Taxation is the process by which each regime, governments and dynasties across the world collect the essential financial resources required in the running of welfare programmes meant for their citizens as well as to meet the day to day expenses of administering the area under their rule. From time immemorial, taxation was one of the core areas of State intervention and this policy of collecting revenues from the masses was practiced partially or fully in every historical civilizations and nation states. Thus government intervention in general and taxation, in particular, was a topic of interest for not just the administrators but also for numerous philosophers and thinkers. Understanding the historical perspective of taxation, as given by various such scholars over the course of time, thus helps us to not only understand the history of taxation but also how this fiscal instrument evolved into its present form and in what all ways it can be improvised for an efficient and productive scenario of economy and society.
Adam Smith and David Ricardo were two such classical economists who took a gander at the element of taxation and its role in any civilized society. Though they shared a common heritage of English ancestry and lived their lives as contemporaries, their principles on taxation and State intervention were unique within themselves and reflected the overall philosophical orientations of the both. Through this paper, an attempt is made to understand how these two eminent, enlightened Englishmen viewed the role of taxation and its influence in the affairs of the State. Being the most widely discussed economists of all time, a study on the taxation principles provided by these two social savants will be a fruitful exercise and will definitely generate a lot of constructive academic output.
Adam Smith on Taxation and State Interference
Adam Smith is often credited as the father of modern economics and is proclaimed even today for his classical work “An Inquiry into the Nature and Causes of the Wealth of Nations”, a book which contains major share of his popular ideas and economic propositions. This work is actually an omnibus of five small books or sections under which he discusses various themes. Among them, the fifth book is devoted completely to the matters related to the “Revenue of the Sovereign or the Common Wealth.” While looking into his propositions on taxation, however, it is necessary to understand the ideological background in which he formulated his arguments, particularly his views on government interference. Though the Smithian principles of taxation and his famous canons of taxation comes in his fifth book, his views on government and its interference should be analysed before trying to absorb the essence of his taxation principles.Smith always maintained the position that there should be minimum government interference to ensure the freedom of individuals. He firmly opposed the mercantilist position of maximum government control in social and public affairs. For him, ‘Man is an animal that makes bargains: No other animal does this – No dog exchange bones with another’ (Book 1, Chapter 2). In other words, he was implying that Man can bring the best when he is left for his own so that he will pursue for the best. However, Smith did recognise some form of State interference. Some of them were regarding the taxation. For instance, he was for the imposition of an import duty on goods over which a tax was levied in the form of an excise duty already so that equality in treatment will be safeguarded. Smith also recognised the importance of taxation as a matter of retaliation in the cases where the foreign trading partner imposed high duties.
The heart of the Smithian theory of taxation lies in the fifth part of his wealth of nations titled as “Of the Revenue of the Sovereign or the Commonwealth.” Though he supported the idea of revenue generation through taxation, he was concerned with the nature, level and intensity of taxation. Since he was very much oriented towards the free market principle, his idea was that government should only collect tax to an extent within which it could discharge the basic functions like defense, law and order, public services, etc. His contribution to the idea of taxation is still considered as classic, and it is doubtful that any other thinker before or after him surpassed his theories in terms of quality and acceptability.
David Ricardo and Principles of Taxation
Born into a Jewish family in London in 1772, he was a banker based in London. Though he was a stockbroker in his early life, he later retired into intellectual discussions and philosophical discourses. His companionship with many of his contemporary thinkers like James Mill, Jeremy Bentham and Malthus helped him with regard to this. Due to the overwhelming response to his theory of comparative advantage in international trade, his principles on taxation often went unnoticed though they were of superior quality and thought provoking.
According to this great Englishman of 18th century, tax is a share of the total product of land as well as labour provided at the disposal of the government for meeting its expenditure. While attempting to make a division between various forms of capital, he divides them into two broad categories: Fixed and circulating capital. And according to him, the State expands its capital holdings when its annual production outweighs its gross annual consumption. Though the capital can be reduced by higher consumption rates, he is of the firm opinion that this issue can be settled by further achieving higher production. For this purpose, he cites the example of the English government which increased its expenditure for 20 years without creating any drainage in the level of national capital due to the high production rates of the people. Ricardo is of the opinion that every tax has the power to reduce the power to accumulate as almost every tax falls upon the capital or revenue. Though every tax shares this common characteristic, the extent to which they cause this effect will vary across various forms of taxes and tax regimes.
Ricardo also points out the inverse relationship between the rate of taxation and government revenues. He has aptly stated that as the governments try to increase their revenues by proliferating the taxation, it will reduce the ‘annual enjoyments’ of the people, given the tax falls on the income of the people. On the other hand, if the taxation is derived from the capital in the hands of people, this in turn will retards the funds available to maintain the labour supply and thus leading to a shrinking effect on the future production levels of the economy. He also raises a strong point against the duties and taxes that falls upon the process of transfer of property from one individual to another. He suggests that the more it costs to attain a property, the lesser will be the net capital value of that property and this will further reduces the labour supporting funds.
Ricardian and Smithian Theories of Taxation – Symmetries and Conflicts
Any modern study of taxation will be incomplete and a half-done exercise without looking into the historical perspective of taxation; written rules and procedures of taxation of former nation States in general and the philosophical propositions of great thinkers and economists like Ricardo and Smith in particular. It will not only help us to understand how the concept of taxation was perceived by the people of those times but also helps us to trace how those ideas evolved into their present format. By analyzing the thoughts of Ricardo and Smith which, so far discussed in this paper, we can conclude that both the scholars supported the idea of taxation in general. Though the degree of their support for taxation varied from each other, they strongly believed that there should be some form of taxation as a source of revenue for the government to meet its expenditure. These men also identified the relationship between taxation and the after effects of taxation on the people who are being taxed.
However, it was Adam Smith who arranged his thoughts in a clear manner. It is evident from the fact that he was able to come up with four, well formulated, well defined canons of taxation to define an ideal tax regime. Also, his canons are more or less followed today whenever any government make decisions on the tax structure and rates. This in turn implies that his canons are still valid and holds true even after nearly 300 years after his demise. Both Ricardo and Smith was in favour of free trade and raised voice against any government interference beyond the minimal level. Ricardian theory of taxation proposed that tax should be an instrument used to reduce the conspicuous and luxurious consumption trends prevailing among the people; not a tool to raise government revenue by depriving the capital fund for maintaining labour supply in the production process.
Looking at the contradictions in the taxation theories Smith and Ricardo, we can find how these contemporary theoreticians differed on several aspects of revenue collection by the sovereign. In fact, Ricardo criticized Smithian theory of taxation and tax incidence on numerous grounds. Smithian system of thought on taxation gave exogenous character to rate of profits, as he considered rent as an endogenous variable. In other words, according to the Smithian theory, profit rates are not influenced by any variations arising within the system. He firmly believed that an expansion in taxation on raw materials, remunerations paid, profits earned and levies on rent, gradually decreases rent. Since the Ricardian theory lacks the idea of rent, it made the profit as an endogenous economic factor. Ricardian theory differs from that of Smith also because of the fact that Ricardo paid more attention towards the input-output relationship between commodities and because of the fact that their understanding of natural price systems were different from each other.
Thus Adam Smith and David Ricardo looked into the nature and essence of taxation through two different perspectives and their abstractions still attracts interest among novices who attempts to understand the evolution of taxation and the influence of economic thought over it.
-Contributed by Jiss Palelil
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