This article provides an analysis of the principles (logic) and ethics of taxation, as well as information on actual tax practices.
In a multi-employer state -- i.e., one in which the bulk of the employment and production is in the private sector -- the government's function is largely limited to providing services (e.g. police, army, and unemployment compensation, to name a few). The primary role of taxes in such a state is to provide the operating funds for the government.
In capitalist economic theory, the major incentive which keeps people working at the maximum of their ability is the desire to "advance" and become "more successful". That can only happen if there is somewhere to advance to, and if it's apparently possible to become richer. In short, the engines which drive a capitalist state are the gap between rich and poor and perceived social mobility. Consequently, in capitalist theory, taxes are least damaging to the economy if they do nothing to reduce the gap between rich and poor, and may, in fact, be most effective if they actively increase the income gap.
Note well, however, that this is an utterly amoral approach to the issue of taxes. Furthermore, it's one based on the false assumption that the State possesses wealth. The notion underlying it is that the wealth of a nation is its production, which is deeply flawed: It is individuals who possess wealth, not an abstract State, and if the wealth is concentrated in the hands of a few individuals, then the aggregate amount of such wealth is irrelevant from a moral or ethical standpoint. In short, if widening the gap between rich and poor makes the poor people work harder, the result may be less wealth and poorer quality of life for most of the residents of the nation, despite the overall increase in production which may result.
On this page we will be discussing several forms of taxation, and in each case we will consider the moral aspects of the tax. We will take as our definition of a "moral" tax that of one which is most burdensome on those who can best afford it.
A secondary aspect to taxation, which we will not be considering here, is as an instrument for controlling the behavior of the populace. A heavy tax on cigarettes, which could be intended to encourage reduction in smoking, would be one example of such a tax.
When tax rates are set sufficiently high, taxation may be used as an instrument of wealth redistribution. For example, if the top income tax bracket is set at or above 100%, then all income which exceeds the top bracket amount will be confiscated, thus putting a cap on incomes, and limiting the gap between rich and poor.
The difficulty with such a scheme, when used in a single country, is that it's a lot like spraying for roaches in an apartment. The roaches just move next door until things are more to their liking. Thus, while a top bracket of 100% does something to limit salaries, it may also cause the best paid workers to move out of the country. It also tends to cause companies to pay their top people in kind rather than in cash (providing a company car, paying for an apartment, giving the use of the corporate jet, etc). Plugging the loopholes by declaring various things to be part of a salary then becomes a running battle with companies looking for ways around the tax.
The larger the country, or the more impermeable its borders are, the smaller is the problem of wealth flight in the face of confiscatory taxes.
It's possible to have confiscatory taxes in forms other than an income tax. As another example, a 100% tax on inheritances would "confiscate" all property at a person's death, thus reducing heritability of wealth to zero, and (presumably) increasing social mobility.
An income tax is a tax on income received by a taxpayer. Depending on its form, an income tax can be among the most moral of taxes.
Someone with a large income needs a small fraction of that income in order to live well. Conversely, someone with a smaller income needs a larger fraction of it to live. Thus, taking a given percentage of a poor person's income is more onerous than taking the same percentage of a rich person's income.
There are several main forms of income tax, which differ in the how the tax burden is distributed.
A progressive tax takes a proportion of income which increases as the taxpayer's gross income increases. Thus, an attempt at placing the burden where it can best be borne is built into the structure of a progressive tax. It is thus intrinsically a moral form of taxation.
Special purpose tax breaks may, of course, pervert the intent of a progressive tax, and the government may choose to set the brackets so as to defeat the purpose of the tax, but those are separate issues which don't bear on the fundamental structure of the tax.
Flat Tax or Proportional Tax
The term flat tax is usually used to mean a tax which levies the same proportion of each taxpayer's income. Another name for it is a "proportional tax".
A proportional tax is income-blind -- it is applied equally to all levels of income. As previously noted, the poor need a bigger proportion of their income just to live than the rich do, as a result of which a proportional tax falls unevenly on taxpayers, hurting the poor more than the rich. As such, it's less "moral" than the progressive tax.
A number of U.S. states have proportional income taxes. In some cases this may be due to clauses in the state constitution which make any other tax structure illegal.
A regressive tax is one which may be broadly proportional but with a percentage which decreases as the taxpayer's income increases.
Most people would agree that this is the wrong way round -- the poor shouldn't be taxed more heavily than the rich.
The United States social security tax, which is proportional up to a cap, is an example of a regressive tax.
Head Tax or Hearth Tax
A head tax levies the same dollar amount from each taxpayer or household. It could be considered even less moral than a regressive tax, because it treats all taxpayers as though they have an identical amount of income from which to pay the tax.
This kind of tax was used by the European powers as an instrument of colonial rule in the Global South in the 19th and 20th centuries. Its purpose or effect was to force indigenous people out of their customary economic activities and into the wage economy. The tax forced indigenous people seek waged employment (in effect, to work for a European) in order to get money to pay the tax. Without the head tax, many or most indigenous people were quite content to stick to their traditional or subsistence economic activities, remaining outside the colonialists' money economy and avoiding its discipline and exploitation. Head or hearth taxes were widely disliked and often strenuosly opposed. For example, the imposition of the hut tax in Sierra Leone incited its people into war in 1898 against the British colonial administration. (See Wikipedia History of Sierra Leone, Colonial era (1800 - 1961), and Hut Tax war of 188.)
A "head tax" helped to bring down Margaret Thatcher, when she attempted to push it through over the objections of the people of England.
Capital Gains Tax
A capital good is something which has monetary value, or which can be sold for money. Company stock provides one example. When a capital good is sold for more than the owner paid for it, the difference is a capital gain.
This is really just a form of income, but in the United States "capital gains" are taxed separately from other income. Historically, capital gains on goods which had been held for more than some fixed period (first a year, later reduced to six months) were taxed at a much lower rate than ordinary income. The rationale for this was that it encourages long term investment in companies, which is claimed to be beneficial to the economy, and consequently good for everybody. Whether or not that is true, it's certainly also true that special capital gains treatment is applied almost exclusively to sales of company stocks and corporate debt instruments, which are rarely owned by the poor. Thus, special capital gains treatment provides another form of tax break for rich taxpayers, and consequently shifts the tax burden onto the poor.
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Sales and VAT Taxes
A sales tax or its cousin, the Value Added Tax, are often proposed as alternatives to raising the income tax. A VAT is used heavily in both Canada and Europe. The major argument for a VAT or a national sales tax is that taxes on spending are considered less disruptive to the economy than taxes on income.
As a general rule, wealthy taxpayers spend a smaller proportion of their incomes than the poor. Consequently, since these are taxes on spending, the effect is very similar to that of a regressive income tax. From an ethical point of view, these taxes are therefore less desirable than a progressive income tax, which at least sets out to place the largest tax burden on those who can best afford it.
A peculiarity of some capitalist countries is the ability to create artificial entities called corporations. The basic idea is that a corporation can take risks which an individual would not be able to afford, because if the corporation loses everything, it doesn't matter -- it isn't a real person. But the consequences of such "artificial personhood" go far beyond risk management.
One very confusing consequence of the existence of corporations is that it raises the question of corporate taxes. In principle, it's people who spend money and people who benefit from it, so it might seem to make sense that money should be taxed when it's finally handed out to people. Thus, one might think that money earned by a corporation should be taxed only when it's handed over to a person, either in the form of a salary or in the form of dividends. But in practice, corporations are used for so much beyond their original intended purpose of limiting liability that such a scheme results in tax avoidance on a gross scale. For example, an individual with a large income can set up a corporation, have all his income go to the corporation, draw a small salary from the corporation, and have the corporation buy him nearly everything he needs out of its own funds. This is, or was, a common arrangement among consultants in the computer business.
Alternatively, one might think taxing corporations at the same rate as individuals would make sense. It does up to a point, but if you want to allow large corporations, then there is a problem, which is that the income of a large corporation is nearly always going to put it in the top individual tax bracket. With post-Reagan brackets topping out at 25% that may be acceptable, but with Johnson-era brackets, which hit 90%, it would lead to problems. Again, if one doesn't want to allow large corporations to exist, then this isn't an issue, and taxing them as individuals works just fine.