Taxes come in different forms and shapes. Regardless, they all have certain consequences. The discussion about what is the optimal size of the state, and which public expenditures are justified and beneficial never tires. Some argue for minimal state focused only on protecting the lives and property of its citizens from external and internal aggression, while others dream of a huge welfare state.
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There are also many voices in-between arguing in favor of introducing public benefits for education or basic safety, while at the same time criticizing overblown social transfers. No matter the size of the government, it needs to be funded somehow, and it can be done in different ways, but nearly always taxes will be the main source of financing and different taxes will have different effects, as discussed by Tomasz Kasprowicz.
Well-designed taxes should fulfill several criteria, true, but most of all they should never cause unnecessary distortions in economy. The question of how to construct a tax system is not new – Adam Smith considered that problem many years ago. In The Wealth of Nations he pointed out that taxes should follow four principles:
fairness – taxation should be compatible with taxpayers’ conditions, including their ability to pay in line with personal and family needs;
certainty – taxpayers should be clearly informed about why and how taxes are levied;
convenience – the process of paying and collecting taxes should be as easy as possible;
efficiency – the administration of tax collection should 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 state1.
These rules are still valid today, although they need to be further specified. We should remember that the starting point for the designing of a tax system is the desired amount of tax revenue and the level of redistribution built into the system.
Typically, much more emphasis is currently put on efficiency – from the growth perspective, taxes should be designed in such a manner that harms economic activity as little as possible. The majority of economists would agree that in order to fulfill those criteria, taxes should be neutral, simple, and stable.
A neutral tax system is one that treats similar activities in similar ways. Such a design minimizes distortions – people choose among similar alternatives according to their preferences and not tax differences. It also limits the number of disputes between administration and taxpayers about which rate should be applied.
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1 Smith, A. (1776) The Wealth of Nations, London: W. Strahan and T. Cadell. Available [online]: https://www.gutenberg.org/files/3300/3300-h/3300-h.htm