Taxation is a highly controversial issue. It is challenging to design a tax system that is considered fair by the general public. That’s why the economist Adam Smith presented four basic rules and principles of proper tax policy in his famous book The Wealth of Nations. His maxims are often referred to as the four canons of taxation. Namely (1) equity, (2) certainty, (3) convenience, and (4) economy. We will look at each of them in more detail below.
In this context, equity means that the taxation of people or organizations should be proportional to their income. That means the more money a person earns, the higher their income taxes should be, and vice versa. This idea is commonly known as the ability-to-pay principle (see also Types of Tax Systems). The principle behind this is that the people who can afford to pay more taxes (i.e., carry the burden) should pay more than those who cannot afford to pay as much.
To illustrate the canon of equity, imagine all US citizens had to pay USD 10,000 a year in federal taxes, regardless of their income. In that case, a millionaire who earns USD 1,000,000 and a cashier who only makes USD 20,000 a year would have to pay the same amount. In other words, the taxes would account for 1% of the millionaire’s income, whereas the cashier would have to spend 50% of his income to pay his tax bill. Most people wouldn’t consider that fair and, therefore, not a good tax system. Therefore, in reality, virtually all tax systems are designed so that higher taxes are levied on the rich, and they pay a larger share of their income than the poor.
Certainty refers to the idea that taxation should be clear and transparent. That means everybody should know or quickly find out how much they have to pay, when they have to pay, and how they have to pay their taxes. This is important because it allows taxpayers to consider their taxes when drawing up a budget. In addition to that, it has been shown that transparency increases public acceptance.
For example, imagine what would happen if the United States government didn’t have any official regulations on how taxes are determined and when they are due. Instead, people would simply get their tax bills at different times throughout the year, and the amounts would seem somewhat arbitrary because some people would have to pay property taxes along with their income taxes, whereas others would just have to pay direct taxes. Again, most people wouldn’t consider this an acceptable tax system and refuse to pay taxes at all. It is, therefore, essential for the government to lay down clear rules and tax structures to ensure a transparent system.
Convenience means that both the timing, as well as the method of payment are convenient for the taxpayers. That means the tax system should be designed in a way that allows people to quickly file and pay their taxes when they’re due. In that sense, the canon of convenience is sometimes also considered an extension of the canon of certainty (see above) that focuses more on the administrative process (e.g., reporting, payment).
To give an example, assume the government decided that people had to pay their federal taxes in cash. That means they would have to withdraw large sums of money from their bank, show up to the IRS offices in person, and hand over their money at a dedicated desk. This is extremely inconvenient for several reasons: (a) It’s much more complicated than simple wire transfers, (b) it’s a lot more time-consuming, and (c) withdrawing large sums of cash exposes people to an unnecessary risk of being robbed.
In this context, economy refers to the principle that the cost of collecting taxes should be minimized. That means the government has to ensure that the collection of taxes only requires the least possible expenditure. The reasoning behind this is that most of the money collected through taxes should be used to fund projects that, in turn, benefit the taxpayers.
To illustrate this, imagine that the collection of federal income taxes (i.e., tax administration) was costly and accounted for about 90 percent of all tax revenues. That means only 10 percent of the total revenue could be used for projects that actually benefit the taxpayers, while most of the money would go elsewhere. In that case, the population would most likely be dissatisfied with the tax and demand a more efficient tax system.
In his book The Wealth of Nations, Adam Smith presented four basic principles of proper tax policy. These rules are often referred to as the four canons of taxation: (1) equity, (2) certainty, (3) convenience, and (4) economy. Equity means that the taxes people or organizations have to pay should be proportional to their taxable income or revenue. Certainty refers to the idea that taxation should be clear and transparent. Convenience means that both the timing, as well as the method of payment, should be convenient for the taxpayers. Finally, economy refers to the idea that the cost of collecting taxes should be minimized.