There are two important system of taxation, i.e., proportional and progressive. Let us discuss both these systems of taxation in detail.
(1) Proportional Taxation:
Definition and Example:
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 example, 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.
“The merit of proportional taxation is that it is very simple”.
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 example, the marginal utility of $10 to a man earning $4000 per month is much greater than to a man earning $10000 per month. 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.
(2) Progressive Taxation:
Definition and Example:
Taxation is said to be progressive when the rate of tax increases as the tax base increase.
For example, the monthly income of a person is $9000 and he is asked to pay 2% of his income to the government. Suppose further that his 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.
Merits or Advantages:
(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 proportional taxation.
(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 employment.
Demerits or Disadvantages or Criticism:
The principle of progressive taxation which is the most popular and plausible theory of justice in taxation has not escaped criticism. The main disadvantages or criticism against progressive taxation are as under:
(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 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 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 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.