Principles of Taxation

Horizontal equity

"Taxing like things alike". In other words, individuals who have the same wealth, or are in the same economic bracket, should face the same tax rate.

Origin system

Under this system, goods and services will cross borders carrying VAT (this means that the supplier will charge domestic rates of VAT on the supply, and the purchaser will be able to set off that VAT as he would any input tax). No distinction between domestic and overseas cutomers.

Transfer pricing in the context of fiscal devolution

Used to work out where a business' profits are made for tax purposes. This is done by treating and pricing every transaction as if it were at arms' length, even if the transactions were carried out within the same multinational company. Problematic as it loses the economies of scale inherent in such transfers, and doesn't capture valuable intangibles which pass across borders (e.g. IP, know-how, data) which are hard to value.

Regressive taxes

Individuals and entities with low incomes pay a higher proportion of that income compared to high-income earners (e.g. VAT, excise duties, especially tobacco taxes)

'Rules of thumb' of a tax system

Neutrality, simplicity and stability

Comprehensive income tax (TTE)

Pay tax on all income, accrued gains and accruals of value within a tax year, whilst spending is exempt from taxation.

Progressive taxes

Proportion of tax liability rises as an individual or entity's income increases. Tax burdens are meant to be more of an imposition to wealthy, high-income earners than they are to low or middle class individuals (e.g. income tax)

Three methods of imposing tax on consumption

1. Cascade tax 2. Single stage tax 3. Multi-stage tax

Single stage tax

A charge either at the retail or wholesale stage, e.g. excise duties in Europe. Should be imposed as close to point of consumption as possible, to avoid tax being built into cost of production

Land Value Tax (LVT)

A levy collected by the government (local or national) on the value of land and land alone. No account is taken of capital improvements, such as buildings, drainage or fixtures of any kind.

Missing trader fraud

A problem with the destination system of VAT. Items leave exporting country with VAT washed out, importer sells on with VAT, pockets the difference and goes missing.

Tax competition

A so-called 'race to the bottom', where governments undercut one another in order to attract mobile factors. Ultimately, this results in tax yields that are insufficient to fund public expenditure. Such a situation is often prevented by Treaty agreements between countries.

Broad tax base

A tax levied on a 'broad tax base' is one which taxes most of the potential tax base. For example, a broad-base sales tax is one that applies to almost all purchases of goods and services.

Mansion tax

A tax levied on high value residential property.

Accessions tax

A tax that is levied on the amount that an individual receives by gift or bequest over a lifetime (donee-based)

Legal incidence of tax

Allocation of statutory burden of taxation among taxpayers.

Proportional taxes

Also known as flat tax system. Assesses the same tax rate to taxpayers regardless of income or wealth. Individual taxpayers pay a set percentage of their income regardless of total income earned

Tax burden

An individual bears the burden of a tax to the extent that it makes him or her worse off (that is, causes a loss of welfare)

Annual tax on enveloped dwellings (ATED)

Annual charge on the ownership of dwellings through companies and other non-individual persons. Has brought in nearly £100 million since its introduction in 2013.

Laffer curve

Demonstrates that as tax rates initially increase, state's revenue begins to increase. However, if you keep putting up taxes, substitution effect takes hold

Basic principles for funding sub-national governments

Equity, autonomy, accountability, stability/predictability, simplicity/transparency, efficiency

Barnett formula

Formula used in the UK to automatically adjust the amount of public expenditure allocated to NI, Wales and Scotland. Adjusted depending on relative size of population and spending on a devolved function in England. Political agreement, so not subject to litigation.

Flat tax

Functionally a VAT. The tax base = income from sales - costs of production. Tax is paid on the result of this calculation. A degressive tax - flat rate of tax with an exemption (personal allowance) at the bottom.

Income effect

Impact of an increase in a tax on earnings on people's work decisions. The tax will reduce the income that people receive for a given number of hours of work, encouraging them to work more to limit any decline in living standards

Council tax

System of local taxation used to part fund services provided by local authorities. Responsibility for setting these rates rests with local authorities. Taxes levied according to 1991 property valuations.

Cascade tax

Tax is imposed at each stage of production, becoming inextricably bound into the cost of the product at each stage, without any deduction for tax paid at earlier stages.

Business rates

Tax on business property to help pay for local council services. Based on property valuation and generally don't reflect the turnover or profits of the business.

Expenditure tax (EET)

Taxes consumption (but not in the same way as VAT). Withdrawals from 'registered asset box' are treated as taxable income. This is the system used in the UK for taxation of pensions. Pension contributions are made out of untaxed income, pension funds which are invested in do not pay tax on the return. However, they are taxed as income upon being paid to the individual.

Wealth taxes

Taxes levied on the accumulated stock of purchasing power. Takes into account total value of personal assets, including owner-occupied housing, cash, bank deposits, money funds, savings in insurance and pension plans, investment in real estate, corporate stock etc.

Stamp Duty Land Tax (SDLT) and Land and Buildings Transaction Tax (LBTT)

Taxes on the transfer of interests in land. LBTT is the Scottish system of land transfer tax.

Vertical fiscal imbalance

Term used to describe the situation whereby a sub-national government's spending and revenue raising powers are not matched.

Diminishing marginal utility

The additional benefit a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has

The benefit principle

The idea that government spending on goods should be met by those who receive then. Follows basic market principles. A regressive approach to taxation.

The ability to pay principle

The idea that taxes should be levied according to a taxpayer's ability to pay. Increased tax burden placed on those entities with higher incomes. A progressive approach.

Subsidiarity

The idea that, where desirable, decision's should be taken as close to the citizen

Neutrality (in relation to indirect taxes)

The incidence of tax should not: 1. Distort the production of the commodity 2. Affect enterprises from locating in or supplying from or to one tax jurisdiction rather than another, or 3. Provide unintended neutralities in the cost of production or final price of the goods

Positive externalities

The positive effect that the use or production of something has on someone who is not party to the transaction, e.g. education - we all benefit from living in a society whereby all citizens are educated

Zero-rated

These are goods and services upon which no VAT is charged on the transaction, and the supply can reclaim the input VAT relative to the supply

Imputed income tax

This is the money which is purportedly saved because a homeowner owns and occupies a home rather than renting it out.

Full fiscal autonomy

This is where sub-national governments have responsibility for raising the entirety of their revenue.

Tax capitalisation

This is where tax will be impacted in the market value of good or services.

Destination principle

To say that tax is charged according to this principle can mean one or more of these things: 1. The tax goes to the country where the commodity is consumed 2. The tax is charged at the rate of the country where the commodity is consumed 3. The country of consumption collects the tax The current EU system achieves all three of these

Multi-stage tax

VAT. Whiel VAT is imposed on and collected from the producer at each stage of production, any VAT paid by the producer in the course of production can be set off against the VAT collected by him.

Vertical equity

Wealthier people, or those with access to more resources, should pay higher taxes.

Taxation of ISAs (TEE)

When you deposit money into an ISA, it is out of taxed income. However, both the return on and the withdrawal of the return on the ISA is tax-free.

Substitution effect

Whereby a tax rate increase makes an hour of work less attractive relative to an hour of leisure than it had been previously, encouraging people to work less

Principal private residence exemption (CGT)

Whilst disposals of property are subject to CGT in principles, the exemption for private residences excludes an estimated £18 billion per annum.

Economic difference between zero rating and exemption

Zero rating: tax on all stages of production is repaid, until final consumption. Exemption: exempt supply carries with it no charge to tax on that supply, but the tax up to that point gets factored into the cost of production. Less problematic when exempt supplier is supplying to end consumer.