Tax Base

The tax base is the amount on which a tax is levied, such as income, consumption, or the value of property. The definition of the tax base determines the scope of the tax and the distribution of the burden.

Definition

The tax base is the measure to which the tax rate is applied. For an income tax, the base is the taxable income, which is the income after allowances and deductions. For a consumption tax, the base is the value of the goods and services consumed.

The definition of the base determines which activities and which entities are subject to the tax. The base may be defined broadly, to include most forms of income or consumption, or narrowly, to include only certain categories.

Broadening and Narrowing

The broadening of the tax base means extending the range of activities subject to the tax, while the narrowing means restricting it. The broadening is often accompanied by a reduction in the tax rate, as in the reforms that reduce rates and eliminate allowances.

The broadening of the base can improve the efficiency of the tax, by reducing the distortions that arise from the differences in the treatment of different activities. The broadening can also increase the revenue, which allows the rates to be reduced.

The narrowing of the base, through the introduction of allowances and exemptions, is often justified by the objectives of the policy, including the promotion of particular activities and the relief of particular groups. The allowances, however, create distortions and complicate the tax system.

International Aspects

The definition of the tax base is central to the international taxation of income. The allocation of the base among the jurisdictions, through the principles of source and residence, determines the division of the tax revenue.

The base erosion and profit shifting by multinational firms has prompted the reform of the international framework, to ensure that the profits are taxed where the activities that generate them take place. The reform involves the definition of the base and the allocation of the rights to tax.

Policy

The choice of the tax base involves trade-offs among the objectives of revenue, efficiency, and equity. The design of the base affects the distribution of the burden and the incentives of the taxpayers.

The analysis of the tax base informs the design of tax reform. The reform must consider the effects of the base on the behaviour of the taxpayers and on the distribution of the burden, and it must balance the objectives of the policy.

The Tax Base and the Efficiency

The design of the tax base affects the efficiency of the tax, since the base determines the activities that are taxed and the distortions that arise.

The broad base with the low rate is generally more efficient than the narrow base with the high rate, since the broad base reduces the distortions from the differences in the treatment. The broadening of the base also allows the reduction of the rates, which reduces the distortions for the given revenue.

The analysis of the efficiency informs the design of the tax reform. The reform that broadens the base and reduces the rates can improve the efficiency and the simplicity of the tax.

The Tax Base and the Equity

The design of the tax base also affects the equity of the tax, since the base determines the distribution of the burden.

The broadening of the base can improve the equity, if the allowances that are eliminated benefit the higher-income taxpayers. The narrowing of the base, through the allowances, can reduce the equity, since the allowances often benefit the specific groups.

The analysis of the equity informs the design of the tax. The design must balance the efficiency and the equity, and the choice depends on the objectives of the policy.

The International Tax Base

The international tax base concerns the allocation of the taxing rights among the jurisdictions, and it is central to the taxation of the multinational firms.

The principles of the source and the residence determine the allocation, and the transfer pricing rules determine the prices of the transactions among the affiliates. The erosion of the base and the profit shifting have prompted the reform of the framework.

The reform includes the measures to ensure that the profits are taxed where the activities that generate them take place. The design of the framework informs the understanding of the international taxation.

The Base and the Administration

The definition of the tax base affects the administration of the tax, since the base determines the information that the taxpayers must report and the authorities must verify.

The broad base with the few allowances is generally simpler to administer, since the taxpayers have less scope to reduce the base and the authorities have less to verify. The narrow base with the many allowances is more complex, since the taxpayers must document the entitlements and the authorities must verify them.

The administration also concerns the withholding of the tax at the source and the filing of the returns, which affect the compliance. The design of the base and of the administration must be coordinated to ensure the effective collection of the tax.

Summary

The tax base is the amount on which the tax is levied, and its definition determines the scope of the tax and the distribution of the burden. The analysis of the base, of the efficiency and the equity, of the international dimension, and of the administration informs the design of the tax.

See also

• Taxation
• Public Finance
• Fiscal Policy