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 Fundamentals of Taxation
Why this book?
The main purpose of this book is to promote the dissemination of the basic notions of taxation from
a policy, legal and administrative perspective, offering its readers a balanced view of rights and
obligations connected with the levying of taxes. The book sets out current principles of taxation
from both an economic and legal perspective, explains taxation in different legal systems, outlines
considerations for substantive and procedural tax law design and deals with sanctions in tax law.

The book explains the fundamentals of taxation in a simple manner and without reference to a
specific legal system. This method allows the book to set out fundamental considerations beyond
the boundaries of any actual tax system whilst emphasizing that taxation is always rooted in a legal
regime, policy considerations and administrative practice.

The book aims to strengthen awareness of taxation beyond technical circles and was written for the
most diversified categories of users in civil society and beyond. People who can benefit from this
book may range from university students to tax practitioners or members of civil society from both
developed and developing countries who seek a clearer view of current fundamental issues regarding
the levying of taxes in a global setting. Furthermore, the book provides basic notions of taxation
required for building a theoretically responsible understanding of the operation and challenges of
international taxation.

Title: Fundamentals of Taxation

Subtitle: An Introduction to Tax Policy, Tax Law and Tax Administration
Author(s): Pasquale Pistone, Jennifer Roeleveld, Johann Hattingh,
João Félix Pinto Nogueira, Craig West
Date of publication: July 2019
ISBN: 978-90-8722-537-7 (print/online), 978-90-8722-538-4 (ePub),
978-90-8722-539-1 (PDF)
Type of publication: Book
Number of pages: 196
Terms: Shipping fees apply. Shipping information is available on our website
Price (print/online): EUR 50 / USD 60 (VAT excl.)
Price (eBook: ePub or PDF): EUR 40 / USD 48 (VAT excl.)

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To order the book, please visit www.ibfd.org/IBFD-Products/shop. You can purchase a copy of the
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variety of topics, and are available in one or more of the following formats:

• IBFD Print books

• IBFD eBooks – downloadable on a variety of electronic devices
• IBFD Online books – accessible online through the IBFD Tax Research Platform

IBFD, Your Portal to Cross-Border Tax Expertise

IBFD

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ISBN 978-90-872-537-7 (print)

ISBN 978-90-8722-538-4 (eBook, ePub); 978-90-872-539-1 (eBook, PDF)
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 Production of this Work

This multi-authored book is the result of the scientific cooperation between

the University of Cape Town and IBFD. While each author was tasked with
the initial drafting of aspects of the book, the book is and remains a col-
laborative and multi-authored single manuscript.

In the interest of transparency, the initial division of work is recorded as

Pasquale Pistone (preface and chapter 5); Jennifer Roeleveld (preface and
section 4.3.); Johann Hattingh (sections 2.3., 3.1., and 3.3.-3.4); João Félix
Pinto Nogueira (chapter 6); and Craig West (chapter 1 and sections 2.1.-2.2.,
3.2. and 4.1.-4.2.).

Peer Review Process and Statement

This statement serves to confirm that the full manuscript of this book was
subjected to external peer review at the pre-production stage. For this exter-
nal peer review, three independent international academic experts in the field
were tasked with reviewing the manuscript. In particular, the reviewers were
asked to comment on whether the manuscript provides an original analysis
based on thorough knowledge of the existing literature on the subject.

Upon receipt of the positive reviews, the manuscript was accepted for publi-
cation and the publishing team made the final editorial, stylistic, grammati-
cal, typographical and typesetting amendments.

IBFD
May 2019

v
 Table of Contents

Preface ix

Chapter 1: Introduction to Tax Policy 1

1.1. Fiscal policy and tax policy 1

1.2. The budgetary balance of tax, debt and expenditure
in fiscal policy 1
1.3. Policy principles for a state to raise taxation 3
1.3.1. What is a tax? 3
1.3.2. Theories justifying taxation 4
1.3.3. Justifying taxation through its use 6

Chapter 2: Principles of Taxation 9

2.1. Features of a good tax policy 9

2.1.1. Introduction 9
2.1.2. Equity 10
2.1.2.1. Defining equity in tax policy 10
2.1.2.2. Horizontal equity 11
2.1.2.3. Vertical equity 11
2.1.2.4. Legitimacy 13
2.1.2.5. Inter-nation equity 13
2.1.3. Economic efficiency 13
2.1.3.1. Defining economic efficiency for
tax policy 13
2.1.3.2. Neutrality 13
2.1.3.3. Stability 14
2.1.3.4. Simplicity 14
2.1.3.5. Productivity 15
2.1.3.6. Sufficiency 17
2.1.4. Administrability 17
2.1.4.1. Defining the administrability of
tax policy 17
2.1.4.2. Certainty, transparency, accountability
and legality 18
2.1.4.3. Collection cost/tax yield 19

vii
Table of Contents

2.1.4.4. Simplicity 19
2.1.4.5. Enforceability 20
2.1.4.6. Information security and confidentiality 21
2.1.5. Coherence 21
2.1.5.1. Defining coherence 21
2.1.5.2. Interaction within and between taxes 21
2.1.5.3. Broad base 22
2.1.5.4. Tax mix 22
2.1.5.5. Adaptability and continuity 23
2.1.5.6. International coherence 24
2.1.6. Challenges in application 24
2.1.6.1. Tax mix to be relevant 24
2.1.6.2. Understanding the purpose of the tax 24
2.1.6.3. Developing versus developed countries 25
2.1.6.4. Reliance on external reference points 25
2.2. Economics and tax policy 26
2.3. Rule of Law 28
2.3.1. Introduction and rationale for the Rule of Law 28
2.3.2. Functioning and presence of the Rule of Law
in a legal system 29
2.3.3. Nature and features of the Rule of Law 29
2.3.4. “No taxation without representation” 33
2.3.5. Certainty: Interpretation of law 35
2.3.6. The principle of legality 36
2.3.7. Law – not discretion – and the exercise of
public power 38
2.3.8. Equity in tax law 40
2.3.8.1. Justice, fairness and ability to pay 40
2.3.8.2. Non-discrimination 41
2.3.9. Other aspects of the Rule of Law 42
2.3.9.1. Dispute resolution and fair trial 42
2.3.9.2. International law 42

viii
 Table of Contents

Chapter 3: Legal Systems 45

3.1. Common law 45

3.1.1. Introduction and features 45
3.1.2. Territorial reach of English common law 47
3.1.3. Commercial and tax law in common law countries 48
3.1.4. Sources of tax law and rules of precedent 49
3.1.5. Interpretation of tax law 52
3.1.6. Relation of tax law to the general legal framework 55
3.2. Civil law 56
3.2.1. Introduction and features 56
3.2.2. Territorial reach of civil law 58
3.2.3. Commercial and tax law in civil law countries 59
3.2.4. Sources of tax law and the rule of precedent 60
3.2.5. Interpretation of tax law 61
3.2.6. Relationship between tax law and the general
legal framework 62
3.3. Mixed legal systems 63
3.3.1. Introduction and features 63
3.3.2. Commercial and tax law 65
3.4. Supranational law and international institutions 65
3.4.1. Introduction 65
3.4.2. Supranational law and tax law 66
3.4.3. International institutions and tax law 67
3.4.4. The impact of hybridization and pluralism
on tax law 67

Chapter 4: Substantive Tax Law 71

4.1. Introduction 71
4.2. Institutional design 72
4.2.1. Federal versus central (unitary) systems 72
4.2.1.1. Introduction 72
4.2.1.2. Federal systems 72
4.2.1.3. Central systems 75
4.2.2. Regional integration 76
4.2.3. Division of powers 77
4.2.3.1. Overview 77
4.2.3.2. Legislative powers 79
4.2.3.3. Executive powers 81
4.2.3.4. Judicial powers 82
4.2.4. The making of tax policy 84

ix
Table of Contents

4.3. Tax system design 85

4.3.1. Who will be taxed? 85
4.3.1.1. Natural persons 86
4.3.1.2. Corporate entities 86
4.3.1.3. Transparent entities 86
4.3.1.4. Permanent establishments 87
4.3.1.5. Geographical scope 87
4.3.2. What will be taxed? 87
4.3.2.1. Income 88
4.3.2.2. Wealth 88
4.3.2.3. Transactions 89
4.3.2.4. Consumption or use 89
4.3.2.5. Net or gross basis 89
4.3.2.6. The influence of accounting principles
on tax law 90
4.3.3. When will it be taxed? 91
4.3.3.1. Direct taxes 91
4.3.3.2. Indirect taxes 91
4.3.3.3. Transactional 92
4.3.4. How will tax be collected? 92
4.3.4.1. Employment 92
4.3.4.2. Business or other income 92
4.3.4.3. Withholdings 93
4.3.4.4. Indirect taxes 93
4.3.4.5. Cross-border assistance 93
4.3.5. Administration of tax collection 94
4.3.6. How do you deal with avoidance and evasion? 95
4.3.6.1. SAARs 95
4.3.6.2. GAARs 96
4.3.6.3. TAARs 96
4.3.6.4. Amnesties and voluntary disclosure
schemes 96
4.3.7. Treaties 96

x
 Table of Contents

Chapter 5: Procedural Tax Law 99

5.1. The general framework of tax procedures 99

5.1.1. The structure of tax procedures 99
5.1.1.1. Instrumental function in the exercise
of taxing powers by means of tax collection 99
5.1.1.2. Administrative and judicial tax
procedures 100
5.1.2. The principles of tax procedures 102
5.1.2.1. Fairness and legal protection 102
5.1.2.2. The four foundation principles of fair tax
procedures 103
5.1.2.2.1. The principle of
proportionality 103
5.1.2.2.2. The prohibition of double
jeopardy 105
5.1.2.2.3. The right to be heard 106
5.1.2.2.4. The right to not
self-incriminate 110
5.2. Administrative tax procedures 110
5.2.1. Tax rulings 110
5.2.1.1. Features, functions, effects and
legal basis 110
5.2.1.2. The effects of tax rulings and their
relationship with other tax procedures 111
5.2.2. Tax assessment 112
5.2.2.1. Self-assessment versus assessment of
tax by tax authorities: Features,
functions, effects and legal basis 112
5.2.2.2. Relationship with other tax procedures 114
5.2.3. Tax audits 116
5.2.3.1. Structure and goals 116
5.2.3.2. Preliminary phase 116
5.2.3.3. Main types 118
5.2.3.4. Core phase 120
5.2.3.5. Tax notice 121
5.2.4. Tax collection 123
5.2.4.1. Collection through third parties 123
5.2.4.2. Voluntary payments by the taxpayer 124
5.2.4.3. Forcible collection 125

xi
Table of Contents

5.2.5. Tax refunds 126

5.2.5.1. Main features 126
5.2.5.2. Procedural aspects 127
5.2.5.2.1. Tax refunds 127
5.2.5.2.2. Tax reimbursements 127
5.3. Reviews and appeals 128
5.3.1. Administrative reviews 128
5.3.1.1. Self-correction and administrative
reviews 128
5.3.1.2. The taxpayer and administrative
reviews 129
5.3.1.3. The relationship between administrative
reviews and judicial appeals 129
5.3.2. Judicial appeals 130
5.3.2.1. The system and function of judicial
appeals 130
5.3.2.2. Judicial actions in tax matters 131
5.3.2.3. Judicial appeals involving several
taxpayers 132
5.3.2.4. The jurisdiction of courts in tax matters
and the dynamics of judicial appeals 133
5.3.2.5. The judicial decision 134
5.3.2.6. Appeals before higher judicial courts 135
5.3.3. Alternative tax dispute settlement procedures 135
5.3.3.1. The mechanisms for settling tax disputes 135
5.3.3.2. Conciliation 136
5.3.3.3. Mediation 137
5.3.3.4. Arbitration 138
5.4. The procedures for the settlement of cross-border t
ax disputes 139
5.4.1. The mutual agreement procedure 139
5.4.2. Arbitration 139
5.4.3. Their mutual relations 141
5.4.4. Relations with domestic administrative
and judicial procedures 142

xii
 Table of Contents

Chapter 6: Sanctions 143

6.1. Introduction 143

6.2. Principles and corollaries 144
6.2.1. Introduction 144
6.2.2. Legality 143
6.2.3. Proportionality 145
6.2.4. Prohibition of double jeopardy 146
6.2.5. Individual culpability 146
6.2.6. Due process of law and its corollaries 147
6.3. General framework 148
6.3.1. Introduction 148
6.3.2. Objective and subjective element 149
6.3.3. Responsibility of corporate officers for
sanctions for legal entities 150
6.3.4. Codification 150
6.4. Classification 151
6.4.1. Introduction 151
6.4.2. According to the nature 151
6.4.3. According to the need for a material result 152
6.4.4. In respect of the person 152
6.4.5. In respect of the underlying protected value 153
6.5. Infringements 154
6.5.1. Introduction 154
6.5.2. Failure to pay taxes in due time 154
6.5.3. Obligations regarding reporting and other
formal obligations 155
6.5.3.1. In general 155
6.5.3.2. Tax returns 156
6.5.4. Obligations regarding documentation and
accounts 156
6.5.4.1. Bookkeeping and invoices 156
6.5.4.2. Transfer pricing documentation 157
6.5.4.3. Omissions or false documents/
declarations 157
6.5.4.4. Failure to use approved forms or
other documents 158
6.5.4.5. Failure to display certificates of
payment of taxes 158
6.5.4.6. Accounting software 158

xiii
Table of Contents

6.5.5. Obligations regarding due cooperation 158

6.5.6. Other infringements 159
6.5.6.1. Mandatory use of bank accounts 159
6.5.6.2. Appointment of legal representatives 159
6.5.6.3. Withholding agents or other related
parties 159
6.5.6.4. Transfer of money abroad 160
6.5.7. Infringements by tax authorities or other
public servants 160
6.6. Sanctions 161
6.6.1. Main sanctions 161
6.6.2. Ancillary sanctions 162
6.6.3. Sanctions and interest 162
6.7. Determination of the sanction 163
6.7.1. Introduction 163
6.7.2. Abstract framework 163
6.7.3. Adjusting the framework 164
6.7.4. Determination of specific amount 165
6.8. Exclusion or reduction of the sanction 166
6.8.1. Exclusion of punishment 166
6.8.2. Waiver of the sanction 166
6.8.3. Self-disclosure schemes 167
6.8.4. Settlements 168
6.9. Suspension 168
6.9.1. Suspension of the determination of a sanction 168
6.9.2. Suspension of the application of a sanction 168
6.10. Extinction 169

Bibliography
Books and Journals 171
Other 176

xiv
 Preface

Taxes are an essential component of modern society, since they secure the
financial resources through which a given community funds its essential
functions.

For long, the world of taxation has been an inaccessible maze of techni-
calities, confined to a narrow circle of navigated experts and often hard to
understand, even for people with a solid legal background.

More recently, taxes have made their way to headline news, raising a grow-
ing interest in civil society across the world and a genuine curiosity to
understand how taxes in fact work.

Besides being a moral duty, paying taxes is a legal obligation, which each
legal system regulates within a positive framework that also establishes the
rights arising in connection with such payment.

Often, the revenue-raising function overshadows the legal dimension of

taxation. Yet, the latter constitutes an essential component, since it ensures
that the levying of taxes complies with the Rule of Law and the principles
of civilized nations, which are the fundamental values of each community.
Our view is that both are indispensable in a modern tax system.

The main purpose of this book is to promote the dissemination of the basic
notions of taxation from a policy, legal and administrative perspective, offer-
ing its readers a balanced view of rights and obligations connected with the
levying of taxes.

When examining the fundamentals of taxation, this book explains them in a

simple manner and without reference to a specific legal system. This method
allows the book to set out fundamental considerations beyond the bound-
aries of any actual tax system whilst emphasizing that taxation is always
rooted in a legal regime, policy considerations and administrative practice.

In adopting this fundamental basis method, the authors aim to strengthen

awareness of taxation beyond technical circles and reach out to the most
diversified categories of users, in civil society and beyond.

The readers of this book can be university students of a tax course, from
a developing or developed country, those who come across taxation dur-
ing their studies or those who are just curious to better understand what

xv
Preface

taxation is about. People with a solid legal culture or members of civil

society without a legal background may use this book to gather a clearer
view of the main issues connected with the levying of tax. Furthermore, the
book can serve as a starting point to gather the basic notions of taxation that
are required for building up a theoretically responsible understanding of the
problems of international taxation.

The six core chapters of this book, as well as this preface, reflect the needs
of its potential readers, guiding them step by step through the fundamentals
of taxation.

A few remarks can help understand how our readers may best use this book.

After a comprehensive overview of the principles of taxation, chapter 2

bundles them together in a context that also takes into account their legal
dimension, policy goals and implications.

Since legal systems may affect the actual context in which tax law operates,
chapter 3 elaborates on the main features of common law, civil law, mixed
and supranational legal systems.

The subsequent chapters focus on substantive tax law and the type of taxes
most frequently contained in tax systems (chapter 4), procedural tax law
(chapter 5) and sanctions (chapter 6). All of them reflect our approach,
which combines the search for effective tax collection and the protection
of fundamental rights.

In particular, substantive tax law consists of the rules through which a

system imposes taxes. In such framework, chapter 4 addresses the issues
connected with the different levels of government at which taxes may be
imposed, the impact of the division of powers on the levying and application
of taxes, tax law design and the conundrum of rules that determine who and
what will be taxed, as well as how and when.

When analysing procedural rules in chapter 5, the book underlines that the
power of tax authorities in this context is essential for the achievement of
the goals of revenue collection, but also limited by the need to comply with
the Rule of Law. In such system, we connect rights and obligations arising
for tax authorities and taxpayers.

xvi
 Preface

Chapter 6 elaborates on a thorough analysis of tax sanctions, which

addresses them in the light of a preliminary study on the concept and typol-
ogy of tax infractions. In line with the overall goals of the book, this chapter
reconciles the effectiveness of tax sanctions as deterrents proportional to the
infractions, also taking into account the effectiveness of legal (also interim)
remedies applicable to them.

Because of such features, this book constitutes an experiment for a global

study of tax law, which we hope will contribute to raising the awareness of
taxation throughout the world. Our wish is that this awareness will be ben-
eficial to civil society, which already fought some centuries ago to combine
the obligation to pay taxes with the right to participate in the decision-mak-
ing that establishes such taxes (“no taxation without representation”) and
meanwhile may have somehow lost track of the basic features of modern
tax systems. Aside from this, we hope that such awareness helps develop-
ing countries reach their own understanding of what is good for their own
governance.

Since this book is the result of the scientific cooperation between the
University of Cape Town and IBFD, the authors would like to thank all the
human and financial resources that supported this innovative experiment to
serve the international tax community. Our wish is to help the new genera-
tions and bright minds of developing and developed nations contribute to
a better world by establishing fairer taxation across countries throughout
the world.

Pasquale Pistone
Jennifer Roeleveld
Johann Hattingh
João Félix Pinto Nogueira
Craig West

Amsterdam and Cape Town, May 2019

xvii
 Chapter 1

Introduction to Tax Policy

1.1. Fiscal policy and tax policy

Fiscal policy is generally defined as the policy to use government revenue

(taxes) and government expenditure to influence the market (the economy).
Tax policy is a subset of fiscal policy examining the revenue side of fiscal
policy (i.e. the collection of revenue by a state).

Tax policy touches on a number of disciplines, including, but not limited

to, economics, behavioural science, political science, accounting, finance
and law. Often, these disciplines are intertwined with respect to numerous
concepts.

The economics perspective provides the initial broad overview of tax policy,
containing both macro and microeconomic aspects. The macroeconomic
aspects consider the influence of tax policy on the economy as a whole
(unemployment rates, economic growth, consumption levels, etc.). The
microeconomic aspects include the impact of tax on individuals, firms and
the market.

1.2. The budgetary balance of tax, debt and expenditure

in fiscal policy
The levying of taxes has rapidly become the main source of government rev-
enue in most states. There are, of course, exceptions, such as states levying
royalties on natural resource extraction. Taxes are used to fund government
expenditure, but frequently, government expenditure exceed the amount
of taxes collected. This is particularly prevalent when states try to main-
tain a counter-cyclical budget (i.e. in periods of downturn of the economy,
government expenditure is increased despite the lack of tax revenue in an
effort to stimulate the economy). However, the shortfall (deficit) between
the expenditure and the revenue must be settled. Governments therefore
borrow money to fund additional expenditures (usually through the issuance
of government bonds).

1
Chapter 1 - Introduction to Tax Policy

Taxes, borrowings and expenditures form the three points of the budgetary
triangle of government funding. The balance between tax revenue and bor-
rowing must be strictly monitored. Interest charged on the monies borrowed
by governments must equally be serviced by the tax revenue collected, and
it therefore erodes the tax revenue. When borrowings become excessive, this
can lead to a downward spiral in which tax revenues are fully absorbed by
the interest charges and the government cannot justifiably increase the tax
revenue, rendering government expenditure on the delivery of public goods
and services impossible.

Governments must therefore preserve a delicate balance of tax revenue and

borrowings to fund its expenditure. This, in long periods of downturn, has
prevented governments from successfully applying a perfectly counter-
cyclical policy.

The triangle of tax revenue, borrowings and expenditures mean that govern-
ments have three mechanisms with which to fund a deficit: (i) raising taxes;
(ii) increasing borrowings; or (iii) spending less. Each of these options has
a direct impact on the economy. The decision regarding the mix depends on
the nature of the fiscal policy of the government and the economic circum-
stances in which it finds itself.

Examining only the fiscal policy in the absence of other factors, govern-
ments tend to either have an expansionary or contractionary fiscal policy.
Expansionary policies encourage increasing government expenditure and/or
decreasing tax revenue. The intended impact of either of these choices is the
stimulation of the economy. Governments in such a cycle are generally try-
ing to decrease unemployment and increase the productivity of the economy
(leaving more revenue for reinvestment by the taxpayers rather than extrac-
tion through taxes). However, increased expenditure, when coupled with
decreased tax revenue, will require the balancing of the budget/funding of
the deficit through borrowings.

In contractionary policies, governments decrease expenditure and/or

increase taxes. Such actions have the effect of contracting economic activ-
ity. Increased taxes take more away from productively generated income,
leaving less capital for expansion. Similarly, decreasing expenditure can
equally lead to reduced public services (requiring more private investment
for such services) and can increase unemployment, shrinking the economy.
While contractionary policies may lead to a budget surplus, this assumes
that the increased revenue is sufficient to offset the reduced expenditure, but

2
 Policy principles for a state to raise taxation

this is not a universal truth. A contractionary policy may still yield a deficit
that has to be funded through borrowing.

Increasing taxes can create problems in the economy through increasing

deadweight losses, as the increased prices impact the supply-and-demand
equilibrium (i.e. increased taxes raise the prices, thereby decreasing demand
and increasing deadweight loss). Increased spending by governments or
funding a deficit through increased borrowings can crowd out similar spend-
ing or borrowing in the private sector in a full-capacity economy, and there-
fore can be detrimental if not carefully monitored. Increased borrowing can
also raise interest rates, reducing the disposable income of households and
businesses.

Increased taxes may also generate uncompetitive conditions for multina-

tional entities and be detrimental to the development of small businesses
domestically. Decreasing government expenditure can directly affect
employment levels and the level of social benefits that may be provided.
Increased government borrowing can remove providers of capital from the
pool from which the private sector may seek finances.

While it is clear that in designing a tax system, a holistic picture is needed

with respect to raising taxes (considering the expenditure by the govern-
ment, its borrowings, political influences, cultural aspects and interactions
with other economic aspects, such as monetary policy), this book considers
only issues concerning the levying and collection of taxes raised by states.

1.3. Policy principles for a state to raise taxation

1.3.1. What is a tax?

While the concept of “tax” does not carry a universally accepted definition
and therefore is not possible to exhaustively define, it is possible to provide
some common identifiers with respect to tax.

It should be noted that most jurisdictions do not define “tax” and that tax
should be considered as something different than a levy (which may equally
be imposed by a government).

As taxes can be considered a direct violation of the right to property and

other constitutional rights, the procedure for governments to introduce a tax
is usually subject to some form of special process. In this regard, it should

3
Chapter 1 - Introduction to Tax Policy

be noted that “levies” are usually not considered taxes and are therefore not
subject to discussion here. However, it is important that in the design of any
system, taxes are not disguised as levies.

For a government charge to be considered a tax, there are some common

traits observable in all taxes:
– a tax is a compulsory charge (i.e. not a voluntary contribution);
– a tax is imposed by legislation (government);
– a tax is to be used for a public purpose; and
– a tax is usually not tied to a specific service to be provided to the indivi-
dual paying the tax (i.e. the tax may support services to the collective
and not the individual).

While these elements are observable, there is no uniformity in application

among states. Also, states may well add to the requirements of this list
before the charge may be classified as a tax in the particular jurisdiction.
Critically, the legitimacy of the tax is found in its creation by legislation.

1.3.2. Theories justifying taxation

In assessing why states raise taxation, the first consideration is the justifi-
cation for a state to raise tax (i.e. the legitimacy of the tax). This is one of
the most neglected issues in defining tax principles. Taxes have become so
firmly entrenched in the collective thinking that the more common approach
is to ask what governments will do with the tax revenue rather than whether
the collection of tax is justified.

In assessing whether tax is justified, numerous theories have evolved over

the years, ranging from (i) an emergency levy, to fund particular identified
state expenditures; (ii) the benefit theory, which implies that all individuals
should contribute to the state from which they receive protection and ben-
efits; (iii) the social contract, according to which all must contribute to the
greater good of the community; and (iv) the sacrifice theory, according to
which all individuals should contribute in accordance with the wealth they
generated (the precursor to progressive tax rates) in order for the state to
redistribute (to some extent) that wealth. All of these theories are rooted in
the particular circumstances of the time and linked to individual taxpayers
rather than corporate entities. As these theories evolved, taxation moved
from an emergency measure to a regular levy on individuals. Many of these
theories are still quoted today as justification for taxation.

4
 Policy principles for a state to raise taxation

Over the period of development of these theories, taxes rapidly became the
main revenue source for modern states, and it is often from the accepted
norm that taxes will be levied that the discussion of tax policy begins.
However, most of these theories were developed considering the interac-
tion of individuals with the state (either one-on-one or as a collective).
Subsequent to these theories and with the advent of legal corporations, fur-
ther development in the justification of taxes has resulted.

Current writings seem to conflate these theories to justify taxation. This

combining of the theories is perhaps representative of a change from con-
sidering the individual in a relationship with the state to a wider perspective
that includes the state, the economy (including corporations and organiza-
tions) and society (representing individuals as a collective). In this triangular
relationship, individuals and corporate entities play a role in the economy,
being the generators of the economic productive activity that generates in-
come and wealth. The state will generally impose taxes on the productive
economic goods of the economy, which returns a portion of the value cre-
ated within (and implies a nexus with) the state and enables the state to fulfil
the purposes for which the taxes were levied. The state may also impose
necessary limitations on the economy, but should not overly restrict it, or
else it runs the risk of eroding the very productive element that funds it. In
this respect, one can see evidence of aspects of each of the earlier theories
justifying taxes being present in this interdependent relationship.

There is perhaps a rising fourth element with respect to taxes, and that is
the global economy and global society. Taxes are inherently restricted by
the bounds of the jurisdiction of the state, but global influences are already
directly impacting states, introducing global pressures to conform with
respect to various aspects of taxation.

Global conformity is, of course, problematic. Tax systems are inextricably

bound to the fiscal and macroeconomic policies of the state and the legal
structure in which they are housed (see chapter 3). Tax policy is driven by
more than idealist values and sound principles, as it is sensitive to political
forces, ideologies, lobby groups and international organizations.

Tax culture in a jurisdiction also plays a part in the manner in which tax
is imposed in a state and in whether the state will be able to justify the
tax to the persons it affects. Numerous forces and social challenges can
influence the tax culture in a state. These challenges may range from the
level of inequality within the state to whether the government is viewed as
legitimate. Similarly, the perception of taxes may equally impact the success

5
Chapter 1 - Introduction to Tax Policy

of any tax policy. Views may range between seeing all taxes as creating
distortions in the market and an unnecessary cost to seeing them as a nec-
essary interventional tool for the state to stimulate and shape the economy
(encouraging incentives; see chapter 4) or redress inequalities. Within this
broad range, many states see taxes as necessary for providing welfare ben-
efits within the state. This speaks to the justification of taxes through the
purpose the tax will serve.

All of these factors play a significant role in the balance of the theories for
the justification of tax in a particular state.

1.3.3. Justifying taxation through its use

While tax must firstly be created by a legitimate body authorized by the

public to impose taxes – which should be accountable to ensure that taxes
are not levied that would violate fundamental human rights – justification
for tax is regularly provided with respect to the purpose that the tax is meant
to serve.

The purposes for which taxes may be levied can be grouped into various
categories. The most commonly used categories include (1) providing gov-
ernment functions (also called “state building”) such as government infra-
structure and military; (2) providing other public goods and services; (3)
creating greater equality through redistributive functions; and (4) guiding
behaviour in society (as tax can serve to provide guidance as to acceptable
and unacceptable behaviour). Categories (2)-(4) are sometimes grouped as
elements of state-building or classified as “internal management”, which is
the nature of what the government is trying to achieve (management of the
economy and society). More recently, the influence of the global economy
and global society (discussed in section 1.3.2.) can also be perceived as a
need for taxation (i.e. revenue is required to respond to these influences),
which has been termed “negotiated expansion”.

The fact that taxes are raised by the state in terms of the enacted law implies
that there should be some limitation to tax as well. Three key principles
emerge, namely the following:
– taxes should not erode capital. Erosion of capital will lead to reduced
income in the future, which ultimately could destroy the productive
economy;

6
 Policy principles for a state to raise taxation

– taxes should not exceed that which is needed to fund the public needs.
This implies that taxes should fund service delivery and (efficient) ad-
ministering of those services; and
– however justifiable the tax may be, if it costs more than what the levied
tax would collect, it should not be levied. It is critical that the govern-
ment service be delivered efficiently, as excessive taxation to fund ex-
cessive expenditures or inflated government services cannot be justi-
fied.

While the general purpose of taxes should be justified in terms of the com-
mon good (public need), ear-marked taxes (taxes levied to fund a particular
purpose) may be justifiable, but may equally disrupt the economy by manip-
ulating economic behaviour. However, the objectives that surround public
needs may be broadly determined. Depending on the particular country, the
redistributive aspects that taxation delivers can form part of the public need
(i.e. to achieve greater social equity). Equally, taxes influencing behaviour
may be perceived as necessary (environmental taxes, sugar taxes, etc.).

Ultimately, the core of the justification of taxation largely has to do with

the (general) purpose for which the tax will be imposed for the benefit of
society and represents a blend of the benefit and sacrifice theories and the
theory of social contract. Whichever description is used to justify the tax,
governments are ideally served by a broad tax base on which taxes are lev-
ied that is fair, efficiently administered and responsive to societal challenges
and demands. The taxes levied should be levied legitimately and in an envi-
ronment in which corruption, inefficiencies and inequities are minimized
or eliminated. Developing a tax-compliant culture is equally important to
tax policy, but this is only realistically achieved when taxes are viewed as
justified and the obligations of the state with respect to the delivery of public
goods or services are met.

7
Notes
Notes
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