we tax and how do we tax?
- Why? The benefit principle
- Why? Principle of sovereignty
- How? Ability to pay + equality principle
- How? Principle of legality
- How? Efficiency
The benefit principle (Why?)
- Justifies taxation based on taxpayer’s usage of government goods/services
- Governmental goods/services provide a benefit to taxpayers Taxes are required
- Those who use and derive more benefits therefore must pay more taxes
, This goes against element of tax as mandatory payment without personal compensation
- Argument against the benefit principle
- Citizen is entitled to governmental services because he is citizen of that government
- Not because he pays taxes Presumed benefit of being a citizen
- Tax Unilateral payment without personal compensation
- E.g., general administration, police protection, national education, healthcare, …
The principle of sovereignty (Why?)
- Sovereignty Right of a state to regulate its (tax) affairs in the most suitable way
- Through use of governmental institutions Parliament, executive power, and judiciary
- Allows states to impose + enforce rules on/against persons connected to state territory
- Limited to state territory and people connected to state territory ( Nationals + residents)
- Relationship of subordination between government and taxpayers ( Justifies taxation)
- Only valid if legality principle is respected ( No taxation without representation)
Ability to pay principle + equality principle (How?)
- Ability to pay principle Tax rate must be in order with economic capacity of taxpayer
- Taxes must be equally distributed in function of income, wealth, and consumption
- Goes together with equality principle (= non-discrimination principle)
- Horizontal equity Persons in comparable economic situations pay the same tax
- Vertical equity Persons in different economic situations should not pay the same tax
- Implementing vertical equity Law of diminishing marginal utility
- Loss of utility of increasing income Progressive tax ( Higher income, higher tax)
- In practice Only personal income taxes are progressive
- Income taxes on companies are rarely progressive on the other hand ( One flat rate)
- Consumption taxes, in particular VAT, are also not the same for all goods
- Essential goods (food, non-alcoholic drinks, medicine, …) Low VAT
- Non-essential or luxury goods Higher VAT
The principle of legality (How?)
- Taxation is only possible in case of valid legal basis
- All essential elements of a tax must be determined by statutes
- Statutes (of a tax) are approved/declined by the parliament ( Majority voting)
- Impossible to provide all necessary details in the statutes of a tax ( Too complex)
- Supplementary to tax statutes Executive decrees, regulations, and rulings
- In case of disagreements Judicial power makes final decisions
Part 1: The fundamental principles of taxation
1. What is a tax?
2. What are the fundamental questions of taxation?
3. What are the essential elements of taxation?
1. What is a tax?
Mandatory payment in cash or in kind to a public authority
- Tax No contractual obligation
- Payments on a contractual basis are not taxes
- Gifts, donations, or voluntary payments to public authority are not taxes
- Financial sanctions are not taxes ( Fines)
- Taxes are determined by law ( Legal basis is required)
A tax is a payment without consideration or compensation
- No quid pro quo You get nothing in return ( No individual compensation to taxpayer)
- Unilateral contribution to the budget of a public authority
- This governmental budget is used to finance any public purpose
- Taxpayer has no control over the use of this budget ( Public authority has control)
- Control over spending of public authority is exercised by parliament
- This parliament is elected by citizens/taxpayers ( Indirect control)
What is a tax? ( Summarized)
- Mandatory contribution ( In cash or in kind)
- In accordance with rule of law ( Legal basis is required)
- Imposed by public authority ( Paid by taxpayers/citizens)
- Without any personal compensation ( Individual taxpayers get nothing in return)
- Used by public authority for public spending
Mandatory contribution
- Taxpayers/citizens have no choice and must comply
- Can be imposed by force by the public authority (Fines, seizing of private property, …)
- Only way to legitimately avoid payment of tax Tax avoidance
- Tax avoidance Placing yourself outside the legal scope of application of a certain tax
- Tax laws are not internationally harmonized ( E.g., No individual taxation in UAE)
- More international organizations can engage in more complex tax planning
In accordance with rule of law
- “No taxation without representation” Legislation is required for application of taxes
- Taxation needs a legitimate legal basis Principle of legality
- Legal scope of application is determined individually ( Constitutional organization)
- Any governmental body of any country can levy taxes
- All essential elements of must be laid down in the tax codes
- Tax statutes (or tax codes) What is taxed + who pays + tax rate (+ set of rules)
- National parliaments vote, amend, etc. tax statutes or (tax codes)
- E.g., Magna Charta (1215), UK Bill of Rights (1689), …
, Imposed by the public authority on its subjects
- Taxable subjects are individuals and legal persons
- Only taxpayers/civilians vote ( Legal persons don’t vote)
- Governments exercise authority in 2 ways Over persons + over territory
For purpose of public spending (in the public interest)
- In principle taxes can’t be reserved for only certain expenses
- Government is free to determine for which public purposes tax money is used
- The spending of governments is subject to parliamentary control ( Not directly)
- Dissuasive taxes Taxes are created + motivated by specific goals ( Climate, health, …)
- E.g., environmental taxes are mostly introduced to reduce emission gasses ( CO2)
- Direct link between tax rate and governmental spending is very rare in practice
Mandatory payment with no personal compensation
- Tax Unilateral payment for all subjects of a governmental authority
- No quid pro quo Government doesn’t owe taxpayer anything in return for payment
- Government has authority on all citizens and persons on its territory
What about social security contributions?
- Not taxes ( Legal perspective)
- Social security contributions are also mandatory payments imposed by law
- Paying SSC entitles contributor to specific social benefits ( Unlike taxes)
- Social protection against unemployment, illness, accidents, retirement, childcare, …
- Subjects Cut from the wages of the working population
- No direct proportional link between size of contributions and individual benefits
- Based on principle of solidarity and insurance ( You pay now & receive benefits later)
What about toll charges and fees?
- User fees and toll charges Payments for specific goods/services provided by government
- E.g., toll for driving on certain roads, tunnels, bridges, …
- Not taxes Clear and specific compensation for payment ( Quid pro quo)
- Price is unilaterally fixed by the public authority ( Public has no say)
- You can avoid them by not making use of the specific goods or services
2. Fundamental questions of taxation
Why do we tax and how do we tax?
- Why? The benefit principle
- Why? Principle of sovereignty
- How? Ability to pay + equality principle
- How? Principle of legality
- How? Efficiency
The benefit principle (Why?)
- Justifies taxation based on taxpayer’s usage of government goods/services
- Governmental goods/services provide a benefit to taxpayers Taxes are required
- Those who use and derive more benefits therefore must pay more taxes
, This goes against element of tax as mandatory payment without personal compensation
- Argument against the benefit principle
- Citizen is entitled to governmental services because he is citizen of that government
- Not because he pays taxes Presumed benefit of being a citizen
- Tax Unilateral payment without personal compensation
- E.g., general administration, police protection, national education, healthcare, …
The principle of sovereignty (Why?)
- Sovereignty Right of a state to regulate its (tax) affairs in the most suitable way
- Through use of governmental institutions Parliament, executive power, and judiciary
- Allows states to impose + enforce rules on/against persons connected to state territory
- Limited to state territory and people connected to state territory ( Nationals + residents)
- Relationship of subordination between government and taxpayers ( Justifies taxation)
- Only valid if legality principle is respected ( No taxation without representation)
Ability to pay principle + equality principle (How?)
- Ability to pay principle Tax rate must be in order with economic capacity of taxpayer
- Taxes must be equally distributed in function of income, wealth, and consumption
- Goes together with equality principle (= non-discrimination principle)
- Horizontal equity Persons in comparable economic situations pay the same tax
- Vertical equity Persons in different economic situations should not pay the same tax
- Implementing vertical equity Law of diminishing marginal utility
- Loss of utility of increasing income Progressive tax ( Higher income, higher tax)
- In practice Only personal income taxes are progressive
- Income taxes on companies are rarely progressive on the other hand ( One flat rate)
- Consumption taxes, in particular VAT, are also not the same for all goods
- Essential goods (food, non-alcoholic drinks, medicine, …) Low VAT
- Non-essential or luxury goods Higher VAT
The principle of legality (How?)
- Taxation is only possible in case of valid legal basis
- All essential elements of a tax must be determined by statutes
- Statutes (of a tax) are approved/declined by the parliament ( Majority voting)
- Impossible to provide all necessary details in the statutes of a tax ( Too complex)
- Supplementary to tax statutes Executive decrees, regulations, and rulings
- In case of disagreements Judicial power makes final decisions
