Proportional Versus Progressive Taxation:

Proportional Versus Progressive Taxation:

Systems of Taxation:

While discussing the 'ability to pay theory', we gave a passing reference to two important systems of taxation, proportional and progressive. Let us discuss both these systems of taxation in detail.

(1) Proportional Principle of Tax:

Definition and Explanation of Proportional Principle of Tax:

The proportional system of taxation was advocated by classical economists. Under this system, the individuals are required to pay tax in proportion to their income, i.e., the rate of tax remains same as the base changes.

If for instance, the rate of tax is 5%, a man. with an income of $1,200 will pay $60 and another person with an income of $5,000 will pay $250 to the state.

The main advantages claimed for proportional system of taxation are that it is the must equitable method of raising revenue open to the state. When the individuals pay taxes to the government, their relative position remains the same after and before the tax. Moreover, this system is very simple. In the words of Say:

"The merit of proportional taxation is that it is very simply".

Meculoch was firm supporter of the principle of proportional taxation, He writes:

"When you abandon the plain principle (of proportional) you are at sea without radar and compass and there is no amount of injustice you may not commit".

The greatest drawback of the proportional system is that it does not entail equal sacrifice J.S. Mill and other supporters of this principle were not aware of this fact that when income increases, the marginal utility of money decreases.

For instance, the marginal' utility of $10 to a man earning $4000 p.m. is much greater than to a man earning $10000 p.m. So. if rich and poor are taxed at the same rate, it will be most unjust and unequitable. The best way to attain justice in taxation is that persons with higher incomes should be taxed at higher rates and those with lower incomes at lower rates. This equality of sacrifices can be attained if we adopt principle of progressive taxation. This we discuss now in detail.

(2) Progressive Principle of Tax:

Definition and Explanation of Progressive Principle of Tax:

Taxation is said to be progressive when the rate of tax increases as the tax base increase.

For instance, the monthly income of a person is $9000 and he is asked to pay 2% of his income to the government. Suppose further that hrs monthly income rises from $9000 to $15000.per month. The government instead of taking 2% of his income in a tax asks him to pay 6% in the form of tax.

Arguments in Favour of Progressive Taxation:

(i) The most powerful argument advanced for progressive taxation is that it leads to equality of sacrifice, whereas proportional taxation does not. As the income of a person increases, the marginal utility of income gradually decreases. So, if a man with higher income is taxed at a higher rate, it would not be unfair, but will be quite in conformity with the principle of justice.

(ii) Progressive taxation is also justified on the ground that it yields more revenue to the state than proportional taxation.

(iii) The merit of progressive taxation lies in the fact that it greatly helps in reducing the inequality in income by higher taxation oh the rich classes.

(iv) Progressive taxation is advocated on the ground that -it entails less expenses on collection. The tax is economical because when the rate of tax increases with the increase in income, the money spent on administration and collection does not increase or if it at all increase, it does not increase in the same ratio.

(v) Another merit claimed for the system of progressive taxation is that it conforms to the canon of elasticity. The state can easily increase its revenue by raising the tax rate.

(vi) J.M. Keynes is of the opinion that if we want to achieve full employment in the country, then progressive taxation is an imperative necessity. Progressive taxation helps the state in reducing inequalities of income by transferring wealth from the rich to the poor. When the inequality in the distribution of wealth is reduced, the propensity of the nation to consume increases. The rise in. aggregate demand for goods and services stimulates investment and provides greater opportunities for employment.

Arguments Against Progressive Taxation:

The principle of progressive taxation which is the most popular and plausible theory of justice in taxation has not escaped criticism. The main objections leveled against this principle are as under:

(i) In order to secure justice in taxation, it is very difficult to formulate a rational scheme of progression. The finance minister settles the degree of progression arbitrarily. As the rates of taxes are fixed on purely personal valuation, therefore, they may not lead to equal sacrifice. In the words of J.S. Mill:

"A graduated income tax is an entirely unjust mode of taxation and in fact of a graduated robbery".

(ii) Another objection leveled against this theory is that if the rate of progression is very high, it will discourage saving, impede the accumulation of capital and thus hamper the economic development of the country.

(iii) It is also pointed out that a very steep progression encourages evasion of I taxes. When people come to know that with the rise in their incomes, they will be taxed at steep rates, they may try to conceal their incomes by showing false statements. The state is, thus, deprived of much of its revenue.

(iv) If we carefully study the objections leveled against the principle of progressive taxation, we will soon come to the conclusion that they are not very convincing. Take the first objection. It is true the rates are fixed arbitrarily by the finance minister, but the members of the assembly are there to see that the rates of progression do not exceed the limits of justice. Moreover, the objection is not on the principle itself. It is only the degree of progression which has been brought under criticism. The second and third objection-like the first are again on the degree of progression.

We agree here with the criticism that if the people are taxed at very steep rates, it will discourage saving and encourage evasion of the tax. But if the degree of progression does not exceed the limits of reason and expediency, then progressive taxation is justified in every respect, because it conforms to the canon of equality, elasticity productivity and economy.

Theories of Taxation:

Theories of Taxation:

The economists have put forward many theories or principles of taxation at different times to guide the state as to how justice or equity in taxation can be achieved. The main theories or principles in brief, are:

(i) Benefit Theory:

According to this theory, the state should levy taxes on individuals according to the benefit conferred on them. The more benefits a person derives from the activities of the state, the more he should pay to the government. This principle has been subjected to severe criticism on the following grounds:

Firstly, If the state maintains a certain connection between the benefits conferred and the benefits derived. It will be against the basic principle of the tax. A tax, as we know, is compulsory contribution made to the public authorities to meet the expenses of the government and the provisions of general benefit. There is no direct quid pro quo in the case of a tax.

Secondly, most of the expenditure incurred by the slate is for the general benefit of its citizens, It is not possible to estimate the benefit enjoyed by a particular individual every year.
Thirdly, if we apply this principle in practice, then the poor will have to pay the heaviest taxes, because they benefit more from the services of the state. If we get more from the poor by way of taxes, it is against the principle of justice?

(ii) The Cost of Service Theory:

Some economists were of the opinion that if the state charges actual cost of the service rendered from the people, it will satisfy the idea of equity or justice in taxation. The cost of service principle can no doubt be applied to some extent in those cases where the services are rendered out of prices and are a bit easy to determine, e.g., postal, railway services, supply of electricity, etc., etc. But most of the expenditure incurred by the state cannot be fixed for each individual because it cannot be exactly determined. For instance, how can we measure the cost of service of the police, armed forces, judiciary, etc., to different individuals? Dalton has also rejected this theory on the ground that there s no quid pro qua in a tax.

(iii) Ability to Pay Theory:

The most popular and commonly accepted principle of equity or justice in taxation is that citizens of a country should pay taxes to the government in accordance with their ability to pay. It appears very reasonable and just that taxes should be levied on the basis of the taxable capacity of an individual. For instance, if the taxable capacity of a person A is greater than the person B, the former should be asked to pay more taxes than the latter.

It seems that if the taxes are levied on this principle as stated above, then justice can be achieved. But our difficulties do not end here. The fact is that when we put this theory in practice, our difficulties actually begin. The trouble arises with the definition of ability to pay. The economists are not unanimous as to what should be the exact measure of a person's ability or faculty to pay. The main view points advanced in this connection are as follows:

(a) Ownership of Property: Some economists are of the opinion that ownership of the property is a very good basis of measuring one's ability to pay. This idea is out rightly rejected on the ground that if a persons earns a large income but does not spend on buying any property, he will then escape taxation. On the other hand, another person earning income buys property, he will be subjected to taxation. Is this not absurd and unjustifiable that a person, earning large income is exempted from taxes and another person with small income is taxed?

(b) Tax on the Basis of Expenditure: It is also asserted by some economists that the ability or faculty to pay tax should be judged by the expenditure which a person incurs. The greater the expenditure, the higher should be the tax and vice versa. The viewpoint is unsound and unfair in every respect. A person having a large family to support has to spend more than a person having a small family. If we make expenditure. as the test of one's ability to pay, the former person who is already burdened with many dependents will have to' pay more taxes than the latter who has a small family. So this is unjustifiable.

(c) Income as the Basics: Most of the economists are of the opinion that income should be the basis of measuring a man's ability to pay. It appears very just and fair that if the income of a person is greater than that of another, the former should be asked to pay more towards the support of the government than the latter. That is why in the modern tax system of the countries of the world, income has been accepted as the best test for measuring the ability to pay of a person.

Proportionate Principle:

In order to satisfy the idea of justice in taxation, J. S. Mill and some other classical economists have suggested the principle of proportionate in taxation. These economists were of the opinion that if taxes are levied in proportion to the incomes of the individuals, it will extract equal sacrifice. The modern economists, however, differ with this view. They assert that when income increases, the marginal utility of income decreases. The equality of sacrifice can only be achieved if the persons with high incomes are taxed at higher rates and those with low income at lower rates. They favour progressive system of taxation, in all modern tax systems.