Babeș- Bolyai University

College of Political, Administrative and Communication Sciences

Master of Public Administration- Community Development and Urban Planning 1st year

Evaluating a tax and tax structure

-Bucila Anamaria-

Abstract

One function of government is to provide the goods and services that individuals need and
want but are unable to obtain from the private sector. In order to provide these services, the
government must impose taxes to pay for them. A state can tax virtually anything that it chooses
but the objective is to develop taxes and a tax system that serve the broad needs of society in an
efficient, fair and impartial way. Several attributes of taxes are widely accepted as criteria for
evaluating the impacts of taxes on society and the economy. These criteria are: economic
efficiency, economic competitiveness, administrative simplicity, adequacy, and equity.

Keywords: tax, criteria, tax system, wealth tax, business tax

 What is the definition of a tax system?

The terms describe a distribution effect, which can be applied to any tax system (income or
consumption) that meets the definition. A progressive tax is a tax imposed so that the effective tax
rate increases as the amount to which the rate is applied increases.

How Does One Evaluate a Tax System?

There are a number of factors used to evaluate a tax system. While opinions on what qualifies
as a good tax system differ there is general agreement that some of the most important factors are
adequacy, fairness and transparency1.
Adequacy: a tax system is considered adequate if it collects enough revenue to pay for the
services required by residents and policymakers. One threat to the adequacy of a tax system is a
structural deficit. In states with a Structural deficit, revenues do not grow at the same rate as the
costs of providing government services. If revenues do not keep up with these increased costs, the
state must either raise taxes or cut services.
Fairness: the main area of thought on tax fairness is the ability to pay principle. Based on
this principle, taxes can be categorized into three types:
- progressive: a tax system is progressive if persons with higher incomes pay a greater percentage
of their income in taxes than those with lower incomes. Most income taxes, including the federal
income tax, are designed to be progressive;
-proportional: a tax system is proportional if all persons, regardless of income level, pay the same
percentage of their income in taxes. Flat taxes are proportional.
-regressive: a tax system is regressive if persons with lower incomes pay a higher percentage of
their income in taxes than those with higher incomes. Sales taxes are generally regressive, because

1 https://goo.gl/106GeK accessed at 19.02.2017

families with lower incomes tend to spend a larger fraction of their income on taxed goods than
do higher-income families.2
Transparency: the transparency of a tax system indicates whether or not information about
the tax system is easy to obtain. Available information should include who and what is taxed, the
process for making tax decisions and how the funds collected are spent. Some states with high
transparency use tools like fiscal notes and tax incidence analysis. Fiscal notes provide an estimate
of the revenues gained or lost for a proposed change in law. Tax incidence analysis provides an
estimate of how different income groups are affected by a tax or proposed tax change.
From government, prospective, taxes are both a policy tool for economic management and
a prime source of revenue. Taxes can be effective in discouraging certain activities that have
negative consequences for the community as a whole.
A good business tax system will not distort business decision-making by, for example
penalizing certain kinds of economic investments. A poor tax system will encourage businesses to
consider tax issues ahead of other criteria for investment. Large number of state taxes increases
the likelihood that the system as a whole will distort business decisions, without necessarily
meeting government policy objectives.
Criteria for evaluating a tax system are as under:
 Simplicity: the tax law should be simple so that taxpayers understand the rules and can
comply with them correctly and in a cost-efficient manner.
 Certainty: the tax rules should clearly specify when that tax is to be paid and how the
amount to be paid is to be determined.
 Equity: people should pay their taxes according to their taxable capacity or faculty as
measured by some criteria, usually their revenue, that is, their income or their wealth or
both.
 Economic growth and efficiency: that tax system should not impede or reduce the
productive capacity of the economy.
 Neutrality: the tax should not be discriminatory in any for, thus ensuring that a taxpayer
will not alter his situation or be influenced in his actions by any tax effect.

2
Stallmann, J. I. (2004). Evaluating Tax Systems, Report 17-2004
  Transparency: taxpayers should know that a tax exists and how and when it is imposed on
them and others.
 Minimizing noncompliance: a tax should be structured to minimize noncompliance.
Government should be able to judge the extent of tax evasion and the certainty with which
the authorities can overcome it.
 Cost-effective collection: the costs to collect a tax should be kept to a minimum for both
the government and taxpayers.
 Impact on government revenue: the tax system should enable the government to predict the
amount of revenue to be collected from year to year.
 Payment convenience: a tax should be due at a time or in a manner that is most likely to be
convenient for the taxpayer3.

Evaluation framework

A superior tax system would score well on simplicity and certainty, efficiency, competitive
neutrality, equity, cost effectiveness, resilience/buoyancy and transparency. Criteria should be
ranked in following order:
1) Simplicity and Certainty: for a tax system to work efficiently, it is important that taxpayer
clearly understands his or her obligations and the amount of tax he or she has to pay and also when
and where to pay his tax liability. For the Revenue Department, it means clear understanding of
the extent of its powers, lowered administration costs, less litigation and general higher compliance
levels.
2) Efficiency: in an efficient tax system: taxpayers have limited scope to rearrange their affairs
or re-configure transactions to materially alter the tax consequences; same business decisions are
made pre-tax or post-tax; risk taking innovations are not discouraged; economic restructuring is
not hindered; the choice between private sector and public sector provision should not be distorted
by tax considerations.
3) Competitive neutrality: a competitive neutrality ensures that: people with same level of
income (or wealth or both) bear the same share of tax burden; there is no discrimination between

3 https://goo.gl/8kiXIn accessed at 19.02.17

business location, form, functions and transactions; and tax does not create imbalance across
competitors or industries.
4) Equity: people should pay their taxes according to their taxable capacity. However, the
ultimate impact of taxation on different groups is difficult to interpret without examining the
economic incidence of taxes and the distributional aspect of government spending. Exclusion of a
class of taxpayer from tax liability is inequitable. For instance, the principal place of residence
exemption from income tax and land tax in Australia causes a bias against property used for rental
and commercial purposes. Also, applying a standard levy regardless to capacity to pay may be
considered to be regressive.
5) Cost effectiveness: tax compliance and enforcement should be modest in relation to
revenue raised so that revenue raised is not eaten up in administration costs. Compliance and
administration costs can be kept low by: simplifying tax legislation and calculations; harmonizing
interstate tax base and rates; good record keeping; education and informing taxpayers; and
providing ancillary and support services.
6) Buoyancy: government require revenue that is certain over time to enable their expenditure
needs to be met. In a buoyant tax system: the revenue yield from tax regime is sustainable and not
subject to wide fluctuations; tax revenues are broadly based and strongly linked to growth in the
economy; and the tax regime accommodates the effects of market redefinition, substitute
transactions and/or products, and new ways of doing business. Secure revenue growth facilitates
fiscal management, because government can better meet the costs of providing services.
7) Transparency: the principles and purpose behind the design of a tax should be clearly
identified. It should be clear what is being taxed (tax base), who is liable (taxpayer) and how their
liability is calculated.
I recommend alternative tax system replacing Tiny's current tax system using Zero-based
approach. This system is auditable, progressive and extremely simple. Further, it seems to provide
the correct incentives for education, savings and investment and virtually eliminates the cheating
incentive.

Wealth Tax
 Purpose of levying Wealth Tax: Tiny might not be able to raise much revenue from the
Wealth Tax but it helps achieve equity and efficiency. The objectives of wealth taxation can be
concisely summarized by the words, equity, efficiency and revenue." In terms of equity, wealth
taxes are justified on the basis that to effectively treat persons with equal capabilities to pay
equally, wealth must be taken into account. From efficiency point of view, wealth tax discourages
the investors in holding assets yielding low or zero returns and therefore incentives to seek out
high yielding ones. Wealth Tax is based on a person's net worth from balance sheet reporting.
This provides a progressive tax effect; the flat Wealth Tax rate would perhaps be in 4% range.
Annual Wealth Tax should be paid by lodging an Annual Wealth Tax return; Alternatively,
inflation indexing can be carried out to adjust asset values for net appreciation; Under this proposed
tax system, tax compliance can be verified by providing a net worth audit trial. Identifiable assets
can be valued for easy and cost-effective auditing; Administrative costs will be low because
compliance and monitoring is easier due to just one tax. A centralized system of monitoring can
be adopted4.
Alternatively, OECD has suggested that the value of particular classes of asset may be
fixed by periodical official valuations which then remain in force for several years; This will
reduce the incentive to cheat.

Assessing tax systems

How do we identify a good tax system when we see one?

One way is to see how it stacks up against a ‘checklist’ of desirable properties. The most
famous is the four canons of taxation set out by Adam Smith in the Wealth of Nations:
-The subjects of every state ought to contribute towards the support of the government, as nearly
as possible, in proportion to their respective abilities ...
- The tax which the individual is bound to pay ought to be certain and not arbitrary ...
- Every tax ought to be levied at the time, or in the manner, in which it is most likely to be
convenient for the contributor to pay it.

4 Idem
- Every tax ought to be so contrived as to take out of the pockets as little as possible, over and
above that which it brings into the public treasury of the state.
These recommendations may command near-universal support but they are not
comprehensive, and they do not help with the really difficult questions which arise when one
objective is traded off against another. The way we formulate the objectives of a tax system is to
say that for a given distributional outcome, what matters are:
•the negative effects of the tax system on welfare and economic efficiency: they should be
minimized;
• administration and compliance costs: all things equal, a system that costs less to operate is
preferable;
•fairness other than in the distributional sense: for example, fairness of procedure, avoidance of
discrimination, and fairness with respect to legitimate expectations;
•transparency: a tax system that people can understand is preferable to one that taxes by ‘stealth’.

Conclusions

As we will see below, simple, neutral, and stable tax systems are more likely to achieve
these outcomes than are complex, non-neutral, and frequently hanging systems. But simplicity,
neutrality, and stability are desirable because they promote these ultimate outcomes, not in their
own right.
A good tax system will not just limit negative effects on efficiency. It will also promote
economic welfare by dealing with externalities which arise when one person or organization does
not take account of the effects of their actions on others. Taxes can affect this behavior by altering
the incentives for certain sorts of behavior, most notably when polluting activity is taxed to reduce
the total amount of pollution.
We have formulated the question of the assessment of a tax system by suggesting what to
take into account given a desired distributional outcome. So, understanding how to think about the
impact of the tax and benefit system on the distribution of income is clearly central. We look at
that first. We then focus on the effects of the system on economic efficiency. This is the most
important constraint on tax system design. We then turn to issues of fairness and transparency, and
the other positive effects a tax system can have on correcting market failures such as externalities.
 Bibliographie

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review”, NBER Working Paper 14263, National Bureau of Economic Research
Kaldor, N. (1955) “An expenditure tax”, London: Allen and Unwin
Kraan, D.‐J. (2004) “Off ‐Budget and tax expenditures”, OECD Journal on Budgeting, OECD,
Paris,4(1)
Mirrlees, J.A. et al., (2010) “Tax by Design”, Oxford: Oxford University Press
Stallmann, J. I. (2004). Evaluating Tax Systems, Report 17-2004