Tax principles by Adam Smith

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Tax principles by Adam Smith
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Adam Smith's tax principles are the set of guidelines that should characterize good and effective national tax system. Adam Smith described those tax principles in his most famous book An Inquiry into the Nature and Causes of the Wealth of Nations. These basic principles were described as:

  • Every taxpayer have to contribute to the state income to the same extent. This, however, raises a question what does to the same extent mean? It can be interpreted as giving to the state budget the same percentage of income by every taxpayer - what is called a flat tax nowadays (this view was supported by Adam Smith) or diversifying the tax rate between taxpayers. Within the second approach, taxpayers that have bigger income should pay bigger percentage of that income to the state budget, so the tax progression is applied.
  • Every taxpayer has to be sure how much taxes he will have to pay. According to Adam Smith, this rule is of great importance. He indicated it as one of the most important features of the tax system. The confidence on how much tax should be paid determines often the overall condition and assessment of the tax system.
  • Every tax should be collected at the time and in the manner that is most appropriate for the taxpayer. Adam Smith shows that this is very important as well for the taxpayer, because then he can pay taxes on time, and for the tax collector, because then he can collect taxes on time.
  • Every tax should return to the society in the value similar to the value of the tax collected from the society. The perfect situation would be that the same value that was collected comes back to the society, however this would mean no administration costs, which is impossible. However, the lower the administration costs, the better for the tax system.

Universality of Adam Smith's tax principles

The principles mentioned above are standard tax principles, despite they were presented in 1776, they are still of very great importance, since they present the fundamentals of every effective tax system.

The taxation systems changed during centuries. In ancient times they were mainly based on taxes paid in kind, then they evolved to payments in money. Taxation systems also became more and more complex, including tax relieves and introducing variety of tax rates. Due to the growing number of international connections the issue of double taxation was raised.

Nowadays, when the globalization process is inevitable, the transfer pricing issue and tax evasion are important topics. All this makes tax systems different from what they used to be, however tax principles introduced by Adam Smith should still be applied. They are universal and whatever the tax system is it should represent those principles. Despite different economic circumstances the statement that the more simple the tax system is, the better it is, still stays true.

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Author: Maciej Sawicki