While discussing the 'ability
to pay theory', we gave a passing reference to two important systems
of taxation, proportional and progressive. Let us discuss both these
systems of taxation in detail.
Principle of Tax:
Explanation of Proportional Principle of Tax:
The proportional system of
taxation was advocated by classical economists. Under this system, the
individuals are required to pay tax in proportion to their income, i.e., the
rate of tax remains same as the base changes.
If for instance, the rate of tax is
5%, a man. with an income of $1,200 will pay $60 and another person with an
income of $5,000 will pay $250 to the state.
The main advantages claimed for
proportional system of taxation are that it is the must equitable method of
raising revenue open to the state. When the individuals pay taxes to the
government, their relative position remains the same after and before the tax.
Moreover, this system is very simple. In the words of Say:
"The merit of proportional taxation
is that it is very simply".
Meculoch was firm supporter of
the principle of proportional taxation, He writes:
"When you abandon the plain principle
(of proportional) you are at sea without radar and compass and there is no
amount of injustice you may not commit".
The greatest drawback of the
proportional system is that it does not entail equal sacrifice J.S. Mill
and other supporters of this principle were not aware of this fact that when
income increases, the marginal utility of money decreases.
For instance, the marginal'
utility of $10 to a man earning $4000 p.m. is much greater than to a man earning
$10000 p.m. So. if rich and poor are taxed at the same rate, it will be most
unjust and unequitable. The best way to attain justice in taxation is that
persons with higher incomes should be taxed at higher rates and those with lower
incomes at lower rates. This equality of sacrifices can be attained if we adopt
principle of progressive taxation. This we discuss now in detail.
Principle of Tax:
Explanation of Progressive Principle of Tax:
Taxation is said to be progressive
when the rate of tax increases as the tax base increase.
For instance, the monthly
income of a person is $9000 and he is asked to pay 2% of his income to the
government. Suppose further that hrs monthly income rises from $9000 to
$15000.per month. The government instead of taking 2% of his income in a tax
asks him to pay 6% in the form of tax.
Arguments in Favor
of Progressive Taxation:
(i) The most powerful argument
advanced for progressive taxation is that it leads to equality of sacrifice,
whereas proportional taxation does not. As the income of a person increases, the
marginal utility of income gradually decreases. So, if a man with higher income
is taxed at a higher rate, it would not be unfair, but will be quite in
conformity with the principle of justice.
(ii) Progressive taxation is also
justified on the ground that it yields more revenue to the state than
(iii) The merit of progressive
taxation lies in the fact that it greatly helps in reducing the inequality in
income by higher taxation oh the rich classes.
(iv) Progressive taxation is
advocated on the ground that -it entails less expenses on collection. The tax is
economical because when the rate of tax increases with the increase in income,
the money spent on administration and collection does not increase or if it at
all increase, it does not increase in the same ratio.
(v) Another merit claimed for the
system of progressive taxation is that it conforms to the canon of elasticity.
The state can easily increase its revenue by raising the tax rate.
(vi) J.M. Keynes is of the
opinion that if we want to achieve full employment in the country, then
progressive taxation is an imperative necessity. Progressive taxation helps the
state in reducing inequalities of income by transferring wealth from the rich to
the poor. When the inequality in the distribution of wealth is reduced, the
propensity of the nation to consume increases. The rise in. aggregate demand for
goods and services stimulates investment and provides greater opportunities for
The principle of progressive taxation
which is the most popular and plausible theory of justice in taxation has not
escaped criticism. The main objections leveled against this principle are as
(i) In order to secure justice in
taxation, it is very difficult to formulate a rational scheme of progression.
The finance minister settles the degree of progression arbitrarily. As the rates
of taxes are fixed on purely personal valuation, therefore, they may not lead to
equal sacrifice. In the words of J.S. Mill:
"A graduated income tax is an
entirely unjust mode of taxation and in fact of a graduated robbery".
(ii) Another objection leveled
against this theory is that if the rate of progression is very high, it will
discourage saving, impede the accumulation of capital and thus hamper the
economic development of the country.
(iii) It is also pointed out that a
very steep progression encourages evasion of I taxes. When people come to know
that with the rise in their incomes, they will be taxed at steep rates, they may
try to conceal their incomes by showing false statements. The state is, thus,
deprived of much of its revenue.
(iv) If we carefully study the
objections leveled against the principle of progressive taxation, we will soon
come to the conclusion that they are not very convincing. Take the first
objection. It is true the rates are fixed arbitrarily by the finance minister,
but the members of the assembly are there to see that the rates of progression
do not exceed the limits of justice. Moreover, the objection is not on the
principle itself. It is only the degree of progression which has been brought
under criticism. The second and third objection-like the first are again on the
degree of progression.
We agree here with the criticism that
if the people are taxed at very steep rates, it will discourage saving and
encourage evasion of the tax. But if the degree of progression does not exceed
the limits of reason and expediency, then progressive taxation is justified in
every respect, because it conforms to the canon of equality, elasticity
productivity and economy.