CANONS OF TAXATION

The totality of all taxes being levied by a government is termed as its tax system. The authorities
view their tax system as a means towards achieving one or more objectives (such as, raising revenue)
and, in conformity with them, they identify certain criteria or principles as guidelines for building the
tax system. The features of the tax system also flow from the principles upon which it is designed as
also its detailed structure. Frequently, some objectives of a tax system turn out to be contradictory and
this problem is resolved by some sort of a compromise.

Every tax system generates not only revenue receipts for the government, but also innumerable
other spill over effects. To a typical academician, an ideal tax system is the one which is likely to
maximize the sum total of its most desirable effects. The next step is to identify those tax principles
on which such an ideal tax system should be based. The first set of such principles was enunciated by
Adam Smith which he called Canons of Taxation.

Adam Smith was interested in enabling an economy to increase its productive capacity and thereby
achieve a higher rate of growth. Further, he firmly believed that private sector was more efficient than
the public one and, therefore, the primary responsibility of economic growth should rest with the
private sector. Economic growth necessitates large scale saving and investment. It is also essential that
the investment should be along productive lines. All told, therefore, he was of the view that the private
sector should be entrusted with the maximum possible economic responsibility and for an efficient
discharge of this duty, it should be given as much freedom as possible. The only additional
consideration should be the adequacy of revenue for the State (for its own maintenance, for defence,
for law and order, and for social overheads) and an equitable distribution of the tax burden. With this
end in view, he laid down those principles of taxation which were to satisfy these conditions.

Adam Smith prescribed the following four canons of taxation.

1. Canon of Equality

"The subjects of every State ought to contribute towards the support of the government, as nearly
as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they
respectively enjoy under the protection of the State." This canon tries to observe the objective of
economic justice. It dictates that, in absolute terms, the richer should pay more taxes because without
the protection of the State they could not have earned and enjoyed that extra income. If we interpret
this principle in terms of disutility which the taxpayers suffer by paying taxes, it follows that the tax
should impose equal marginal disutility upon every taxpayer. Two possibilities emerge in this case. If
incomes are subject to constant marginal utility, then both the rich and the poor should be subjected to
proportional taxation each person paying a given percentage of his income as tax. On the other hand,
if we agree with the more realistic proposition that income is subject to diminishing marginal utility,
then the richer should pay a larger proportion of their incomes as taxes (that is, the taxes should be
progressive).

2. Canon of Certainty

This canon is meant to protect the taxpayers from unnecessary harassment by the 'tax officials".
"The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of
payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the
contributor, and to every other person." The taxpayers should not be subject to arbitrariness and
discretion of the tax officials, since that breeds a corrupt tax administration. With a scope for
arbitrariness, even an honest tax machinery will become unpopular. Smith is so emphatic about this
principle as to claim "that a very considerable degree of inequality... is not near so great an evil as a
very small degree of uncertainty."

3. Canon of Convenience

The mode and timings of tax payment should be, so far as possible, convenient to the taxpayer. This
canon recommends that unnecessary trouble to the taxpayer should be avoided, otherwise various ill-
effects may result.

4. Canon of Economy

This canon recommends that cost of collection of taxes should be the minimum possible. The
government should avoid those taxes which are too thinly spread and difficult to administer, since they
entail unnecessary burden upon the society and add to the administrative expenses. The productive
efforts of the people also suffer due to this wastage. Realizing that the tax collections are being wasted,
the taxpayers also tend to evade them.

ADDITIONAL PRINCIPLES

Smith's canons of taxation were derived from a sound reasoning in conformity with the needs the
economy and prevalent thinking of these times, and they continue to be relevant even today. However,
developments in economic thinking and pressing realities of modern economies necessitated
identification of a few additional principles of taxation briefly described below.
5. Canon of Productivity

It is also called the canon of fiscal adequacy. According to this principle, the tax system should be
able to yield enough revenue for the treasury and the government should have no need to resort to
deficit financing

6. Canon of Buoyancy

The tax revenue should have an inherent tendency to increase along with an increase in national
income, even if the rates and coverage of taxes are not revised.

7. Canon of Flexibility

It should be possible for the authorities, without undue delay, to revise the tax structure, both with
respect to its coverage and rates, to suit the changing needs of the economy and of the treasury.

8. Canon of Simplicity

The tax system should not be too complicated. That makes it difficult to understand and administer
and breeds problems of interpretation and legal disputes.

9. Canon of Diversity

It is risky for the State to depend upon too few a sources of public revenue. Such a system is bound
to breed a lot of uncertainty for the treasury. It is also likely to be inequitable as between different
sections of the society. On the other hand, if the tax revenue comes from diversified sources, then any
reduction in tax revenue on account of any one cause is likely to be very small. However, too much
multiplicity of taxes is also to be avoided. That leads to unnecessary cost of collection and violates the
canon of economy.