Taxing Principles

AuthorRuud De Mooij and Michael Keen
Positiona Deputy Division Chief and is a Deputy Director, both in the IMF's Fiscal Affairs Department.

Back to Basics

It is hard to think of anything that some government, at some point, has not taxed. Playing cards, urine, fireplaces, slaves, religious minorities, and windows have all at some point attracted the attention of the tax collector. Nowadays we think of income taxes, value-added taxes, taxes on cigarettes, and the like as the key revenue instruments. But the basic principles for understanding and evaluating all taxes are much the same. In this, the first of two articles on taxation, we examine these principles. In the March 2015 issue of F&D we will apply them to some current controversies.Â

The Organisation for Economic Co-operation and Development defines a tax as a “compulsory, unrequited payment to government.” That is, you have to pay it, and you don’t get anything back—at least not directly. (You may derive some benefit from the public spending your payment helps finance, but if not—well, from the perspective of tax collection—that’s just too bad.)

Importantly, however, many policy instruments that are not in a legal sense taxes have much the same effect. Social contributions are a prime example. These are payments linked to an individual’s labor or business income that confer some entitlement to pensions or other social benefits. The personalized benefit means that these are not, strictly speaking, taxes. But the link between payments and contributions is often so far from actuarially fair, and the prospective benefits so remote, that their effect is likely to be very similar to that of an outright tax.Â

Efficient taxation

A tax transfers resources from the private to the public sector, and so inescapably imposes a real loss on the private sector, leaving aside any benefit from whatever the tax revenue finances. But almost all taxes will cause more harm than that because they typically drive a wedge between the price a buyer pays for something and the amount the seller receives—which may prevent some mutually beneficial trade. Taxing labor income, for instance, means that the cost to an employer of hiring someone exceeds what the employee receives. A worker may be willing to accept a job that pays (at least) $100 and an employer willing to pay (no more than) that, but imposing tax on the wage will prevent this trade from happening. This welfare loss from taxation over and above the loss from the direct transfer of real resources out of the private sector is known as deadweight loss (or excess burden) and is what economists...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT