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Home / Business & Management / Finance & Accounting / Understanding Public Financial Management:
How Is Your Money Spent? / Principles of good taxation

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Principles of good taxation

What are the principles that should underpin taxation and how do these impact on our daily lives? Dr
Alberto Asquer examines the issues.

Monopoly board with Luxury Tax square

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Taxation: one of the clearest manifestations of the powers of a public authority.

It has existed since the earliest forms of recorded government in history: from ancient Egypt, when the
pharaohs levied taxes in the form of shares of agricultural production and labour; to ancient Rome
where farmers were required to pay a tenth of their production (decima) to the tax administration
(aerarium); and even in Medieval Europe, where a similar taxation system became one source of
financing for the Church.

Nowadays, governments have developed more sophisticated systems and processes for defining who is
taxed, what is taxed (the ‘tax base’), how much is taxed and which personal conditions of the taxpayers
should be taken into account. But what are the principles that should underpin taxation and how do
these impact on our daily lives?
Firstly, while it’s true that it’s typically implemented through the coercive power of a public authority,
taxation should not be imposed arbitrarily. Indeed, many modern institutions include some restraints on
the uncontrolled levying of taxes, with parliament usually having to approve the executive’s proposals
(for example, in 1628, the Petition of Rights introduced restrictions on the Crown on non-parliamentary
taxation in England). Rather, there should be careful consideration of how the forced acquisition of
money affects taxpayers: on the one hand, taxation provides a fundamental source of income for
running the government and providing public services; on the other, taxation reduces individual
disposable income and business profits and could therefore have a negative impact on decisions about
work, consumption and investments.

Who was Adam Smith?

The principles of good taxation were formulated many years ago. In The Wealth of Nations (1776), Adam
Smith argued that taxation should follow the four principles of fairness, certainty, convenience and
efficiency. Fairness, in that taxation should be compatible with taxpayers’ conditions, including their
ability to pay in line with personal and family needs. Certainty should mean that taxpayers are clearly
informed about why and how taxes are levied. Convenience relates to the ease of compliance for the
taxpayers: how simple is the process for collecting or paying taxes? Finally, efficiency touches on the
collection of taxes: basically put, the administration of tax collection should not negatively affect the
allocation and use of resources in the economy, and certainly shouldn’t cost more than the taxes
themselves.

Adam Smith’s principles of good taxation form a sound basis for taxation today, however they’re not
always followed. Sometimes tax systems hit certain categories of taxpayers or kinds of consumption
while leaving others relatively untouched. Sometimes tax systems lack transparency, imposing charges
on some goods (eg, fuel excise) without any explicit indication on our bills. Sometimes taxpayers are
burdened with administrative tasks, for example filing yearly tax returns online. Sometimes the tax
administration does not, or cannot, apply regulations or prosecute those who evade taxes in a cost-
effective manner.

Taxation and the economy

How can governments levy taxes while minimising negative effects on the economy? Generally taxes (on
income, on production, or on consumption of goods) have distortionary effects: they alter the decisions
that individuals and businesses would make if the taxes were not in place. For example, excises (taxes
that are levied on the production of goods) often cause producers to increase the prices of goods,
passing the burden of taxation on to consumers. When prices go up, there’s less demand, so businesses
earn less income and consumers enjoy less consumption. In addition, personal income tax reduces
consumer purchasing power: consumers purchase fewer goods than they would do without the income
tax, generally cutting luxury and unnecessary items first, and thereby hitting some industries more
strongly than others.

Want to keep
learning?

This content is taken from

SOAS University of London online course,

Understanding Public Financial Management: How Is Your Money Spent?

View Course

Taxation can also have important effects on economic development and growth. When international
financial markets are liberalised, for example, capital tends to flock towards countries where tax regimes
are more advantageous. When personal income tax is relatively high, individuals may prefer spending
their time on recreational activities rather than on additional work. When taxation on savings (including
taxation on financial rents and on real estate) is relatively high, individuals may prefer consuming their
income today rather than putting part of it aside for the future. Overall, the effects of decisions that
individuals and businesses make may result in less money being available for investments and less effort
to undertake business activities.

© SOAS

Want to keep learning?

This content is taken from SOAS University of London online course

Understanding Public Financial Management: How Is Your Money Spent?

View Course

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This article is from the online course:

Understanding Public Financial Management: How Is Your Money Spent?

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