Richeria vs. Taxeria: A Tale of Two Tax Systems and What We Can Learn from Them

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According to Nelson Mandela, "A just tax system encourages participation in society's progress by balancing the needs of the state with the rights of the people."

What qualities should a good tax system possess to meet its intended economic objectives?

A good tax system depends on certain economic and fiscal policies and principles. These are referred to as canons of taxation by Adam Smith in his book, “The Wealth of Nations”. Other writers have further expanded the four basic principles (fairness, certainty, convenience, and efficiency) he propounded.

Before we highlight these principles let us look at ‘’the Tale of Richeria and Taxeria’’

Richeria and its Good Tax System

Once upon a time, there was a country called Richeria, known for its efficient and fair tax system. Everyone, from the wealthiest merchants to the humblest farmers, contributed their fair share of taxes based on what they earned. The government in Richeria ensured taxes were simple to calculate and easy to pay. While the farmers paid a small, fixed amount of their earnings, the merchants contributed a percentage of their profits as tax. Taxes were progressive, as higher income earners paid a higher rate while lower income earners paid a lower rate of their income as tax, ensuring fairness. In the village market, a merchant proudly paid her tax at a government booth. She smiled, knowing the roads, schools, and hospitals funded by her taxes would benefit her family and her business. Also, a farmer paid his smaller amount with equal confidence. Richeria’s leaders are characterized by integrity, and patriotism. They used revenues from taxes wisely, funding clean water systems, excellent education, and well-maintained roads and public infrastructure. The people of Richeria were happy. They trusted their government, knowing taxes were spent transparently and improved everyone's lives. Businesses flourished, foreign investors arrived, and the nation thrived.

Taxeria and its Bad Tax System

In Taxeria, things were quite different. Tax laws were complicated, confusing, and riddled with loopholes that allowed the rich to avoid paying their fair share and multiple taxes to be paid by those already in the tax net. Meanwhile, poor citizens struggled under a flat tax system that demanded the same percentage of income from everyone, regardless of earnings. In a bustling city, a poor fisherman argued with a tax collector. “But I barely earn enough to feed my family!” he cried, handing over a large portion of his small income. Meanwhile, a wealthy factory owner secretly paid nothing, using loopholes to hide his profits offshore. Taxeria’s government was corrupt and used tax money to fund lavish lifestyles for officials rather than public services. Roads were full of potholes, schools lacked teachers, and the hospital beds were empty because of missing supplies. Businesses fled the country, and citizens protested regularly.?

Moral of the Story

A good tax system, like Richeria’s, is fair, transparent, and progressive, ensuring that taxes are easy to pay and spent wisely to benefit society. On the other hand, a bad tax system, like Taxeria’s, is complex, unfair, and poorly managed, leading to inequality, corruption, and economic stagnation.

Principles of a Good Tax System

?Below are the basic principles that must be considered in designing a tax system of a nation:

1.???? Equity and Fairness

The tax system should be designed to ensure people with similar income levels pay similar taxes (Horizontal Equity) while those with higher income levels pay more taxes than those with lower income levels (Vertical Equity). In other words, the tax should be imposed on taxpayers based on their ability to pay. Considering the fact that the rich have a greater ability to pay more taxes than the poor, equity and fairness would be achieved when the rich pay more taxes than the poor. A progressive tax system (tax rate increases as taxable income increases) meets this principle, unlike the proportional (tax rate is fixed/ a proportion of income) or regressive tax system (tax rate decreases as taxable income increases).

2.???? Certainty:

A tax system should ensure taxpayers know their obligations. A tax to be paid by a taxpayer must be certain. Taxpayers should not be arbitrarily made to pay taxes. The taxpayer must know when he will pay taxes, how much he should pay as tax, and the mode of payment. Certainty is important so that taxpayers can make adequate preparations for the payment of their taxes. Also, the tax authority should be able to assess the amount of tax a taxpayer is required to pay with certainty while the government should be able to estimate revenue from taxes expected at a given time with certainty.

3.???? Simplicity:

A tax system should be easy to understand, and administer, and reduce confusion and compliance costs. A good tax system should be such that a taxpayer can determine his liability. Where the tax system is complicated, it would create loopholes that will give rise to tax evasion or avoidance.

4.???? Convenience:

A good tax system should be designed in such a manner that it would be convenient to collect and pay taxes. A good tax system needs to be designed to be as convenient as possible for the taxpayers. Examples of tax systems that meet this principle of collection are VAT: by including VAT in the price of goods and services allowing consumers to pay at the point of purchase and collection of income tax at source by the employer referred to as PAYE (Pay As You Earn)

5.???? Economy:

A tax system should ensure the amount of revenue that the government generates from collecting taxes should be higher than the cost of collecting such taxes. If the cost of collecting a tax is greater than the revenue generated from such tax, it would not be cost-effective to impose such a tax as one of the primary objectives of tax is to generate revenue for the government.

6.???? Efficiency:

A tax system should not distort economic behavior or create incentives that would lead to inefficient outcomes. Taxes charged should not disincentivize work, investment, or savings. Efficient taxes should ideally raise revenue without causing excessive changes in people's behavior that reduce overall economic well-being.

7.???? Flexibility:

A tax system should be able to adapt to economic changes and government needs without frequent overhauls, ensuring stability and responsiveness. A tax system should not be rigid as an economy is prone to changes. A good tax system should be flexible in nature. This means that a tax system should be able to be easily increased or reduced as the situation demands. It should be flexible and dynamic enough to ensure it keeps pace with technological and commercial developments and meets the current revenue needs of governments while adapting to changing needs on an ongoing basis.

8.???? Transparency:

A tax system should ensure taxpayers understand easily how their taxes are calculated, what they are used for, and how the system operates. This would build trust in the system, ensure accountability in government spending, and foster public confidence in government spending and tax policies. Transparency of a tax system would ultimately reduce tax evasion and increase voluntary compliance.

9.???? Neutrality: A tax system should not be designed towards victimizing a particular group of people or community or favouring one economic activity over another, but to ensure that decisions are based on economic merits rather than tax implications. There should be no distortion of economic choices that will lead to substitution effect or excess tax burden. A good tax system would ensure that tax revenue is generated while it minimizes discrimination in favour of, or against, any particular economic choice. Hence, the same principles of taxation should apply to all forms of business.

10.? Diversity

A tax system should be structured to be diverse. It should capture areas that have not been previously taxed and introduce them into the tax net. The emphasis is on the importance of broadening the tax base to encompass various sources of revenue. Varieties of tax types such as income tax, corporate tax, sales tax, property tax, and excise duties are introduced. Diversifying the tax base would reduce dependency on a single revenue source, ensuring stability even if specific sectors or sources fluctuate. This principle ought to be applied with utmost good faith such that it would not impede the economic development of major sectors of the economy.

Conclusion

A strong, equitable tax system is the foundation of a prosperous and harmonious society. Therefore, tax reforms carried out by countries of the world should be made with consideration to the principles we have discussed, as they provide a framework to build a tax system that is fair, efficient, effective, and beneficial to both the citizens and the government.

What is your view about these taxation principles and how have your country's recent tax reforms accommodated them?

Feel free to share your thoughts in the comment box below and repost this article.

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