LAWCOMM | 403 | Tax Law | lecture notes | SMITH’S VIEWS ON TAXATION  Sm

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SMITH’S VIEWS ON TAXATION



Smith’s theory of taxaon sets out the

“four canons / maxims of taxaon”

These are intended as the characteriscs desirable in a tax system – they are

criteria by which you might

assess either an exisng tax system or a proposal for reform



The four canons are:

Equality (now called tax equity)

Certainty

Convenience

Eﬃciency

EQUITY



By “equality” Smith meant something like

equity

or fairness – but what is “equity” or fair in taxaon?

To a large extent, it is a maer of opinion or philosophy or ideology

But it is not enrely subjecve, because to some extent equity in taxaon is suscepble to principled analysis,

and Smith’s discussion of his ﬁrst maxim is an early landmark in this kind of theorizing



It is usual nowadays, in discussing equity in taxaon, to disnguish between

horizontal equity

and

vercal equity

(although Smith himself did not invent these terms)

Horizontal equity

is equity between people whose incomes and circumstances are the same



The noon that people whose incomes and circumstances are the same should pay the same amount

of tax is uncontroversial



Even so, there is considerable scope for disagreement as to what horizontal equity entails



For instance, should a taxpayer who supports a spouse and young children pay the same

amount of tax as one whose income is the same, but who has no such responsibilies? Most

governments seem to think so, because most tax systems provide for allowances for these

classes of dependents



One person has a salary of $100,000 while another makes a capital gain of $100,000 – their

ability to pay tax (circumstances) are the same, so should theorecally pay the same tax. But

New Zealand has no capital gains tax and does not treat them the same, so you could say

there is a lack of horizontal equity in our tax system

Vercal equity

is equity between the rich and poor



Vercal equity

is more diﬃcult



In discussing vercal equity, it is customary to disnguish between

regressive

proporonal

and

progressive

taxaon (although Smith did not invent these terms)



proporonal

tax is one that is charged at a ﬂat rate. This means that a rich person will pay

more tax than a poor person, but both will pay the same proporon of their income in tax



progressive

tax is one where the rate of tax increases with income. Thus, the rich person

will not only pay more tax than the poor person, he will pay a larger proporon of his income

in tax



regressive

tax is one where the rate of tax

decreases

with income. Thus, the rich person

might or might not pay more tax than the poor one, but the poor person will pay a larger

proporon

of his income in tax than the rich person



In New Zealand, income tax is progressive, and GST is proporonal



Although GST is possibly regressive in its eﬀect because poor people spend a larger poron

of their income on commodies and thus pay a larger poron of their income on GST



GST may not be as regressive because poor people tend to spend their money on rent and

ﬁnancial services (e.g. loans), both of which do not charge GST



Most people seem to think that what equity requires is progressive taxaon. Also, almost all

democrac systems of government have produced progressive tax systems



But this sll leaves the basic queson – what does equity require? – largely unanswered,

because there is an inﬁnite range of possibilies as to exactly

how

progressive the tax system

should be (e.g. should we make people who earn over $70,000 pay 33% or 25% or 39%?)



There are also many people who think that what equity requires is proporonal taxaon – that is, a

ﬂat tax

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