Taxation. The functions and purposes of taxation. Classification of taxes and methods/systems of taxation. Equity in taxes

Taxation.

I.Tax – a payment of money legally demanded and compulsorily collected from individuals or firms by central or local government authority to meet public expenses. So taxes are uncompensated, non-repayable people’s payments to the state in order to help it to finance its expenditure.

Taxation – the process of collecting taxes to raise revenue to finance government expenditure.

II. The functions and purposes of taxation.

1. The primary function of taxation – to raise revenue to finance government and be a source of a state budget. Through the taxation government collects money to the budget and then spends money for purchasing of goods and services for public; for making transfer payments through the budget and for paying interest on the national debt
2. To regulate and control business activities (e.g. to encourage capital investment). Government can encourage capital investments by permitting various methods of accelerated depreciation accounting that allow companies to deduct more or the cost of investments from their profits and consequently reduce their tax bills.
3. To encourage and discourage consumption and spending. For example, by indirect excise duties can be designed to dissuade people from smoking and drink alcohol.
4. To reallocate financial resources and redistribute wealth. For example, income taxes in most countries are progressive, and these taxes are one of the ways in which government can redistribute wealth. But there is the problem with progressive tax. It is the marginal rate, which is always high, that’s why there is no motives for people work harder and earn more money. On the other hand, most sales taxes are slightly regressive, because poorer people need to spend a larger proportion of their income on consumption than the rich. In this case a lot of money is collected, but the poor people suffer most because the most necessary things are taxed; and if un­necessary things like jewels and fur coats are taxed, less money is obtained, but the tax is fairer, as the rich pay it. The best arrangement in this situation is low tax for the poor people ant high for the rich.

III. Classification of taxes and methods/systems of taxation.

1.  According to the way of levying taxes:

-  direct (income tax, land tax, capital gains tax, capital transfer tax, transport tax, wealth tax)

-  indirect (different taxes on sales transactions, property and imports, e.g. value-added tax, excise duties, customs duties, sales tax)

2.  According to the level of authority:

            - federal taxes (VAT, income tax, customs duties)

            - regional taxes (entities estate tax, , sales tax, transport taxes)

            - local taxes (land tax, individual estate tax, advertising tax)

3.   According to the system of paying taxes:

            - progressive

            - regressive

            - proportional

A progressive tax system is one under which, as persons earn more, their average tax rate rises. Under a proportional tax system, everyone pays the same average tax rate. With a regressive tax system, as persons earn more, their average tax rate falls.

    IV. Equity in taxes

1.  The marginal tax rate (the tax rate on added income) affects incentives.

2.  In a progressive tax system, people with more income pay a higher percent of their income in taxes. The marginal tax rate exceeds the average tax rate, causing the average rate to rise as income goes up. In a regressive system, people with more income pay a smaller percent of their income in taxes. The mar­ginal tax rate is below the average rate, causing the average rate to fall.

Principles of equity:

1.  Horizontal Equity: Equals should pay equal taxes. For example, consider the double taxation of corporate income.

2.  Vertical Equity: Unequals should pay different taxes.