Taxation
Taxation is the process by which a government imposes compulsory financial charges—taxes—on individuals and businesses in order to raise revenue for public purposes. Taxes are the principal source of government revenue in most countries and are used to finance public goods, transfer payments, and public services, as well as to influence economic behaviour.[1]
Definition and purposes
A tax is a mandatory payment to the government, distinct from a voluntary purchase of goods or services. Governments levy taxes for several purposes:
- Revenue raising — to finance public expenditure.
- Redistribution — to reduce inequality by shifting resources from richer to poorer members of society.
- Regulation — to discourage or encourage particular activities, such as smoking or pollution.
- Stabilisation — to influence aggregate demand as part of fiscal policy.
Classifications
Taxes may be classified in various ways:
| Classification | Types |
|---|---|
| By base | Income, consumption, wealth, property. |
| By incidence | Direct (borne by the taxpayer) or indirect (passed on to consumers). |
| By rate structure | Progressive, proportional, or regressive. |
Common forms include Value-Added Tax (VAT), Personal Income Tax, and Corporate Income Tax.[1]
Principles of taxation
The design of tax systems is commonly assessed against several principles:
- Efficiency — taxes should minimise distortions to economic behaviour.
- Equity — taxes should be fair, both horizontally (similar people taxed similarly) and vertically (different people taxed differently).
- Simplicity — taxes should be easy to understand and administer.
- Flexibility — taxes should be able to respond to changing circumstances.
A tax drives a wedge between the price paid by buyers and the price received by sellers, creating a reduction in the quantity traded known as deadweight loss. The incidence of a tax—who ultimately bears its burden—depends on the relative elasticities of supply and demand.[1]