Wednesday, May 21, 2008


A tax is an involuntary fee paid by individuals or businesses to a public administration, to support the operation of that government, or to otherwise achieve government goals (also called fiscal policy). Other purposes might include redistribution of income from the rich to the poor, or the support and maintenance of public works. Taxes are most often levied as a percentage, called the tax rate, of a certain value, the tax base (how much you have, earn, spend, inherit, etc.).

An important feature of tax systems is whether they are flat (the percentage does not depend on the base, hence the tax is proportional to how much you have), regressive (the more you have the lower the tax rate), or progressive (the more you have the higher the tax rate). In theory, progressive taxes get a smaller percentage of the income of poorer people, and require less record-keeping and complexity by people with simpler affairs. Progressive taxes reduce the tax burden of people with smaller incomes.

The most common tax is a direct tax. The best example of a direct tax is income tax, which is paid by individuals and corporations on their earnings. This is commonly a progressive tax because the tax rate increases with increasing income. Some critics characterize this tax as a form of punishment for economic productivity. Other critics charge that progressive income taxation is inherently socially intrusive because enforcement requires the government to collect large amounts of information about business and personal affairs, much of which could be considered proprietary.

The crucial invention permitting the high income tax rates was direct withholding of taxes from payrolls by employers. Employees have less visibility to the taxes they are paying because they never handle the money. Direct withholding also discourages cheating because there are fewer employers than employees and the government can focus enforcement.

The classic way of cheating on income tax is to lie about one's affairs. Either one fails to declare income, or declares nonexistent expenses. The government fights this by looking at individual ratios using computer programs. For example, if a person spends too much on cars, they might be examined.

The collection of tax in order to spend it on a specified purpose, for example collecting a tax on alcohol to pay directly for alcoholism rehabilitation centres, is called hypothecation. The practice is often disliked by finance ministers, since it reduces their freedom of action. Some economic theorists consider the concept to be intellectually dishonest since money is fungible.

Another idea is to arrange the taxation so that it causes minimal economic disruption, with the hope of maximizing the total efficiency of the economy, thereby making everyone wealthier. The classic economically neutral tax is a tax on land. A government's primary duty is to maintain and defend title to land, and therefore (so the theory goes) it should collect most of its revenues for this unique service. Since governments also resolve commercial disputes, especially in countries with common law, this doctrine is often used to justify a sales tax or VAT (value-added tax).