The politics of taxation & tax reform

Posted: March 21, 2010 in Political economy

The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.

Jean Baptiste Colbert (attributed), c. 1665[1]

Introduction: politics of taxes

More than twenty years ago, the reigning doyen of public finance succinctly outlined the politics of his field in these words:

It is not surprising and is indeed appropriate that fiscal policy, on both its tax and expenditure sides, should be among the most controversial of policy issues.  The fis­cal process, as much as any other democratic institution, occupies the middle ground between anarchy and absolute rule.  It provides the forum on which interest groups and ideologies may clash without resort to the barricades, and on which compromise and cooperation may be sought.  Located at the centre of dispute, the budget process can hardly be expected to function neatly and without error if only because it is cre­ated by the same conflicting interests which it must reconcile (Musgrave 1981: 76).

Taxation is “a compelling phenomenon precisely because it is where the politics meets the economics” and because the “way in which a nation taxes creates incentives that pervasively influence the way in which political and economic life become organized” (Bates 1989: 487).  When a government collects taxes, it removes revenues out of the private sector and therefore reduces the disposable income of private economic actors.  Taxes meanwhile are necessary so that public goods may be supplied in adequate quantities and in a timely fashion.  Thus taxes represent the costs imposed by governments so they can provide public goods.  From the point of view of an average citizen, taxes potentially can (and do not actually) change the public-private mix of goods and services that she consumes.[2] If no taxes were imposed (i.e., there is no state), then a person’s consumption package composed solely of private goods.  However, as the English political philosopher Thomas Hobbes reminded us, life in the ‘state of nature’ (i.e., the state of statelessness) is “solitary, poor, nasty, brutish and short” (Hobbes 1651 in Ebenstein and Ebenstein 2000: 365).  Thus a state is created so public goods (in this case, recourse to a powerful Leviathan to maintain peace and order and prevent people from simply taking the lives and the property of others as they see fit) could be provided.  When a state is created, a person becomes a citizen and the latter’s consump­tion package is now a mix of public and private goods.  The lower the share of taxes relative to a citizen’s total revenues, the higher the proportion of private goods in her consumption package.

The forerunners of fiscal sociology, Joseph Schumpeter and Rudolf Goldscheid, offered it as a macro-historical paradigm that clearly identified the dominant catalysts of societal, economic and political change.  According to these authors, social change was driven by ways in which states handled the challenges of raising revenues and managing spending.  The paradigm offers two significant general propositions about European history and state formation.  First is the notion that the great transformation in modern western European history was neither the emergence of capitalism (from Marx’s viewpoint) or the development of modern rational-legal bureaucracies (ala Weber).  Rather, it was the transi­tion from the so-called demesne (or domain) state, in which government activities were financed through the ruler’s own properties, to the tax state, where public activity was funded through regularized tax levies on the private sector and private incomes.  The second proposition is that this penetration of the tax apparatus into the private economy had important social con­sequences.  They include the reshaping of culture and values and the creation of a large, civilian public bureaucracy that in itself became a distinct and powerful social actor (Moore 2004).

Other writers (Moore 2004 and Daunton 2001) offer the category fiscal state, of which Great Britain was the first modern exemplar.  A fiscal state is able to supplement its tax reve­nues with borrowed money.  As a high-performing tax state, Britain was able to parlay its secure revenue base to raise large loans quickly and cheaply in both domestic and interna­tional bond markets.  Historians saw the superiority of the fiscal state relative to the tax state in its capacity to raise the resources needed to wage war.  For this reason, Daunton (2001) called 19th century Britain a fiscal-military state.  Other observers offer the concept of the state’s relative political capacity (RPC), which refers to the ability of the state to “effectively carry out its tasks imposed on it by political elites, important societal groups and the pressures of the international system” (Kugler and Domke 1986: 44).  More specifically, a state’s RPC refers to its ability “to extract fiscal resources from society, which in turn provide the state with the necessary means to wage war” (Weiss and Hobson 1995: 43).

Weiss and Hobson (1995) note that three elements are behind Britain’s relatively su­perior fiscal-extraction capacity compared to its continental rivals: (a) the penetrative power of the British state, which had probably the most highly developed revenue extraction bu­reaucracy in Europe in the 18th century[3]; (b) the ability of the state to achieve consensus with major taxpayers through their representatives in Parliament; and (c) the commercialized na­ture of the economy and the existence of specific capitalist institutions.

Relative to continental practices where private tax farmers were heavily employed with the risk of enormous fiscal leakage, the British fiscal system was set up in a highly cen­tralized and effective way (Brewer 1989; Holton 1985; Levi 1988; and Mann 1993).  This en­sured that the British state enjoyed a practical monopoly of taxation (Weiss and Hobson 1995). Levi (1988) points out that in comparison with France, Britain enjoyed much lower fiscal transactions costs due to a smaller and less heterogeneous national territory, lower agency costs due to a more efficient collection system, and lower information costs due to Parliament’s existence.  It is the existence of Parliament and its cooperation with the ruler on fiscal matters, which is the second main ingredient of a state’s relative political capacity.

In comparing coercive and consensual or negotiated taxation, Moore (2004) argued that the latter constituted a better institutional technology.  Coercive taxation (largely in agrarian societies) is relatively ineffective since it tends to generate resistance and because coercive tax collectors were well placed to pocket a large part of the proceeds for them­selves.  In contrast, consensual taxation offers (within the boundaries of individual states and at the potential expense of rival states) joint gains for both rulers and taxpayers.

If kings and representatives of the main potential taxpayers could agree on taxation and expenditures policy, several benefits will accrue compared to the counterfactual case of coercive taxation.  First, since there is consensus among rulers and principal taxpayers on taxes, tax payment and collection became less onerous and costly as well as more predictable.  With more information and better knowledge of likely future obligations and revenues, tax­payers will feel more secure in investing and rulers can plan on a long-term basis more ef­fectively.  Second, Parliament as a forum wherein tax revenues are ‘exchanged’ for policies stimulated the search for policies that benefited both parties.[4] Third, taxpayers would be more ready to approve emergency requests for war funds if they were already implicated in, or responsible for, major policy decisions.  Fourth, an organization that represented taxpay­ers would be relatively effective at overseeing revenue collection and public expenditure process and will help reduce corruption, extravagance, and inefficiency.  Fifth, and more generally, kings dependent on taxes developed a stake in the prosperity of (at least some of) their citizens and therefore are encouraged to promote that prosperity which, in turn, would generate more revenues for the state (Moore 2004; Weiss and Hobson 1995; Tilly 1990).

The superiority of consensual taxation can be seen in the contrasting paradox invol­ving Britain and France.  One of the prime causes of the French Revolution was the tax burden imposed by the late 18th century ancien régime, perceived by many taxpayers to be op­pressive (Skocpol 1979; Mann 1993).  What puzzles and is quite paradoxical to many is that the British tax burden was comparatively higher (according to the estimates of Mathias and O’Brien 1976) and that the French tax burden was declining (while it was increasing in Britain).  The possible explanation:  the loathing caused by French taxation “must be judged according to the political and administrative hostilities aroused by such taxes, not so much by the economic burden they imposed upon the economy” (Mathias and O’Brien 1976: 635).  Levi (1988) argued that Parliament’s existence and the development of quasi-voluntary compliance spelled the difference.  English kings conceded to powerful constituents (i.e., landlords and/or nobles) a say in government through the Parliament, in contrast to the more exclusive and arbitrary ways of the French kings.  Since British taxation involved the consent of the key political actors, fiscal extraction could be maximized.  Thus British state strength or extractive capacity rested upon the consent of the dominant classes (see also Fryde 1991).

The British case (as well as the subsequent colonial American case[5]) has led to the view that taxation tends to produce more representative government.  Moore (2004) calls it the fiscal contract proposition.  According to one observer, this interpretation has strongly influ­enced a generation of political scientists, sociologists and economic historians (including Robert Bates, James Buchanan, Margaret Levi, Michael Mann, Barrington Moore, Jr., Doug­lass North, Kenneth Organski, Mancur Olson, Theda Skocpol, and Charles Tilly) whose theories of state-building, taxation and representative government have in turn influenced many other scholars.  It is also pointed out that this generation was likewise influenced by an earlier generation of German and Austrian scholars, the pioneers of ‘fiscal sociology includ­ing Otto Hinze, Rudolf Goldscheid and Joseph Schumpeter (Ross 2004).

Testing this claim statistically, Ross (2004) finds that a rise in taxes per se does not lead to democratization and representative government[6].  He thinks this was probably be­cause higher taxes are often used to fund an increased level of desirable government services leaving citizens better off or equally well.  He finds out however that a rise in the price of government services is associated with subsequent democratization.  The increase in the price of government services can either take the form of an increase in taxes for a given set of public services, or a constant level of taxes with fewer public goods.  This suggests that people do not generally rebel against taxation without representation.  They appear to rise up rather against taxation without commensurate government services.  Ross’ statistical evi­dence supports the theoretical claim of Bates and Lien (1985) that struggles between citizens and governments over both taxes and public goods tend to produce greater democracy and representative government.  However, it does not support the argument of Huntington (1991) and others who argue that attempts to raise taxes alone tend to lead to democratiza­tion.

Of course, it must be pointed out that the context of consensual or negotiated taxation is capital mobility within the greater context of capitalism.  Where the main potential source of revenue was agriculture, coercive taxation was the norm.  Rulers relied on landlords or tax farmers to squeeze the peasants and the former will try to ensure that these intermediaries will not be too greedy to pocket too much for themselves.  Since land is immobile, peasants had few alternatives to taxation: armed resistance or flight.  In contrast, owners of transport­able capital (i.e., money) had more options.  As Adam Smith wrote in the Wealth of Nations:

The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country.  He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease [p. 318].

Along these lines, Weiss and Hobson (1985) pointed out that the existence of specific capitalist institutions and the nature (as opposed to the size) of the economy helped explain British state strength.  For one, many states resorted to loans during war, partly because or­dinary tax revenues cannot cover military expenses adequately, and because borrowing pro­vided a measure of relief to weary taxpayers (Kennedy 1989; Tilly 1990).  To this end, the English state implemented the ‘financial revolution’ that established the Bank of England in 1694 and led to the Bank forming close ties with the Treasury and the (private financial) City of London in the 18th century.

This development was vital in providing the British state with cheap monies to fund the expensive wars of the 18th century.  Furthermore, the com­mercialized nature of the British economy with considerable international and domestic commerce enabled the massive extraction of indirect taxes.  Britain enjoyed a larger and wider indirect tax base compared to France since a larger share of output and consumption was market-mediated.  In turn, a strong base is important to assure private creditors that they will eventually be paid for the war loans they have extended.  In effect, one of the key distinctions between Britain and France (and Spain, for that matter) lay in the former’s ability to pay its loans on time enabling to maintain both creditworthiness and access to easier loans.  Spain and France, meanwhile, were saddled with high interest rates since France, es­pecially, was notorious within lending circles of its inefficient fiscal practices and predisposi­tion to debt repudiation.  Britain was able to keep its credit cheap because the state was able to extract high taxation levels.  In essence, by cooperating with landowners and capitalists and by developing a strong centralized fiscal bureaucracy, the British state enjoyed various advantages over its continental rivals (Kennedy 1989; Skocpol 1979; and Weiss and Hobson 1995).

Taxation as exchange: coercion and volition

The view that taxation could be seen as an exchange and consensual transaction between government and citizens is one of the two broad approaches to the study of taxa­tion.  It is associated with Wicksell (1896) and Lindahl (1919), two of its most important early proponents, and Buchanan (1968, 1976).  With this approach, the emphasis is on “taxation as a price for public output consumed by voters, and on institutions or methods designed to link the fiscal and the expenditure sides of the budget” (Winer and Hettich 2002: 2).  A second approach—which has its origins in Edgeworth (1925), Ramsey (1927) and Pigou (1952), and developed further by Mirrlees (1971)—sees taxation as the coercive capture of re­sources to finance largely unspecified government activities and programs.   This approach’s emphasis is on “ways to minimize the efficiency costs of taxation through the policy choice of a social planner” who “may also take account of distributional aims in achieving his or her objectives, by including distributional weights in the design of fiscal policy” and “such weights will be derived from an exogenously given welfare function, rather than being the outcome of a political process” (Winer and Hettich 2002: 2).

If the payment of taxes were voluntary, one can surmise that the total revenue col­lection would be zero or close to nil (provided some misguided but well-meaning individuals do indeed pay their taxes).  For this reason, taxes are collected by states (and non-state enti­ties)[7] since they have coercive facilities.  Secondly, since public goods are characterized by “nonrivalrousness in consumption and nonexcludability in supply” (Bates 1989: 479), people will free ride in a world of public goods.  People have the incentive to misrepresent their true preferences, “seeking to secure the benefits of government expenditure while behaving as if they in fact placed a low value on them” (Bates 1989: 479).  In addition to being induced to behave in a duplicitous manner, people also possess the incentive to engage in politics in or­der to write tax laws that enable them to enjoy public goods without paying for them.  There always exists the possibility that the benefits of government can be consumed even while the costs are transferred to others.  Rational actors (who will maximize gains and minimize losses or costs) can be expected to exploit this possibility.  They also expect that others will behave in a similar fashion.

Notwithstanding the essentially coercive nature of taxation, a ‘tax culture’[8] has devel­oped through the centuries, especially in liberal and democratic polities, that saw taxes as the payment for public goods that only the state can provide.  In this sense, tax compliance can be seen as a function both of the state’s strength and legitimacy.  This is the essence of the fiscal contract proposition alluded to earlier in this chapter.  Private actors will pay their taxes if they are convinced that they will be promptly detected and punished by state agencies if they evade or underpay their taxes; and if they are convinced that the state compensates the loss of private revenue through an appreciable increase in public goods and services.  If a state’s revenue collection and punitive agencies are weak, the level of tax compliance will be low.  Furthermore, if a state’s legitimacy is compromised in the eyes of its citizens, then the level of tax compliance will similarly be low.  For instance, a regime’s legitimacy may be tarnished if political leaders are suspected of raiding the public treasury.  From the point of view of private actors, taxation by the said regime represents ‘grand theft’ since the revenues are used to enrich the political leaders and/or their relatives, friends, and cronies rather than finance the provision of much-needed public goods.

These considerations arise in the minds of private economic actors given the physical and temporal separation between taxing and public spending.  Citizens have no assurance that their governments (or their political leaders) will:

  • use the public monies to provide public goods;
  • provide public goods at the most efficient and economic fashion, i.e., provide public goods and services with the minimum of wastage; and
  • not use the public monies to favor narrow and vested interests.

Furthermore, the gap between taxing and spending apparently gives rise to additional welfare losses on top of the losses due to the tax payment itself, giving rise to what is called in public finance literature as the ‘excess tax burden’ or ‘deadweight cost of taxation’.  Indi­vidual citizens will supposedly respond to tax rates by adjusting their activities in order to reduce their tax liability.  However, these adjustments are quite unrelated to the consumption of public goods.  For instance, taxpayers may respond to income taxation by reducing work and ‘consuming’ more leisure in order to maximize their utility in the light of such taxation.  According to economists, this obviously results in a reduction of economic welfare if com­pared to a situation where payment for the same public goods elicits no such trade-off or evasive adjustment (Winer and Hettich 2002; Creedy 1998).

Other complications must be considered.  Unlike the case of private goods, the di­rect connection between payment and consumption of public goods is not obvious.  A pithy definition considers a tax as a “compulsory levy made by a public authority for which no­thing is received directly” (James and Nobes 1992: 266), except for a receipt that has no di­rect economic utility since it is neither negotiable nor could be eaten for dinner!  The nature of public goods allows ‘free riding’; that is, non-taxpayers can also enjoy the benefits of pub­lic goods because it is difficult or even impossible to restrict the consumption of public goods to actual taxpayers.[9] This problem has given rise to several normative approaches to the distribution of the tax burden as alternatives to the ‘taxation according to benefits re­ceived’ principle.[10] The most notable alternative is the ‘taxation according to ability to pay’ principle.[11]

If one assumes that people are rational, then it could be surmised that their reaction to a change in taxes will be a function of a cost-benefit calculus.  That is, when the value of private goods lost because of a tax increase is greater than the value of public good gained, then people will oppose the tax reform.  Insofar as the increase in public goods compensates for the loss in private revenues, they can be expected to favor the tax change.  People will behave in this manner if there was no free riding.[12] To the extent that different sets of eco­nomic actors will sustain differing tax impacts, political reaction to a tax reform, especially to a comprehensive effort that seeks to change a broad array of tax measures, will likewise vary.  If some groups find themselves with either lower tax burdens or greater share of public goods ex post tax reform, they will support the proposed changes.  If they will have both, then the level of support for tax reform will be much higher. The reverse will be true for groups that eventually end up with a heavier tax burden or a smaller share of the govern­ment budget.

Having said that, it remains important to emphasize that people’s evaluations would   underpin their political responses to policy changes.  And as many observers have reminded us, people often will be uncertain as to the accuracy of their tax impact calculations.  After all, even professional economists find it difficult to assign the incidence of particular taxes.  In view of these uncertainties, political reaction to proposed tax changes will largely be a function of people’s subjective evaluation (albeit imperfect) of their positions under different tax policies (Bates 1989; Koppel 1992).  However, the level of uncertainty regarding tax im­pact is not the same across the board.  Organized economic actors are in a better position than atomized individuals to assess the impact of new tax measures. Apart from having al­ready hurdled the initial cost of organizing, pre-existing organizations possess other advan­tages including a greater capability to collect and analyze information because groups would ordinarily have more resources than disorganized individuals to deploy for this ‘tax-impact-assessment’ task.

Of course, political scientists (as well as economists, I believe) know that taxpayers respond to taxation in ways other than reducing their work effort or increasing their ‘con­sumption of leisure’.  They can lobby their elected political leaders for a lower tax burden.  In this arena, organized groups again enjoy a distinct advantage over the unorganized.  It may cost little to add lobbying over tax legislation to the activities of the organization.  It may have lobbied for lighter tax burdens in the past and have developed the links and accu­mulated the information crucial for a successful lobbying effort.  They can also undertake a tax revolt; they may avoid and evade taxes through various means.  They can do so because the non-payment of taxes does not immediately mean that the non-payer will not have ac­cess to public goods financed by tax revenues.  However, as more and more people will free ride and evade taxes, the supply of public goods will prove to be inadequate.  This problem will be more acute if the population is growing.

Politics of tax reform[13]

No matter how it is presented or proposed, tax reform will invariably be seen by most people as a plan to increase taxes as well as a redistributive game (Ascher 1989), a process where resources will be taken away from a set of people and given to another set of individuals.  For this reason, there is usually political opposition to tax reform.  One of the fundamental theorems in the literature of public goods, that of Leo Hurwicz (1986), shows that in the absence of a dictatorship, it is impossible to devise a means for efficiently allo­cating public goods, which is strategy-proof.  This means that a democratic social choice process cannot produce a means to allocate government services efficiently that is robust enough to withstand the strategic behavior of individually rational agents.  Hurwicz’s theo­rem is akin to the impossibility theorem of Arrow (1963)[14].

Bates (1989) identifies several implications of Hurwicz’s theorem.  First is that those seeking tax reform (i.e., the efficient and equitable collection of taxes) must coerce and over­come popular protests by those strategizing against their proposals.  In the predictable ab­sence of perfect dictatorship, people will always find it rewarding to seek to manipulate and overturn the existing disposition of public goods.  Expressed in another way, since a perfect dictatorship will never materialize, the demands for tax reform will never cease.  Another implication indicates that while government, seeking to behave efficiently, should offer dif­ferent tax prices to different groups of people (since they have differing preferences for public goods), it will be unable to or will find it extremely difficult to do so because taxpay­ers (who have a predisposition to free ride) will most likely misrepresent their willingness to pay for public goods.  In the end, government will set a relatively uniform tax rate.  There­fore, some taxpayers are paying less than they should for the public goods they consume while others are probably paying more.  Although some will feel overtaxed, all will claim to feel that way because the logic of free riding promotes such behavior.  Thus, it will be very difficult to separate those who are genuinely aggrieved (since they are overcharged for public services) and those who grumble for strategic reasons.  The fact that some are under taxed while others are overtaxed fuels political discord.  Nonetheless, each taxpayer (following the logic of free-riding) has the incentive to claim that under a prevailing tax system she is over­taxed.  Thus, each also has the incentive to seek tax reform so the tax burden could be shifted to others while she continues enjoying the benefits of public goods.

Since rational citizens possess the incentive to free ride, governments face non-zero costs of tax collection.  “The coercive nature of collecting taxes implies that the resource cost of implementing a tax system is large” (Slemrod 1990: 157).  Governments will there­fore choose tax systems that reduce the rate of tax avoidance.  For this reason, it may tax in ways that are easiest, not in ways that are most efficient (Bird 1989).  In the process, they may even prefer regressive, rather, than progressive measures.  For example, most tax sys­tems in poorer countries (the Philippines included) rely more on the easily collected indirect taxes (e.g., sales taxes and other excises) than in taxes on income and property.[15] Bird (1989: 315) goes on to assert that “the administrative dimension should be placed at the center rather than the periphery of tax reform efforts” and that for this reason “the most rewarding approach to tax reform in most countries is likely to be to design a tax system that can be acceptably implemented by the existing weak administration”.    In making this point, Bird echoes the earlier warnings of Surrey (1958) about the excessive preoccupation with ‘what to do’ (by way of tax policy) and the lack of adequate attention to ‘how to do it’ (by way of tax administration).  Casanegra (1987: 25) was more forceful when she asserted “tax adminis­tration is tax policy”.

The politics of tax reform is better understood if we recognize that private enti­ties can furnish public goods.  Tax relief or a lower tax bite is an example of a public good that can be supplied or obtained by an interest group for and behalf of its constituents.  However, since tax relief is a public good, it partakes of the peculiarities of all public goods.  The tax benefits that lobbyists are able to get will be enjoyed by everyone that bears the at­tributes of that group whether she paid for the costs of lobbying or not.  For example, the fiscal incentives granted to machine tool manufacturers will benefit also those who use ma­chine tools if tool manufacturers lower their prices as a result of the incentives they enjoy.  They may do so in the face of competition from imported machine tools.

Again, because of the free-rider problem, interest groups are difficult and costly to organize.  For this reason, economically concentrated interests are more likely to provide lobbyists.  The same is true for groups whose costs of organization have already been paid since it costs little to add lobbying over tax laws to the organization’s regular activities.  This insight explains why opposition to the liberalization of sugar imports will be forthcoming from a smaller group of domestic sugar-producing firms and why political support from mil­lions of sugar consumers may not materialize.  The per-capita costs of the tariff reform are substantial and apparent to the first group while the per-capita benefit of the reform is min­uscule.  Furthermore, it is more likely that the sugar firms are already organized while the sugar consumers are not.  This explains why most of the special treatment, exceptions and allowances are often accorded to industries as opposed to consumers.

The reality of free riding among rational citizens will lead to a social di­lemma.  If all behave rationally and free ride, they will find themselves worse off since go­vernment will be unable to collect adequate taxes and thus will be unable to provide basic public services.   Or the government may finance the provision of public goods in ways that will lead to inflation, high interest rates and foreign exchange crises.  Rational individuals may thus produce sub-optimal collective outcomes.  The disjunction between rational indi­vidual behavior and perverse collective outcomes leads to demands for tax reform.

However, as Hurwicz’s theorem implies, coercion may be necessary as means for making binding agreements among individuals with the predisposition to free ride.  These individuals rationally may choose to compel themselves to behave differently ala the social contract of Hobbes.  As individuals who are absolutely free in the state of nature find out that life in that natural state is miserable and horrible, as rational beings they collectively agree to give up some of their natural liberties and accept the rule of a Leviathan who will ensure the stability and the peace of the political state.  Similarly, rational free-riding taxpay­ers may agree to subject themselves to new laws and to penalize themselves for pursuing their short-run best interests at the expense of the longer-run good.

On the other hand, Ascher (1989) reminds us that once coercion is injected, people will invest in politics in order to secure or to defend against economic redistribution.  To the minds of people, tax reform, with its connotation of changes in the structure of taxation, will also be seen as entailing major changes in the burden of taxation.  More often than not, peo­ple and interest groups will assume that tax reform could redistribute wealth away from them.   Interest group representatives will rarely participate in the tax reform debate expect­ing that their groups will gain in the redistribution.  This is so not only because of the physi­cal and temporal distance between revenue collection and government spending but also be­cause the organized groups that are well situated to get involved in the debates consist of wealthier interests who are obvious candidates for greater extraction.  So even if tax reform may hold benefits for particular private interest groups, such groups will typically operate in basically defensive mode with respect to the tax reform issue.

In the rare instances when and where the opposition to reform is powerless (follow­ing a revolution, a system-transforming golpe, an overwhelming electoral victory), a reforming government may be able to dispense with political accommodation.  Yet the ability to do so is unlikely in most circumstances.  The multi-phase nature of reform in tax structure and tax administration affords diverse opportunities to minimize or even undermine the implemen­tation and impact of tax changes.  Different sources of power—electoral support, legislative strength, social prestige convertible into policy influence, money to buy votes or mass media, bureaucratic decisions, or to mount opposition campaigns, and the potential to disrupt in reaction to unwanted policy changes—may be brought to bear on the reform process.  Ulti­mately, the reformers will typically face the need for some political compromise.

Tax reform episodes have the potential of being innovative, that is, it can introduce new types of taxes.  The 1986 tax reform episode in the Philippines, for instance, introduced the value-added tax (VAT) that replace many sales, turnover and other excise taxes.  Since tax reform is largely motivated by the gap between actual tax yield and tax potential, one of the major foci of reformers is to devise taxes that will extract the desired amount of revenue through taxes that are easier to administer and harder to evade.  New taxes also threaten to close off prior modes of tax avoidance and evasion, but only if the tax designers are more clever than the targets of reform.  In this case, designers are induced to exercise their inge­nuity and technical sophistication.  Ultimately, innovation also leads to uncertainty.  A new tax has an uncertain impact even without avoidance and evasion and it is not certain that the tax reformers were able to close the loopholes in the tax system.

Another peculiar political dimension of tax reform is the indeterminacy of tax reform risk.  This is so unlike land reform wherein landowners are sure to be threatened.  Ascher (1989: 420) believes that “the essence of the politics of tax reform is the indeterminacy of the impact the reform will have upon particular classes and types of taxpayers”.  While it is true that wealthier individuals and groups would feel threatened by tax reform, the indeter­minacy of reform persists until the final details of legislation and implementation are worked out.

Often, the technicalities of tax reform invite the participation of foreign technical missions sent by multilateral financial institutions.  This external participation may have op­posing effects.  For one, the foreigners’ participation may be seen as an affront to economic nationalism.  On the other hand, it may also be seen in a positive light with the proposed reform considered to be technically sound and fair because unbiased and unencumbered for­eign technical experts lent a hand in their formulation.

The reaction from the tax collection bureaucrats is another major political factor to consider.  Tax reform can often be seen as an indictment of existing tax bureaucracies.  The job tenure and the prestige of tax bureaucrats are at stake in any reform episode and there­fore they are put on the defensive.  There is also the risk that tax changes will represent ad­ditional work for tax bureaucrats.  However, taxpayers will have a different take on the mat­ter.  If in a given jurisdiction tax administration is poor, inefficient or corrupt in the first place, taxpayers may not fear changes in the tax structure knowing that they have a wide latitude to adjust accordingly.  For this same reason, taxpayers (and their representatives) may oppose improvements in tax administration since tax burdens will surely become heav­ier if the previous avenues for avoidance and evasion are closed.

The uncertainty of the entire political economy is one component of the risk facing groups and individuals when a tax reform episode is initiated.  Tax reform risk is dependent both on the specific reform design and the overall political climate.  The reform design can be credited either for success or failure only to the extent that macro-factors do not make microelements impotent or unimportant.  If a key group (or powerful individual) believes that the government is out to destroy it, or that the government’s own survival is in doubt, or that the government is a lame-duck administration, or that it lacks the basic competence to carry out the reform in its anticipated form, then the details of the reform will matter little to that group’s behavior (Bates 1989).  Ultimately, the tax administration—and hence feasi­ble tax policy—in any nation-state ineluctably reflects to large extent the nature of the coun­try itself.  If it is a cesspool of graft, the tax administration will not be an isle of purity (Bird 1989).  It is argued that the proper focus of attention for tax reform is not optimal taxes but optimal tax systems that incorporate important constraints on tax administrative capacity (Burgess and Stern 1993; Slemrod 1990).

In truth, even as tax changes may be understood in terms of their impact on income groups, interest groups are more often organized functionally within industries rather than in terms of income classes.  As they aggregate in peak organizations, interest groups do so within functional economic sectors such as banking, mining, manufacturing, utilities, etc.  Thus much of the politics over economic and tax policy is structured as ‘sectoral politics’.

Summary of discussion

Tax policy is expectedly and understandably a politically contested terrain.  And this borne out not only by the preceding theoretical discussion but also by historical examples including those discussed in detail in this paper.  The last component of the CTRP, which dealt with income tax and tax administration reform, took about four years to complete.  It invited the spirited participation of almost all taxpayers as well as acrimonious debate among legislators and between the legislative and executive branches of government.  While it took the policy mill a shorter period of 10 months to reform the excise taxes of so-called ‘sin products’, a new law was enacted just the same.

Notwithstanding all the intrigues and conflicts, however, the policy process led to equilibrium as a new tax policy is enacted.  Those dissatisfied with the status quo initiate a reform process and this invites opposition from those who benefit from status quo.  None­theless, the ‘policy battle’ gets joined as interested parties and groups struggle over the con­tent, extent, and intent of the proposed reform.  In the end, a new tax law results from the conflictual process.  Since the political process settles into a state of equilibrium—producing a new tax law that will be implemented by the tax bureaucracy—the political conflict is re­solved at some point.  Even if the resulting policy could be challenged after enactment into law, this development does not deny that a balance, albeit temporary, between the contend­ing forces is reached.  Thus the tax reform process, with all its drama and intrigues, can be construed as a bargaining game.  How this is done is the subject of the next section of this chapter.

Tax reform as a bargaining game

The preceding sections alluded to a collective dilemma facing rational free-riding citi­zens and that dilemma invites tax reform.  Resolution of that dilemma requires the introduc­tion of coercion.  However, coercion’s introduction as Ascher (1989) reminds us, makes the tax reform process a redistributive one.  From a political viewpoint, this is critical since “redis­tributive games are inherently unstable; they are games without a core.  For each possible outcome there exists a coalition that would seek an alternative division of the spoils” (Bates 1989: 484-485).

For this reason, redistributive games will be iterated well into the future.  A simple example is supplied to illustrate this point.  Suppose P100.00 is to be shared between 100 people.  The most equitable arrangement is for each of the 100 to get a peso each.  How­ever, this arrangement could be challenged by a coalition of 50 who may want 2 pesos each, or by a coalition of 25 who may want 4 pesos each or even a coalition of 75 each with a P1.33 share, and so on.  What could settle the issue once and for all is an initial adoption of a decision rule by the players.  They will usually adopt the rule even before they know how much is going to be divided among them and this is the case with tax reform.  The decision rule may be that a simple majority of the players involved may decide how the amount in­volved will be distributed among them.  They may also adopt a rule that once that simple majority has decided, that decision is final and binding to all parties involved.  Usually, deci­sion rules of this nature partake of the nature of constitutions.[16]

The above example shows that there is a fundamental conflict between democracy, property and open society.  Another hypothetical case will illustrate this important point.  Suppose a village has only three residents: Uno, Dos, and Tres.  The first two like to play badminton while the third does not.  Within the politico-economic framework of private property and contracts, Uno and Dos could readily use funds from their personal treasuries for the building of a badminton court.  However, since both also comprise a voting majority, they could decide that the provision of badminton courts is a village activity.  In doing so, Uno and Dos could play badminton with less personal expense.  In this case, democracy al­lows the two to rob Tres in order to subsidize their personal preferences. However, it is called democratic policy and not robbery (Epstein 1985; Wagner n.d.).  Again, the impossi­bility theorems of Arrow and Hurwicz come to mind.

However when institutions, construed as rules, are weak, then redistributive games may persist.  For instance, some players may question the simple majority rule like so: “ma­jority of what?”  They may choose a base that will most likely vote for an outcome they de­sire.  The play now becomes one that decides who constitutes the majority: Is it a commit­tee formed by the players?  Is it the assembly of all the players?   But sometimes, constitu­tional rules allow players dissatisfied with decisions reached within an organization to contest them in other fora.  For instance, laws passed can be vetoed by the chief executive (on the lobbying of defeated legislators) or could be questioned before the Supreme Court.

If taxation (and tax reform) is construed as a game, then the rules of the game will be an important determinant of the outcome, that is, changes in tax policy and tax administra­tion.  A string of scholars have in fact shown that different institutional arrangements (aka rules in the Douglass North sense[17]) have systematic effects on political behavior and on po­licy outcomes.

Each democratic polity, according to the needs and features of its society, chooses a set of democratic institutions to resolve basic political questions.  These institutional ar­rangements define a sequence of principal-agent relationships, commonly numbering at least three (Cox and McCubbins 2001; Dahl 1967):

  • First, the sovereign people delegate decision-making power (usually through a writ­ten constitution) to a national legislature and executive.  The sovereign power of the people vis-à-vis their agents is expressed via the power to choose and replace them during elections and the power to write the constitutional rules of the political game.
  • The second delegation of power takes place when the details of the internal organiza­tion of the executive and the legislature are decided.  This process entails the creation of ministries or executive departments, of committees, and of agenda control mechanisms.  In this case, constitutional regulations of the relationship be­tween the legislative body and the chief executive (e.g., can the executive dissolve the legislature?) also come to play.
  • Third, the legislature and the executive delegate to various bureaus and agencies the execution of laws and the implementation of governmental programs.  Law and administrative procedure govern the terms of this delegation.[18]

Rules are also devised to prevent these delegations to be degraded into abdications.  For one, power could be separated or divided among several actors so that the capacity to change governmental policy is shared by competing public entities.  Executive power, the power to execute laws, is separated from the power to enact laws.  Both are also separated from judicial power.  Another device is to separate the purpose of these actors so that differ­ent parts of the government are motivated to seek different goals. Ultimately, the objective is to prevent any single authority from controlling the outcome of any delegation of power at any stage. For instance, at the very basic level of delegation, the sovereign people will never agree to cede authority to a single person or a single body knowing that what will ensue is an authoritarian and non-democratic polity.

These arrangements entail significant tradeoffs.  The first is between a polity’s deci­siveness, the ability to change policy, and its resoluteness, or the ability to stick to avowed policy.  An indecisive polity will be encumbered by gridlock or stalemate between key politi­cal actors.  An irresolute polity meanwhile is an unstable polity.  The key variable here is the number of effective vetoes in the political system: the more vetoes there are in a polity, the more resolute and the less decisive it will be.  The reverse is also true.

The second major tradeoff engendered by separation of power and purpose in de­mocratic polities is between the private- and public-regardedness of public policy.  Ex­pressed as a question, the tradeoff boils down to how much of the policy making is distribu­tive in intent and the direction and scope of the proposed redistribution.  Is the distribution aimed at providing public goods that will promote the general welfare?  Or is it designed to favor particularistic interests and to satisfy narrow and special demands?[19] Again, the key, but not the only, determinant is the number of effective vetoes.  The greater the number of ef­fective vetoes, the more private regarding will be the policies enacted.  The greater number of veto players increases the difficulty and transactions costs of agreement.  Each veto player can demand and will receive side payments in the form of narrowly targeted policies (Kiewiet and McCubbins 1991; Cox and McCubbins 2001).

These tradeoffs will figure prominently in tax reform episodes given the redistribu­tive nature of tax reform.  Interests that are favored by an existing tax regime will most likely oppose any proposed tax reform.  They will likewise lobby with their political representatives to achieve their political objectives.  If the balance of social and political power is in their favor, then the system will be resolutely committed to a private-regarding tax regime.  The balance of power tilts in their favor if there are a great number of veto players in a given polity.  With many veto players, special interests will have more options for recourse. Com­petition among favor-seeking veto players also lowers the price of courting the support of at least one player.  After all, a single veto player can frustrate any proposed change.

A resolute system may prove to be dangerously indecisive especially in crises.  How­ever, a decisive polity also faces a different but equally important danger.  Having demon­strated that it can change policy, a polity must be able to convince private agents and the markets that it will stick to the new policy.  This is so since the ability to change policy also implies that policy can be reversed.  If private actors do not believe that the new law will persist, then they may avoid following the law and dig in to wait until it is repealed in the next legislative cycle (Haggard and McCubbins 2001).

In sum, tax reform could be construed as a bargaining game between relevant political actors and interests. Qua game, tax reform is played according to a certain set of rules.  These rules are institutional parameters of the bargaining game.  Given a particular set of institutional structures or parameters, a polity is confronted with two trade-offs—between private regarding, particularistic and public regarding, welfare-enhancing policy; and between resoluteness and decisiveness.

[1] Quoted in James and Nobes (1992, 4).

[2] It is only a potential since one cannot be sure that the tax revenues collected will be spent to provide public goods.

[3] As Mann (1993: 391) puts it: “The best organized government office of the eighteenth century was probably the British Excise Department”.

[4] Moore (2004: 300) cites this example: “For example, a commitment to strengthen the Royal navy to push Dutch merchants out of North America would, if successful, generate more trade for English merchants and for London, Bristol and Plymouth, and result in higher trade taxes for the crown”.

[5] In the 1760s, the British government imposed new taxes on the American colonies to help pay for the debts incurred by the Seven Years War.  These levies provoked an unprecedented level of organized resistance in the colonies including petitions, boycotts, riots, assemblies of enraged citizens, the formation of anti-tax militias and appeals from the colonial legislatures, which eventually led to the Revolution of 1776, which eventually led to both US independence and a government with strong representative organs.  The American colonists also developed, drawing from British historical experience (particularly the Glorious Revolution of 1688), a theory of rights to underpin the tax rebellions and the subsequent Revolution: that peoples could only be taxed with their consent (Bailyn 1967; Bailyn et al. 1977; and Morgan and Morgan 1953).

[6] Ross (2004) tested the claim using pooled time-series cross-national data from 113 countries between 1971 and 1997.

[7] The ‘revolutionary taxation” of the New People’s Army (NPA) comes to mind here.

[8] Contemporary economic analysts rarely use the concept of ‘tax culture’.  The term itself is attributed to Joseph Schumpeter in his 1929 article “Economics and Sociology of the Income Tax” (translated by B. Nerre). While Schumpeter looked at tax culture as the ‘artistic’ creation of tax economists and tax politicians (since he also regarded taxation as an art and the income tax as the “sweetest blossom of ‘tax culture’, the ‘highest achievement’ of the technique of taxation and tax equity” (Schumpeter 1929: 382), more recent interpretations of tax culture consider it to be more than the ‘culture of taxation’ and ‘tax-paying culture’.  Tax culture is seen as country-specific and is unique and represents the “entirety of all relevant formal and informal institutions connected with the national tax system and its practical execution, which are historically embedded within the country’s culture, including the dependencies and ties caused by their ongoing interaction” (Nerre 2001: 12).  Thus, a tax culture is just a subset of a national culture.  Cultural norms and historically developed institutions co-determine a country’s tax code.  The tax code in turn sets the environment and the rules of the tax ‘game’. The relevant players of the said game include (among others) taxpayers, revenue officials, politicians, experts (e.g. tax lawyers and accountants), and academics.  Nerre (2001) is the latest systematic discussion of this rather rarely used concept.

The June 22-July 3, 2004 survey conducted by the polling firm, Pulse Asia, gives an indication of the tax consciousness of contemporary Filipinos.  The Ulat ng Bayan nationwide survey, probed into Filipinos’ views on how the government of President Gloria Macapagal-Arroyo can address the budget deficit. In general, Filipinos disagree with the imposition of new or increased taxes as a first option and would rather see government cut wasteful spending due to inefficiency and corruption. However, a substantial proportion (30%) of Filipino adults would not oppose new or higher taxes if this leads to improvement in the quality of government services. More than ¾ (at 78%) of adult Filipinos see no need to impose new taxes, as long as the government strengthens its tax collection efforts. They agree with the test statement “There is no need to impose new taxes, just make sure everybody who should pay actually pays.” A small minority (8%) disagrees with the statement, while 14% are undecided.  In addition, 77% of adult Filipinos believe that government should curb wasteful spending while only 9% disagreed with the probe statement, “The government should just cut out wasteful spending that is due to inefficiency and corruption so that it will have enough money”, and some 14% were undecided.  Agreement with this statement was strongest among Metro Manilans and among the economically better-off ABC classes (Pulse Asia 2004; Maragay 2004a).

[9] The consumption of a unit of a public good does not prevent enjoyment of the same by somebody else.  For this reason, every citizen has an incentive to ‘free ride’, i.e., to allow others to pay the taxes necessary to finance the provision of the same public good.

[10] This approach holds that “an equitable tax system is one in which the amount of tax a person pays is in line with the benefits he or she is thought to receive” from the government (James and Nobes 1992: 262).  The main attraction of this principle is that it can include both the taxation and the resulting government expenditure.  Its main weakness lies in the difficulty in ascertaining who actually benefits from the public expenditures that are funded by taxes.  Furthermore, public expenditures such as old-age pensions are outright transfers or redistribution of income towards those in need.

[11] This approach argues that “the amount of taxation individuals pay should be related to their means rather than to the benefits” they receive from government (James and Nobes 1992: 262).

[12] I owe this point to UPSE dean Raul Fabella.

[13] The discussion in this section borrows heavily from Ascher (1989), Bates (1989), and Bird (1989).

[14] In a more formal manner, Arrow produced the famous impossibility theorem, which asserted that collective choice could not bring about a social state which satisfies five conditions: Pareto optimality (P), non-dictatorship or democracy (ND), rationality (R), independence of irrelevant alternatives (I), and unrestricted domain of preferences (U).  These five conditions would satisfy the most demanding arbiters of utopianism.  A Pareto optimum exists when the welfare of one individual cannot be increased without reducing the welfare of another.  The choice is obvious for democracy, where no individual has full control over the collective decision process.  The same is true for the rationality axiom, which provides that the collective choice process can completely rank all alternatives presented for consideration, and, that these rankings display the property of transitivity.  The (U) axiom requires that all possible combinations of preference orderings be allowed for consideration by the collective choice process.  The (I) requirement states that the selection of either of two alternatives by the social choice process must depend on the individuals’ orderings over only those two alternatives, and not on individual orderings over other alternatives.  For a succinct discussion of the Arrow impossibility theorem and its proof, see Inman (1987).  Even if the seemingly innocuous and trivial (I) requirement is dispensed with, the Arrow dilemma could not be avoided.  Inman’s summary: we face a hard choice between democracy and decision-making efficiency.  If Arrow’s is combined with the Gibbard-Satterwaite theorems, a discouraging conclusion results: There is no collective choice process that is democratic, decision-making efficient, allocatively efficient, and immune to strategic manipulation.  This footnote is taken from Mendoza (1992).

[15] The value-added tax (VAT) is attractive to many governments because of its self-enforcing features.  The VAT is popular because it creates incentives for one taxpayer to report the earnings of others.  The taxpayer takes note of the inputs she obtains from others to reduce her taxable income.  She must therefore demand receipts from her suppliers so she can calculate her net-VAT-able income.  If the suppliers issued receipts, then they cannot conceal or will find it difficult to under-declare their taxable income.  However, these features of the VAT system are defeated by exemptions of all kinds since the document chain will be broken.

[16] I owe this explanation and illustration to Joseph Capuno of the UP School of Economics (telephone conversation with Capuno, 19 September 2004).  Raul Fabella pointed out meanwhile that if a simple majority rule is adopted, a ‘proto-dictatorship’ can emerge as 51% will simply vote to divide the P100 among themselves and leave nothing for the rest (consultation with Fabella, 11 October 2004).

[17] While some scholars treat organizations as institutions, North insists that institutions are to be understood as rules while organizations are systems of humans and resources formed to achieve desired objectives (North 1993).

[18] A fourth delegation takes place as bureau and agency chiefs (as principals) instruct their subordinates (as their agents) to implement public policy and programs. In this sense, therefore, the quality of a democratic polity from the viewpoint of the citizenry is defined by quality of the bureaucrats and public employees at the trenches of the state—the immigration agent, the traffic policeman, the clerk at the town hall, the nurse at the health station, etc.

[19] Examples of these interests include regional or ethnic constituencies, influential political financiers and supporters, and interest groups.

  1. Richard Hombek says:

    Simple administrative change = Revolution in taxation in Canada
    Case for the Composite Business Levy.

    The taxes we know today can be traced back millenniums, as far back as the Egyptians who were taxed in the form of crop percentages as recorded on papyrus around 3000 BC. Since then several forms of taxation have evolved and continue to do so as the system become ever more complicated and consequently, ever more inefficient.

    The same business or individual can be taxed several times, even on items that are already taxed (i.e. gasoline). We have income tax, sales tax, real estate tax, property transfer tax, health tax, Employment Insurance, the Canadian Pension Plan, capital gain tax, capital tax, excise tax not even including licensing fees and tolls that could easily fill a page. The number of taxes imposed on Canadian and the level of taxation will soon reach historical highs once the full impact of the budget deficit is taken into account. And yet, we’re still ‘in progress’ as the system continually grows more complicated.

    Tax codes and regulations are thousands of pages long and businesses and citizens are expected to know these regulations. It seems an absurdity, considering even specialists have to consult one another when examining the fine print of the law and even then, full compliance with all of the regulations is not a guarantee.

    Imagine for a moment, the vast amount of administration costs associated with the imposition, collection and enforcement of each tax, toll and fee. To help understand this better, let’s take a look at real estate tax. To simply put a value on every piece of real estate property in Ontario costs $180,000,000/year and the cost of collection comes on the top of it. Annual real estate taxes in Canada amount to approximately 3% of Gross Domestic Product. Real estate properties are gradually becoming more liabilities than assets.

    By using a personal experience, I can illustrate this example better. Several years ago, I was offered a research position in Westchester County in New York. I was very excited about this opportunity and after some consideration, decided uproot my family from Ontario for a few years. One sunny spring weekend, our real estate agent took my wife and I house hunting. After visiting a few properties, a large bungalow with a swimming pool attracted our attention. The price was an extremely tempting $130.000. We couldn’t believe our luck! However, if something feels too good to be true, it probably is. The real estate tax was $26,000 a year. What does that mean? It means that if I bought the property, I would essentially be paying the local government of Westchester County the price of my house in taxes every five years. The situation in other US jurisdictions and in many Canadian municipalities has not yet reached that extreme however, we are moving in that direction.

    A recent study from 2008 by Fraser Institute, estimated that the cost of compliance of tax regulations for businesses and individuals in Canada, as well as the administrative costs for the government, could reach over $30 billion per year. The number does not include differed costs and unfunded liabilities such as pensions and benefits for the government and business employees. Also not included are the costs of lost business opportunities caused by a complicated taxation system.

    The total amount of taxes collected by all levels of government is around 33% of Gross Domestic Product or in the range of $450 billion. Most people accept the fact that society needs certain levels of government and that we pay our taxes to support government activities. This should not mean however, total acceptance of wasteful and complicated methodologies. The simplified schematic of the current taxation system is presented in Figure 2. Only the main sources of government revenues are taken into account and only the main pathways of money flow are included, the real situation is much more complex.

    Many organizations and individuals are trying to improve the situation and offer solutions for the simplification or total overhaul of the taxation system (i.e. the Flat Tax). Many of these suggestions however are politically dead at the start line because they change the current level of taxation, which would of course be opposed by all who would be subjected to increased tax obligations. For a while, I thought that any meaningful reform on the current taxation system was futile but I was wrong. What if I told you that a simple administrative change can eliminate all the taxes and complicated bureaucracy that goes along with it?

    This administrative change is illustrated by using a simple graph (Figure 3). The rectangle on the left represents the price of the product or service under the current tax system. Within it, one can see the cost components including different types of taxes. The question is, what would happen if all of the net costs are separated from the taxes associated with then the remaining taxes are combined (as one as shown by the rectangle on the right)?

    The answer is: the creation of a new and sustainable taxation system. Let’s call this lumped together taxes and fees the “Business Levy” (BL). Created this way, the BL is not a new tax on business. It is simply a replacement as a single charge of all existing taxes already paid by the business or collected by the business on behalf of the government. This collection of all government revenues from a single source of gross business revenue will create a stable source of government revenue. The flow of money in the new system is presented in Figure 1. So how do we determine the BL to guarantee that the same level of government revenue collection withstands? The solution is very simple. Let’s start with the definition of Gross Domestic Product (GDP). GDP is “the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports” (Ref ?). If we take the sum of government budgets at all levels: municipal, provincial and federal, and subtract from it any transfers between governments, divided by the GDP, we get an average rate: the “Business Levy.”

    For a country like Canada, with complex taxation jurisdictions, we have to slightly complicate the system by introducing a “Composite Business Levy” (CBL) which consists of a federal, provincial and municipal component. The level of CBL will be determined for each sector of the economy and in each jurisdiction to reflect the current level of taxation. This will be a one-time exercise at the introduction of the new system. By taking this approach, taxes collected in specific provinces will be allocated to the respective province. Each taxation jurisdiction will retain freedom of changing their part of the CBL.

    This system, very simple in nature, is able to replace all the tax codes and regulations. As a consequence, business and personal financial decisions will be made based on the outcome of transactions without tax implications.

    Since business payroll deductions are included in this system, employees will receive the net pay under the new system to avoid changing of the total money supply in the economy and avoid inflation. All programs and benefits provided by the government will be fully financed and the administrative savings will give the governments new resources for extra stability. Capital gain and interest income are not considered a business revenue under this system. The combination of that and net employment income will allow individuals not involved with business activities out of the tax regulations and obligations. Business real estate taxes are automatically part of the BL system. Residential property taxes are also included in the scheme and financed partially by administrative savings offered by the new system. A slight increase in BL (1-2%) could be transferred to consumers in the form of a price increase.

    The positive consequences of this approach will touch every citizen and business. Specific outcomes for each sector of economic activities will be described in separate articles. Displaced employees involved in the current taxation system could be transferred to other government departments which experienced manpower deficit or presented with generous transition packages.

    This approach to the taxation system reform is a realistic an politically and economically attractive for many reasons:
    saves more than $30 billion a year
    eliminates all tax regulations
    makes Canada very attractive place to do business
    does not change the level of taxation of any party involved
    does not change the money supply in the economy
    reduces the cost of services and goods manufacturing
    keeps individuals not involved in any business out of taxation system
    stable source of revenue related to GDP.

    The economic impact of this reform can significantly reduce the budget deficits on federal and provincial levels. The governments can focus on governing and not be preoccupied with the revenue generation.
    The collection and distribution system of government revenues is fully automated. The governments will have real time economic statistics for each sector of economy and each jurisdiction.

    The implementation of this reform is very simple at negligible cost. What will be required to be a reality?
    On the government side: determination of the average Composite Business Levy for each sector of economy in each jurisdiction (one time exercise), voiding all tax regulations and dealing with displaced employees.
    On the business side: opening the special bank account called “Business Gross Revenue Account”. Any business gross revenue must be deposited to this account. The only functions of this account will be: retaining the information on the source of the revenue and redirecting the money to Government General Revenue Account according to Composite Business Levy and to business operating account.

    This reform will greatly benefits Citizens, businesses and all levels of government.

    The Members of Parliament and Senators have received a copy of a presentation describing this tax reform and some have expressed active interest in it. I hope that all of us will have enough determination to make Canada the world leader in modernization of taxation system.

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