Philosophy of Tax: Adam Smith
Nobody (who is rational) enjoys paying taxes. As unfair as it may seem, however, taxes do have a purpose and, in the American system, much of that purpose is modeled after the tax philosophies of Adam Smith. In his book The Wealth of Nations, Smith outlined four requirements that he believed were integral to a sound tax system. Those requirements were: equality, certainty, convenience and economy. Let’s jump out of the ivory towers and cover what that means in reality.
Equality –According to Smith, a tax should be based on a taxpayer’s ability to pay. That seems pretty reasonable. It wouldn’t make sense to have a corporate CEO and a college student who is working for minimum wage paying the same dollar amount in taxes – although the CEOs would likely not complain. Having taxpayers pay taxes in relation to their level of income results in a seemingly fair distribution of the costs required to support the government. The kid making minimum wage won’t help the gov all that much just by his lonesome, but you’d better believe they’ll still take it. And all those minimum wage-earners add up.
Here is an example:
Betty and Diane both earn $30,000 a year and each pays $3,000 a year in taxes. Because their tax burdens are the same, equality exists.
If Diane were a single mother supporting two children on her own, then clearly Betty and Diane would have a different ability to pay. In the interest of maintaining equity, the American tax system provides tax credits to individuals who support dependents. These credits would lower Diane’s tax burden to compensate for her decreased ability to pay. Thus tax equality remains and all is right in the world. The policy of this country has been to support single mothers having kids. How do you feel about the millions of dollars of taxpayer money Octomom is getting in “support?”
Certainty – Taxpayers should be able to determine the amount of tax they must pay as well as when and how they should pay it. Of course, the amount, the when, and the how can vary from tax to tax. You pay sales tax every time you buy that carne asada burrito with double guac and no sour cream (and really, that lineup seems to be your fare of choice more often than not), but income tax returns are not due until the 15th of April. The idea behind this principle is simply to create transparency in the tax code.
If you want to make a purchase – say, a new silver Ferrari F430 – you ought to be able to determine how much you would have to pay Uncle Sam if you decide to buy. Now granted the tax code is changing constantly in small ways, but for the average individual who has a job, pays rent, and maybe donates some money to charity (giving your money to the poor car dealership in exchange for that Ferrari does not count), the tax code is stable enough that it’s possible to get a reasonable idea of your tax burden without worrying about drastic changes from year to year.
Convenience - A tax should be levied at the time it is most likely to be convenient for the taxpayer, which is generally when they have received income or have money on hand. This is why payroll taxes are taken out of your paycheck, because when you receive income, you obviously have the money to pay. By removing it from your paycheck the government has done the (arm-and-a) leg work for you. Convenience also comes into play with sales tax; paying a sales tax every time you buy an item is much easier than adding up all your purchases at the end of the year and paying a tax on that.
Economy – Taxes should have minimum administrative and compliance costs. This is to ensure that the maximum amount of tax dollars collected goes into the US treasury instead of being used in an effort to collect more taxes. Currently, the IRS is doing just that; in fact, the IRS budget is 0.5% of all the taxes collected in a given year. (We know what you are thinking: stop collecting taxes altogether and it goes to 0, an even nicer number. We like the idea, but don’t think it is going to happen. We’ve written to suggest as much numerous times, but the powers that be don’t seem to be taking us seriously.)