Canons of Taxations

Prof. Javed Anwar

 Canons of Taxation
• What are Canons of Taxation?
• They are the basic principles (i.e. rules) set to
build a 'Good Tax System'. Canons of Taxation
were first originally laid down by economist
Adam Smith in his famous book "The Wealth
of Nations".
• In this book Adam Smith only gave four
canons of taxation, which are now known as
the "Original or Main Canons of Taxation".
These are as follows:
 Canons of Taxation
• Canon of Equity:
– The principle aims at providing economic and social
justice to the people.
– According to this principle, every person should pay to
the government depending upon his ability to pay.
– Rich people should pay higher taxes to the government,
because without the protection of the government
authorities (Police, Defence, etc.) they would not have
earned and enjoyed their income. Adam Smith argued that
the taxes should be proportional to income, i.e., citizens
should pay taxes in proportion to the revenue which they
respectively enjoy under protection of the State.
 Canons of Taxation
• Canon of Certainty:
– According to Adam Smith, the tax which an
individual has to pay should be certain, not arbitrary.
– The tax payer should know in advance how much
tax he has to pay, at what time he has to pay the tax,
and in what form the tax is to be paid to the
government. In other words, every tax should satisfy
the canon of certainty.
– At the same time a good tax system also ensures that
the government is also certain about the amount that
would be collected by way of tax.
 Canons of Taxation
• Canon of Convenience:
– The mode and timing of tax payment should be as
far as possible, convenient to the tax payers. For
example, land revenue is collected at time of
harvest and income tax is deducted at source.
Convenient tax system encourages people to pay
tax and increases tax revenue.
 Canons of Taxation
• Canon of Economy:
– This principle states that there should be economy
in tax administration. The cost of tax collection
should be lower than the amount of tax collected.
– It may not serve any purpose, if the taxes imposed
are widespread but are difficult to administer.
Therefore, it would make no sense to impose
certain taxes, if they are difficult to administer.
 Additional Canons of Taxation
• Activities and functions of the government
have increased significantly since Adam
Smith's time. Governments are expected to
maintain economic stability, full employment,
reduce income inequality and promote growth
and development.
• Tax system should be such that it meets the
requirements of growing state activities.
Accordingly, modern economists gave
following additional canons of taxation.
 Additional Canons of Taxation
• Canon of Productivity:
– It is also known as the canon of fiscal adequacy.
According to this principle, the tax system should
be able to yield enough revenue for the treasury
and the government should have no need to resort
to deficit financing. This is a good principle to
follow in a developing economy.
 Additional Canons of Taxation
• Canon of Elasticity:
– According to this canon, every tax imposed by the
government should be elastic in nature. In other
words, the income from tax should be capable of
increasing or decreasing according to the country’s
requirement.
– For example, if the government needs more
income at a time of crisis, the tax should be
capable of yielding more income through increase
in its rate.
 Additional Canons of Taxation
• Canon of Flexibility:
– It should be easily possible for the authorities to
revise the tax structure both with respect to its
coverage and rates, to suit the changing
requirements of the economy.
– With changing time and conditions the tax system
needs to be changed without much difficulty. The
tax system must be flexible and not rigid.
 Additional Canons of Taxation
• Canon of Simplicity:
– The tax system should not be complicated. That
makes it difficult to understand and administer and
results in problems of interpretation and disputes.
– In Pakistan, efforts of the government in recent
years have been to make the system simple.
 Additional Canons of Taxation
• Canon of Diversity:
– This principle states that the government should
collect taxes from different sources rather than
concentrating on a single source of tax.
– It is not advisable for the government to depend
upon a single source of tax, it may result in
inequity for a certain section of the society and
uncertainty for the government to raise funds.
– If the tax revenue comes from diversified sources,
then any reduction in tax revenue from one source
for any reason is bound to be small.
Ethics for tax administrators
• Federal Board of Revenue is empowered under
the law to monitor, assess, levy, collect taxes as
provided in the tax statutes. There are a number
of occasions whereby they possess any of the
following powers.
– Assess taxes (including best judgment);
– Collect Revenue;
– Seize Property;
– Attach bank accounts;
– Commence legal (criminal/civil) proceedings against
taxpayer
Ethics for tax administrators
• Such powers may be misused and can become
abusive powers as exercise of that power can
result in the following against the taxpayer:
– Loss of property and income;
– Imprisonment
• So, these powers can result in the loss of some
of the fundamental human rights of the
taxpayer. Ethics tend to bring these powers
within the principles of goodness and morality.
 Pillars of tax administration
• In order to safeguard the interest of taxpayers and
avoid abuse of powers by the tax administration,
following four pillars of Tax administration are
defined:
– 1. Fairness; Strive to be impartial, fair, neutral and
consistent in administering the law without regard to race,
social or economic circumstances;
– 2. Transparency All Proceedings must be transparent and
must be seen as transparent.
 Pillars of tax administration
– 3. Equity; Best tax administration is not that which
collects most revenue. Rather it depends on how
this revenue generation is actually accomplished.
Whether all stakeholders are taxed fairly or tax is
collected from the poor /salaried class after failing
to collect taxes from entrepreneurs/businesses.
Thus, equity demands that tax administrators
should not achieve their objectives in an irrational
manner.
– 4. Accountability. There must be a strong system
of accountability for wrong doers which should
curb corruption, nepotism and maladministration.
 Pillars of tax administration
• Under the four pillars, some of the ethical issues
facing tax administration are:
1. Acceptance of gifts;
2. Conflict of Interest;
3. Selective application of the law/ or inconsistency in
applying the law;
4. Political influence;
5. Confidentiality/secrecy;
6. Discretion;
7. Corruption;
8. Lack of Autonomy
 Pillars of tax administration
• In order to avoid pitfalls of the abusive use of
discretion, seven principles for structuring discretion
are defined which are as under:
1. Open plans,
2. Open policy statements,
3. Open rules,
4. Open findings,
5. Open reasons,
6. Open precedents and
7. Fair informal procedure