Attributes of A Good Tax System
Fundamentally, every government plans its monetary and fiscal policies to achieve higher economic growth, i.e. GDP, to keep inflation in check and to curtail unemployment rates. On the fiscal front, governments make efforts to maximize their revenues so as to avoid fiscal deficit which is considered harmful to the society due to its increasing impact on the prices of goods and services. In today’s world, almost all countries raise their revenues through taxes. Taxes whether direct or indirect affect one or more components of the growth equation — consumption, investment, expenditure, imports and exports. In advanced economies, efforts are being made to enforce a tax system that does not hurt the economic growth on the one hand, and increases tax revenues, on the other. This article provides attributes of a good tax system that accelerates economic growth and optimizes tax revenue.
A government has to make payments for goods and services. To meet its expenditure, it requires sufficient funds in continuous flow. Tax revenue and non-tax revenue are major sources of funds for the governments for balancing budgets. Besides, the governments can borrow money from foreign and domestic donors in case revenues fall short of expenditures in a fiscal year. A tax is, therefore, said to be good if it:
- generates adequate revenue to enable the government to meet its budgetary needs without resorting to deficit financing;
- keeps up revenue growth with the pace of economic growth in the long run, which is essential for the policymakers to devise revenue-related futuristic policies; and
- is a stable tax in terms of tax base, tax rate and tax administration. Stability is fundamental to effective planning and efficient compliance.
A tax must be so simple that its provisions are easily understandable. A simple tax is required, inter alia, to:
- reduce cost of tax collection on tax authorities;
- make its compliance easier for taxable persons;
- minimize cost of tax compliance to taxable persons;
- minimize risks to businesses; and
- allow taxable persons to claim their rights (statutory deductions, tax refunds, tax credits, etc.) without any ambiguity.
A tax becomes simple when its legislation has:
- minimum tax exemptions and tax concessions because besides revenue losses directly, these have the impact of squeezing the tax base, and shifting the burden onto a smaller number of existing taxable persons so as to compensate for the loss of revenue;
- no special schemes for designated sectors of economy as it is essential to prevent tax fraud and tax evasion. It is empirically quantified that concessionary regimes and special schemes reduce VAT compliance and increase tax evasion;
- not too many tax rates because multiple rates are associated with higher administrative and compliance costs and tend to reduce VAT efficiency; and
- clear tax provisions to enable taxable persons to claim their rights without undergoing prolonged litigation.
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