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AC108 Principles of Taxation : Income Tax and Consumption

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Demonstrate an understanding of the structure and operation of the system of taxation in the UK and of the application of the various taxation regulations to individuals and businesses – this requires communication and problem-solving skills.

Answer:

Introduction

The assessment aims to analyze and compare consumption taxes and income taxes and establish which form of taxation is fair in its approach. The tax structure of UK is being considered for this purpose. An argument is conducted based on the taxation structure of UK, that consumption taxes are fairer in comparison to income taxes which is to be established considering the comparison between both income tax and consumption tax. Wealth tax is another form of tax which is charged on the wealth of individuals (Lustig 2014). This assessment focuses on the which tax system is fair when consumption tax and income tax of a business is considered. The assessment mainly is there to establish the superiority of a particular tax system on the grounds of fairness. The assessment would be including various arguments which are either for or against a particular tax system which is considered. The assessment would conclude with providing a view as to which tax system has superiority in terms of fairness and just distribution of economic resources.

Discussion

In a society, the concept of fairness is universally applied which established that the resources of the country should be distributed considering distributional equity. On the basis of an argument which is conducted, fairness should be an integral part for selecting the best approach for formulating a tax strategy. The concept of income tax requires taxes to charged on the personal income of residents of a country while consumption tax is charged at predetermined rates. The concept of income tax is quite familiar among the readers while the concept of consumption task is not known to many (Johnson 2014). In order to get personal consumption of an individual by taxing all expenditure on a cash flow basis which includes all receipts including borrowings of a business and all other non-cash expenses are to be deducted. Income tax is historically linked with progression whereas the same is not the case with consumption tax.

As per the view point of Gordon and Kopczuk (2014) personal income can be identified as the algebraic sum of market worth of rights which are used for consumptions and the fluctuation in the value of store of property rights between beginning and end of considered period (Figari and Paulus 2015). In general terms, consumption can be defined as complete usage or depletion of economic resources. In case of income tax, the allocation of income is done among different individuals and the tax itself is computed on personal income at progressive rates. As per Roth (2018), the aim of income tax is to provide a share of every citizen’s income to the government which can be used by the government progressively for the benefits of the entire country. The government has the right to use funds collected from income taxes to uses for public goods or services or redistribution among selective class of people. The regime of income tax can be viewed as the most logical tax system wherein the society as a whole has a claim on the national product of a country before the claims of individuals citizens. Therefore, a certain sense of fairness can be identified under income tax regime in a country.


Consumption tax which is proposed is a form of personal tax which is imposed on graduated rates. As per the rules of consumption taxes, the tax would be managed on expenses or cash flow basis where all the receipts would form a part of the tax base and all expenses which non-consumption in nature are to be deducted (Goda, Onaran and Stockhammer 2014). The principles of consumption tax argues that the funds collected should promote fairness in the distribution of goods and services among the society and should have a positive impact on the standard of living of citizens. The consumption tax affects the decision which is related to both the amount and form of public goods which can be made available for public consumption.

The claim of the citizens under consumption tax scheme is fair share of goods and services which are consumed during an accounting period. On the other hand, under income tax system, the focus is fair share of goods and services generated during a period. In a extreme situation, most of the countries would be focusing on getting equality among the consumers and then the second priority is equality among producers. In case a comparison is made between income tax and Consumption tax, many view points hold that the former is inferior to the latter in terms of equality and fairness (Boadway and Song 2016). An argument can be made that income taxes poorly considers resources which are left in common pool while in case of consumption taxes an approach which allows distributional justice is followed. Another argument which can be made is that income taxes in certain cases are discriminating against the savers while consumption taxes is more preferable from lifetime perspective. The concept of income tax does not bring about total fairness in its approach whereas consumption taxes provides the same fairness.

Another viewpoint that has developed considers consumption taxes to be deficient as its does not consider non-consumer services claim for future consumption as the property rights. The producers under consumption taxation does not have a present consumption but the same is allowed as additional consumption that can be used at will. The reason for such an option is to leave the unconsumed resources in the common pool. Leaving of resources in the common pool has a desirable effect on capital supplied which would not only increase future productivity but also productions in future periods.

Another argument states that fairness and justice in distribution of resources should not only be evaluated through income or any other economic measures but also from the sources of individual’s utility, satisfaction and welfare. As per this theory an ideal tax system should not only put emphasis on proper distribution but also look after the utility of individuals by considering all aspects. This argument also clears out that consumption taxation approach is favorable as consumption is the closest thing which can be related to utility.

Utilitarianism is considered to be the correct criteria for determining the tax base and the same is considered to be based on economic assumptions. However, the same in reality cannot be considered to be the best estimation of utility on the basis of economic resources. In this aspect wealth plays an integral role in deriving utility from consumption of economic resources. Thus, the estimation cannot be deemed to accurate as other factors are also involved and there is also difficulty for the account of consumption which is taken as a substitute of utility.  

According to the analysis of Fisher an argument against the income tax based on the life-cycle of consumption model has re-appeared. On noticing that the anticipated stream of wage for every person is discounted to a comparable current value and added to the value of property that was held at a point then the amount constitutes an endowment which can be treated as the worthy measure of capability to pay taxes (Santoro and Fuller 2015). Once the endowment is considered correct means of ranking the taxpayers based on the ability to pay tax, it follows that the income tax is inferior to the consumption tax. This is because income tax is inferior to the consumption tax and it would be equally endowed among the taxpayers differently given their pattern of spending is different.

According to the arguments stated by Greggi (2016) the base of income tax is less fair than the consumption tax, the case for consumption tax includes the proposition that the income tax is unavoidably in equitable due to the fact that income is a defective concept which is not possible to elaborate rationally. The main argument that income is not possible to define because the concept of income fails to adequately measure the capital gains which is because of the changes in the rate of interest. The argument that taxing only the rate of interest adequately accounts for the differences among the two investors is reliant on the consumption tax where economic return must not be considered until it is consumed.

Another theoretical defect which is considered here is the concept of income which does not has the ability of dealing with the investment in human capital (James 2016). A person that invest a part of his wages in the stock market the investor should invest the after tax dollar since the wages would be liable for income tax. The critics of the concept have argued that every person possess the human capital. Based on the realization terms, making investment in the human capital on this view is presently expensed given the investment comprises of forgoing wages whereas other expenses must be capitalized and recovered on the sale over the life of the asset. The logical inference of these result is that persons would be levied taxed based on the changes in the current value of what they can earn beside what they actually earn (Gullifer and Payne 2015). However, the idea of imposing any tax on the capacity of earnings should be viewed inconsistent with the concepts that is accepted widely for individual liberty because it would disregard the personal choices of an individual.

The advocates of consumption tax on the other hand have stated that the theory of income is incapable of rationally elaborating in the society (David and Abreu 2016). Apparently, the conclusion would be implemented on the comprehensive income tax during the lifetime of the taxpayer because the human capital would be presumably included in the tax base given the increments reaches income tax.

In comparison to the tax on the personal earning capacity both the income tax and the consumption tax are related with the choice of a person. Accordingly, an argument can be bought forward by stating that both the income and consumption tax are preferable to the tax based on the capacity that it interfere less with the liberty and personal choice of taxpayers. An argument has been further bought forward by the Parisi and Klick (2015) if tax on capacity should be avoided in the interest of liberty, only consumed products should form the part of tax base. Consequently, consumption tax is preferred over the income tax for the reason that the former is imposed when an individual chooses to consume.

The argument fails to accept the difference between the person and things which was given as the reason for not imposing tax on the capacity in the scenario of human capital. Moreover, it is viewed that consumption tax is less consistent with the freedom of an individual than that of income tax (Picciotto 2015). The distributive grounds of consumption tax are that decisions of quantitative consumption are for collective purpose rather than individual purpose. An individual’s collective distribution of product is related to collective decision. While an individual’s collective responsibilities are concluded during the production stages under the income tax while in respect of consumption tax those accountabilities are not discharged unless the last resource is consumed by the person. Fleurbaey and Maniquet (2018) asserts that because of such inability to escape the collective accountabilities by consuming available resources has attracted majority of the supporters to consumption tax in UK.

Saez and Stantcheva (2018) states that the argument for superiority of consumption tax over the income tax is not convincing even though on the terms that the direct comparison between the income and consumption tax along with the question of wealth has been kept aside for a day. The conception of income is better understood as the interpersonal perspective on the measurement of every taxable share of product of society’s labour and private capital during the period of accounting (Emerton and James 2018). The case of equity for income tax can be premised based on the claims of society on the portion of product for the purpose of redistribution or production of public goods. Consumption on the other hand can be justified as the criteria of distributional equity by relating the claims of society’s standard of living instead of product.

Essentially, either of the conclusion needs the agreements of outcomes instead of anticipations of what constitute the subject of fairness in taxation. Majority of the recent case for substituting the consumption tax with the income tax is reliant on the completely opposite premise that anticipation is alone relevant (Weinzierl 2018). The concept of human capital constructs the discounting of future consumption to the current value in general which is not helpful in comparing the two taxes. Furthermore, the consumption tax does not appear to be superior in respect of the conceptual coherence or its impact on the personal liberty.    

To be more precise, the either of the taxes can be justified as fair tax policy in the literature depending upon the choice that whether the choice of social product or standards of living version of distributive justice can be considered to be superior as the matter of political philosophy (Abuselidze 2018). In the non-existence of superiority, it is not possible to make choice between the income and consumption tax until the wealth tax is excluded from the consumption. Such kind of indeterminacy suggest that wealth tax must not be ignored in the discussion relating to the choice of tax base. Certainly, the strongest argument favours the income tax in contrast to the consumption tax since the matter of fairness is only income tax.

Conclusion:

On a conclusive note, if the choices are to be made between the consumption tax and income tax then it would be difficult to make decision. The choices would be dependent on the exact components of the two alternatives of tax package. If the arguments relating to the wealth tax were completely rejected then the choice for consumption tax would become clear, because it is only the tax that entirely excludes wealth from the base of taxation. Finally, during any level of income the rich would be able to save less and consumption tax may be progressive than the income tax.

References

Abuselidze, G., 2018. Peculiarities of Determining the Optimal Taxation of Income Tax.

Boadway, R. and Song, Z., 2016. Indirect taxes for redistribution: Should necessity goods be favored?. Research in Economics, 70(1), pp.64-88.

David, F. and Abreu, R., 2016. Taxation and Fiscal Evasion: A perspective on Corporate Social Responsibility. The Ashgate Research Companion to Corporate Social Responsibility, p.357.

Emerton, P. and James, K., 2018. The Justice of the Tax Base and the Case for Income Tax.

Figari, F. and Paulus, A., 2015. The Distributional Effects of Taxes and Transfers Under Alternative Income Concepts: The Importance of Three “I” s. Public Finance Review, 43(3), pp.347-372.

Fleurbaey, M. and Maniquet, F., 2018. Optimal income taxation theory and principles of fairness. Journal of Economic Literature, 56(3), pp.1029-79.

Goda, T., Onaran, O. and Stockhammer, E., 2014. A case for redistribution? Income inequality and wealth concentration in the recent crisis.

Greggi, M., 2016. In Search of a Compass. Base Erosion, Profit Shifting and New Dilemmas in International Taxation. Economic Journal, 119(537), pp.764-795.

Gullifer, L. and Payne, J., 2015. Corporate finance law: principles and policy. Bloomsbury Publishing.

James, S.R., 2016. Accounting and Taxation: UK. Wolters Kluwer.

Johnson, P., 2014. Tax without design: recent developments in UK tax policy. Fiscal Studies, 35(3), pp.243-273.

Lustig, N., 2014. Taxes, Transfers, Inequality and the Poor in the Developing World. Public Finance Review, 42(3).

Parisi, F. and Klick, J., 2015. Functional Law and Economics: the search for value-neutral principles of lawmaking. In Law and Economics (pp. 114-130). Routledge.

Picciotto, S., 2015. Indeterminacy, complexity, technocracy and the reform of international corporate taxation. Social & Legal Studies, 24(2), pp.165-184.

Saez, E. and Stantcheva, S., 2018. A simpler theory of optimal capital taxation. Journal of Public Economics, 162, pp.120-142.

Santoro, J.R. and Fuller, C.S., 2015. Reassessing the fair tax. U. Pitt. L. Rev., 77, p.385.

Weinzierl, M., 2018. Revisiting the Classical View of Benefit?based Taxation. The Economic Journal, 128(612), pp.F37-F64.

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