JANUARY EXAM ESAAY QUESTION-Write an essay in which you [a] critically consider the relevance of Smith’s canons of good taxation for UK tax policymakers in the twenty first century; and [b] clearly identify what you believe are the key attributes of a good tax system (and why).
Four ‘canons’ of a good tax
Adam Smith in The Wealth of Nations published in 1776 outlined four principles of an ideal tax system. These principles are equity, certainty, convenience and economy. If the number of times they are quoted is any guide, they are still relevant to today’s tax environment. These principles are important to the creation of tax policy, because it is only when these principles are upheld that effective taxes are implemented in a manner which satisfies the stated purposes of a tax system.
Proportionate to ability- Equity
‘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.’

Adam Smith’s definition of equity is based on ‘ability to pay’ and ‘an issue that continues to trouble economists is how to measure ability to pay.’ Should the ability to pay bases on ‘income, wealth a composite of the two or some other measure’? Any measure of ability to pay may not necessarily produce equitable taxation, for example, two taxpayers each earning the same income may be in quite different economic positions. One may have no dependants while the other may have a wife and three children. However, if this income is over the relatively low threshold for family support the tax paid will be the same for both.

In designing a tax system, policy makers need to take administrative and compliance problems into account to achieve equity, because it is fairness, by encouraging voluntary compliance, which holds the system together and keeps it running at minimum cost.
Certain, not arbitrary- Certainty
‘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.’

According to Smith, Certainty generally comes from clear statutes as well as timely and understandable administrative guidance readily available to all taxpayers. Certainty in tax legislation is difficult to achieve due to the complexity of tax law. As a result, tax legislation is often incomprehensible and appears unclear and ambiguous. Frequent changes to tax legislation are due to changing. Government tax policy leads to further uncertainty.

Certainty is important to both the taxpayer and the enforcing authority due to its relevance to the overall tax system. It is certainty which helps to improve compliance with the rules and increase respect for the system. Certainty is closely related to simplicity, because if the rules are complex it is more likely the legislation will lack certainty.

Charged at a time when convenient to the taxpayer- Convenience
‘Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it; or, when he is most likely to have wherewithal to pay.’

Taxpayers have to determine their own tax liability, but there are also some taxes collected at source. Therefore the convenience of collection varies depending on the type of tax. Compliance costs also reduce the convenience of the income tax system. Such costs include collecting information, obtaining advice from tax experts and preparation of returns.
Cost of collection should be as low as possible-Economy
‘Every tax ought to be so contrived as both to take out or keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.’

The costs to collect the tax should therefore be kept to a minimum. Such costs include the ‘compliance costs incurred by the taxpayer’ and ‘administrative cost to the Government. Different taxpayers face different levels of compliance costs. Administrative costs are defined as ‘costs incurred by the public sector to collect tax. However various types of taxes have different compliance and administrative costs. Arguably each tax has its own political or economic justification for its existence’ and cannot be avoided.

The loss of efficiency that results when tax distorts economic behavior is also a significant cost, relating to both administrative and compliance costs. Economy of taxation also relates to the principle of simplicity‘The more complex a tax, the greater the administrative and compliance costs.

The characteristics of a good tax structure
As a good tax system, characteristics include:

Incentives and Economic Efficiency
Distributional Effects
International Aspects
Simplicity and Costs of Administration and Compliance
Flexibility and Stability
Transitional Problems
Incentives and Economic Efficiency
There are many channels through which a tax system may affect economic efficiency. It can have important effects on incentives and opportunities to work, to save, to invest in capital development, to take this risks and innovate, to use resources efficiently and to allocate them to uses which best serve the needs of society.

Distributional Effects
Any system of taxes is bound to have distributional effects even if it is only a matter of deciding who should bear the burden of the tax revenue needed to finance some particular level of budgetary expenditure. Moreover, in modern society the distributional aspects of a fiscal system are often more pervasive and more purposive than the simple determination of who should bear the burden of an otherwise given level of government expenditure.

International Aspects
Throughout the world the main structure of taxation is a concern of national governments. But the national economies which these governments influence by their tax policies are in large measure open economies with very extensive and important economic and financial relations with each other.
Simplicity and Costs of Administration and Compliance
In addition to being efficient and just and compatible with the country’s international position, a good tax system should also be coherent, simple straightforward. In a democratic society one o the most important aspects of a tax system is that the taxing authorities should be accountable to the electorate at large.
Flexibility and Stability
The systems for the taxation should be flexible, dynamic and stable to ensure that they keep pace with technological and commercial developments. According to Carter, a tax system must be flexible enough to cope with changing needs and aspirations of different jurisdictions. Flexibility is therefore accepted as a given. It should be, as it is integral to the efficiency of the system.