The Concept of Income
A Multi-Disciplinary Analysis. Doctoral S. 1
This is a resource book primarily for policy makers and academic tax, accounting and economics researchers, who require an in-depth analysis of the concept of income and its development for tax purposes. This book examines income as a surrogate for the underlying features of an individual's well-being, for the purpose of achieving horizontal equity in taxation. To enhance tax equity, the author advocates the adoption of a comprehensive concept of income for practical taxation purposes.
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"A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used." Justice Oliver Wendell Holmes Towne v. Eisner (1918) 245 US 418,425 This thesis is written for a doctorate of philosophy. As such, it entails a philosophical examination of the manner in which the present use of the word income achieves the generally accepted policy objective of horizontal equity in taxation of individuals. The treatise reviews the optimal tax theorists' view that taxation should target individuals' features or attributes that yield wellbeing. Optimal tax analysis is accepted as a conceptually valid theory. However, as commendable and appropriate as optimal tax analysis is in theory, it is not a goalthat is currently attainable in practice. The existing state of knowledge is such that abstract attributes that make up an individual's overall stale of contentment are unable to be measured in a manner that is sufficiently practical and objective on which to levy tax. In practice, income is employed as the surrogate indicator for taxing individuals'characteristics, which depict welfare. The level of one person's income therefore determines the quantum of taxation that is extracted from that individual to contribute towards financing a government's social or collective objectives. Since societies generally place much importance on the notion of income, income must be evaluated in a socially and politically acceptable manner. It is essential that a well defined and consistent concept of income prevails as the basis of transferring resources by way of direct taxation from the private sector of society to government. Equity is a predominant factor in taxing income. Therefore, society needs to adopt some generally agreed fair notion of income to serve as the basis of the calculation of income tax. In 1778, the Scottish moral philosopher and economist, Adam Smith, first published his now famous four basic maxims of taxation: certainty, convenience, administrative simplicity, and equity. 1 Certainty requires that people's tax burdens should be readily and preciselyascertainable. This criterion has been considerably compromised in recent business income tax legislation. Convenience means that taxpayers ought to be levied tax at the time or in a manner that is most likely to be convenient for them to pay. Nowadays, this basic canon has been extended to efficiency in the tax system, which means broadly 1 Smith, Adam, (1778) 2 An Enquiry into the Nature and Causes of the Wealth of Nations, Dent, London, 1947 reprint, 307308.that tax should be economically neutral that is, tax should not influence or distort the production, investment, or consumption decisions of private producers,investors, or consumers. The efficiency principle has been the cornerstone of taxation policy in most modern Western economies during the 1980s and the 1990s. Administrative simplicity means that the costs (being both taxpayer Compliance costs and a government's revenue collection costs) of determining and collecting a tax liability should be minimized. Equity falls into two categories: vertical equity and horizontal equity. Vertical equity proposes that the tax burden should differ between people in different positions such that a proportionately heavier burden falls on those who are better able to bear it. The vertical equity criterion has manifested itself in most income tax systems by way of progressive marginal tax rates and in indirect value added tax systems by way of the imposition of higher tax rates on luxury goods and services and lower rates on necessities. Horizontal equity is a primary tenet of income tax policy that is, people who are in the same economic position should be taxed equally. The principle of horizontal equity requires that income of one person be measured using the same methods as income of another person.