Introduction
Across the world, governments tax people’s income in order to generate revenue for economic development of nations. It is imperative to note that income tax revenues constitute the biggest percentage of the revenue generated by the government. For instance, in Canada, the biggest share of government revenue comes from personal income at 75% compared to 25% that come from other forms of taxation.
So far, the progressive tax structure employed by the Canadian government seem effective than flat rate structure that other countries use, at least according to some analysts.
In Canada, the Canadian Revenue Agency has the responsibility of collecting personal, corporate and other income taxes on behalf of the federal government. It has the responsibility of collecting all forms of taxes in all provinces and territories with the exception of Alberta and Quebec (Aronson, Johnson and Lambert 262-270).
Taxation is not a new phenomenon as it is an old practice well known and supported by numerous acts and statues, as part of legislation. In Canada for example, the Income Tax Act empowers the federal government the ability to collect all forms of taxes from incomes. Among the taxes are personal and corporate income taxes. Different counties have different tax regimes.
In Canada, self-assessment regime is common where individual citizens evaluate their tax liability by making tax returns to the Canadian Revenue Agency within the stipulated time. Consequently, the Canadian Revenue Agency will evaluate the tax returns and data in order to ensure that there are no obvious errors.
In case the taxpayer does not agree with the Canadian Revenue Agency in terms of his or her tax assessment, there are proper channels of making an appeal (Gentry and Hubbard 283-287).
Implication
There are two major structures, the progressive tax structure and the flat rate structure. To start with, the progressive rate structure of tax requires individuals with tax ability should not only pay more taxes for their higher income, but also pay a larger percentage of their incomes in tax.
On the other hand, the flat rate structure of tax takes away a same percentage of incomes from everyone who has the duty to pay taxes without considering the gap of different taxpayers. These two structures have their own merits and demerits (Auerbach, Kotliko and Skinner 81-100).
To start with, the progressive tax structure emphasizes on equality rather than the general collection of personal income tax. Under progressive tax structure, the more the personal income, the more tax, hence it brings equality. In addition, progressive tax is also efficient because it can adjust itself to the changes in economy.
In times of inflation, the progressive tax structure is the best as it corresponds to the hard times of inflation, for example, the widespread wage increase. Additionally, the progressive tax structure enables distribution of wealth among all classes of people with an aim of bringing social equality (Clemens and Veldhuis 5-7).
Progressive tax structure versus Flat tax structure
According to many analysts, the progressive tax structure that the federal government of Canada uses is advantageous towards the realization of full economic of the citizenry and the country at large. In fact, they credit it as the best structure of taxation as compared to flat structure.
As Calsamiglia and Kirman notes, there has been a growing concern that personal and corporate taxes discourage economic growth by making many Canadians less interested to work. This is especially evident if a country applies the flat structure.
In addition to this, entrepreneurs always complain of additional incurred costs arising from the flat tax code and the inefficient collection system. Consequently, this has created huge and unmatched incentives owing to the distorted supplementary costs (1142-1154).
Simplicity: In terms of simplicity, Canadians believe that the progressive tax structure is simpler as compared to the flat tax structure. For example, in order to file tax returns, people spend so much money and time to not only file the records, but are also able to maintain them due to the simple tax code.
On the other hand, under the flat tax structure, the Canadian Revenue Agency will spend so much money to enforce tax laws and collect personal income taxes—over $30.8 billion annually. Thus, comparing the two structures, in terms of compliance, progressive tax structure is proficient, while in terms of administrative costs, flat tax is proficient.
Efficiency: In terms of efficiency, the progressive tax structure raises the projected revenue, and addresses the economic disruptions arising from taxation. Personal income taxes change incentives that are paramount in the production behavior, meaning, many people would invest or even have money to save. In fact, progressive tax structure may be efficient in terms of establishing equality, but it has disadvantages too.
A good example is that it slows the pace of economic progress of activities. On the other hand, flat tax is an epitome of efficiency, but it fails to address some of the issues arising from taxation such as consumption rather than income. In other words, the Canadian-tax system should stick to the progressive tax structure in order to promote savings and investments.
Flat tax structure mandates the federal government to tax individuals or families on expenditure rather than their incomes. In a way, this will affect government revenue and the general economy. The progressive tax structure minimizes the progressive tax structure rates through rising rates, thus, creating equality in terms of taxation (Calsamiglia and Kirman 1160-1172).
Fairness: As discussed above, although flat tax has some advantages, it fails to address some pertinent issues. For example, in order to bring equity to the current tax system, horizontal and vertical equity are necessary, and this is only possible under the progressive tax structure.
Horizontal Equity: In economics, horizontal equity is a situation whereby all persons or households who get the same amount of income pay equivalent tax deductions. It is true that the current progressive tax structure achieves horizontal equity because people pay tax according to their income. Consider an example where a corporate pays dividends to a Canadian with a shareholder of 21% in a firm.
The progressive tax structure proposes a 19.6% tax rate at provincial level and 14.5% tax rate as federal income tax. It therefore means that progressive tax structure rates vary unlike the flat rate structure where rates are the same even for people with low income. Additionally, unlike the progressive tax structure, flat tax encourages equal pay of tax for every individual without considering the levels of their income (Kaplow 139-143).
Vertical Equity
Under vertical equity, people who generate more income ought to pay corresponding higher taxes. In all provinces that make up Canada, with exception of Alberta, individuals with high personal income pay higher tax rates on their income. As Kaplow notes, in terms of progressivity, the flat tax structure needs more attention, and Canadians do not enjoy progressivity owing to flat marginal income tax rates.
On the other hand, the progressive tax structure brings equality as the more the income, the more the tax; hence, it not only removes the negative aspect of increasing marginal tax rates, but also ensures progressivity.
In other words, a single-flat tax will encourage distinctiveness of individuals or households, but the progressive tax structure encourages investment in entrepreneurial activities at much lower marginal tax-cut rates (147-154).
Government Revenue
Many Canadians prefer the progressive tax structure rather than the flat tax structure. This is simply because they believe that the flat rate structure comes with many risks, which will paralyze the operations of the government. A flat rate structure on personal income means that all people irrespective of their income levels will have to pay similar amount as taxes. In other words, the revenue generated would not be high.
Additionally, the flat rate structure will be a disadvantage to low income earners who would like to save some money and invest it in entrepreneurial activities. It is also important to note that the median income earners and the above pay more than 95% of federal personal income taxes.
Notably, the government will have difficulties to retain the same revenue under the flat rate structure of personal income tax on conditions that other terms remain constant(Hall and Rabushka 465-476).
Another disadvantage of the flat rate structure is that it functions as “auto stabilizer”. Meaning, the revenues collected by the government will be low in comparison with the progressive tax structure. Largely, under the flat tax structure, the economy of a country is likely to deteriorate or remain the same.
Certainly, the government can respond to the risk by enlarging tax-base, lowering marginal tax rates, and canceling tax exemptions. This is the reason why progressive tax structure is more convenient than the flat tax structure.
It is also imperative to note that in terms of administrative and operational costs, the progressive tax structure is more convenient than the flat tax structure.
The Canadian government has put in place proper infrastructure, and an impeccable administration management system for both personal and corporate income taxation. Consequently, this will not only improve tax collection afterwards, but also increase the gross government revenues (Paulus and Peichl 620-636).
Conclusion
In Russia, a country that introduced 13% flat rate tax in 2001, government revenue did not increase. Instead, flat rate structure made it easier for some people to evade paying personal income taxes. The government of Russia does not collect the same amount of revenue it used to collect under progressive tax structure.
There are also reduced incentives and decreased labor supplies among other things, which are bad to the economy. Looking at the implications of flat tax on vertical equity, government revenue, fairness, generation of incentives, and economic efficiency, one cannot easily choose between flat rate and progressive tax structures.
In terms of efficiency, flat rate is more convenient, but on economic efficiency, government revenue, increase of incentives and effectiveness, the progressive tax structure is effective. Therefore, the progressive tax structure is the best suited for personal income structure.
Works Cited
Auerbach, Alan, Joseph Kotliko and Jeff Skinner. “The efficiency gains of dynamic tax reform”. International Economic Review 24 (1993): 81-100. Print.
Aronson, Richard, Paul Johnson and Peter Lambert. “Redistributive Effect and Unequal Income Tax Treatment.” Economic Journal 104.1 (1994): 262-270. Print.
Calsamiglia, Xavier, and Alan Kirman. “A Unique Informationally Efficient and Decentralized Mechanism with Fair Outcomes.” Econometrica 61.5 (1993): 1147-1172. Print.
Clemens, Jason, and Niels Veldhuis. Growing Small Businesses in Canada: Removing the Tax Barrier, Ontario: The Fraser Institute, 2005. Print.
Gentry, William, and Glenn Hubbard. “Tax Policy and Entrepreneurial Entry.” American Economic Review 90.2 (2000): 283–287. Print.
Hall, Robert, and Alvin Rabushka. “The Route to a Progressive Flat Tax.” Cato Journal 5 (1985): 465-476. Print.
Kaplow, Louis. “Horizontal Equity: Measures in Search of a Principle.” National Tax Journal 42 (1989): 139-154. Print.
Paulus, Alari, and Andreas Peichl. “Effects of Flat Tax Reforms in Western Europe.” Journal of Policy Modeling 31.5 (2008): 620-636. Print.