Tax Policy Concept Statement 1 Guiding Principles Of Good .
Tax Policy Concept Statement 1Guiding principlesof good tax policy:A framework forevaluating taxproposalsi
About the Association of International Certified Professional AccountantsThe Association of International Certified Professional Accountants (the Association) is the mostinfluential body of professional accountants, combining the strengths of the American Institute of CPAs(AICPA) and The Chartered Institute of Management Accountants (CIMA) to power opportunity, trustand prosperity for people, businesses and economies worldwide. It represents 650,000 members andstudents in public and management accounting and advocates for the public interest and businesssustainability on current and emerging issues. With broad reach, rigor and resources, the Associationadvances the reputation, employability and quality of CPAs, CGMAs and accounting and financeprofessionals globally.About the American Institute of CPAsThe American Institute of CPAs (AICPA) is the world’s largest member association representing the CPAprofession, with more than 418,000 members in 143 countries, and a history of serving the public interestsince 1887. AICPA members represent many areas of practice, including business and industry, publicpractice, government, education and consulting. The AICPA sets ethical standards for its membersand U.S. auditing standards for private companies, nonprofit organizations, federal, state and localgovernments. It develops and grades the Uniform CPA Examination, offers specialized credentials, buildsthe pipeline of future talent and drives professional competency development to advance the vitality,relevance and quality of the profession.About the Chartered Institute of Management AccountantsThe Chartered Institute of Management Accountants (CIMA), founded in 1919, is the world’s leading andlargest professional body of management accountants, with members and students operating in176 countries, working at the heart of business. CIMA members and students work in industry, commerce,the public sector and not-for-profit organizations. CIMA works closely with employers and sponsorsleading-edge research, constantly updating its qualification, professional experience requirementsand continuing professional development to ensure it remains the employers’ choice when recruitingfinancially-trained business leaders.ii Guiding principles of good tax policy: A framework for evaluating tax proposals
Contents2 OverviewPurpose of this tax policy concept statementGuiding principles of good tax policyFormulations of principles of good tax policy7Explanations of the guiding principles of good tax policyEquity and fairnessCertaintyConvenience of paymentEffective tax administrationInformation securitySimplicityNeutralityEconomic growth and efficiencyTransparency and visibilityMinimum tax gapAccountability to taxpayersAppropriate government revenues11 Challenges13 Conclusion14 Bibliography15 Notice to readers1
OverviewPurpose of this tax policy concept statementDiscussions occur regularly among politicians, economists, tax practitionersand others about changing national and subnational tax systems. Anysuggestion for modifying tax rules — whether major or minor — raises thequestion of how to best analyze and compare proposals. A frameworkbased on appropriate tax policies is needed to effectively analyze proposalsto change tax rules and tax systems. Such a framework, based on widelyaccepted principles, also provides an objective approach for evaluating andimproving existing tax rules.2 Guiding principles of good tax policy: A framework for evaluating tax proposals
Guiding principles of good tax policyThe guiding principles, listed below, are commonly citedand used as indicators of good tax policy. The firstfour principles are the maxims of taxation laid out byeconomist Adam Smith in his 1776 work, The Wealthof Nations.1 These principles, along with the additionaleight, have been used for many years by governments,economists, tax advisers and others.2 The numberedorder of the principles in this statement is for referenceonly and is not an indication of the order of importanceof these principles.1. Equity and fairness — Similarly situated taxpayersshould be taxed similarly.2. C ertainty — The tax rules should clearly specify howthe amount of payment is determined, when paymentof the tax should occur, and how payment is made.3. C onvenience of payment — Facilitating a required taxpayment at a time or in a manner that is most likelyconvenient for the taxpayer is important.4. E ffective tax administration — Costs to collect a taxshould be kept to a minimum for both the governmentand taxpayers.5. Information Security — Tax administration mustprotect taxpayer information from all forms ofunintended and improper disclosure.6. S implicity — Simple tax laws are necessary so thattaxpayers understand the rules and can comply withthem correctly and in a cost-efficient manner.7. Neutrality — Minimizing the effect of the tax lawon a taxpayer’s decisions as to how to carry outa particular transaction or whether to engage in atransaction is important.8. Economic growth and efficiency — The tax systemshould not unduly impede or reduce the productivecapacity of the economy.9. T ransparency and visibility — Taxpayers should knowthat a tax exists and how and when it is imposedupon them and others. inimum tax gap — Structuring tax laws to minimize10. Mnoncompliance is essential.11. A ccountability to taxpayers — Accessibility andvisibility of information on tax laws and theirdevelopment, modification and purpose arenecessary for taxpayers.12. Appropriate government revenues — Tax systemsshould have appropriate levels of predictability,stability and reliability to enable the government todetermine the timing and amount of tax collections.1Adam Smith, The Wealth of Nations, edited by Edwin Cannan, New York, The Modern Library, 1994, pages 887 to 8902 or example, per the OECD: “Assuming a certain level of revenue that needs to be raised, which depends on the broader economic and fiscal policies of the countryFconcerned, there are a number of broad tax policy considerations that have traditionally guided the development of taxation systems. These include neutrality,efficiency, certainty and simplicity, effectiveness and fairness, as well as flexibility.” OECD, Addressing the Tax Challenge of the Digital Economy, 2014, page 30.3
Formulations of principles of good tax policyThe following table shows how the guiding principlescorrespond to commonly used formulations of criteriaused to analyze tax systems.AICPA principles ofgood tax policyOECD tax principlesEquity and fairnessSee neutrality below.CertaintySee simplicity below.Convenience ofpayment“ Compliance costs for taxpayersand administrative costs for the taxauthorities should be minimized asfar as possible.”Effective taxadministrationSee convenience of payment above.Information securityStructural features should keeppace with technological changes.Simplicity“ The tax rules should be clear andsimple to understand so thattaxpayers can anticipate the taxconsequences in advance of atransaction, including knowing when,where and how the tax is to beaccounted.”U.S. Joint Committee onTaxation (JCT) analysiscriteriaU.S. GovernmentAccountability Office (GAO)criteria for a good tax systemIs “the tax system fair? Doesthe tax system treat similarlysituated individuals similarly?Does the tax system accountfor individuals’ differentcapacities to bear the burdenof taxation?”Equity includes two principles:(1) ability to pay (horizontaland vertical equity), and (2)benefits received. “When makingjudgments about the overallequity of government policy, it isimportant to consider both howindividuals are taxed and how thebenefits of government spendingare distributed.”“ Can the tax system beeasily administered by thegovernment and can it inducecompliance by all individuals?Is enforcement costly? Cansome individuals successfullyavoid their legal liabilities?”Administrability including“processing returns, enforcement,and taxpayer assistance.”Is “the tax system simple?Is it costly for taxpayers todetermine their tax liability andfile their taxes?”Simplicity in terms of the“compliance burden (recordkeeping, planning, returnpreparation, and responding toaudits).”4 Guiding principles of good tax policy: A framework for evaluating tax proposals
AICPA principles ofgood tax policyOECD tax principlesU.S. Joint Committee onTaxation (JCT) analysiscriteriaU.S. GovernmentAccountability Office (GAO)criteria for a good tax systemNeutrality“ Business decisions should bemotivated by economic ratherthan tax considerations. Taxpayersin similar situations carrying outsimilar transactions should besubject to similar levels of taxation.”See economic growth andefficiency below.The system should not distorteconomic decisions.Economic growth andefficiency“ The systems for taxation should beflexible and dynamic to ensure thatthey keep pace with technologicaland commercial developments.”Does “the tax system promoteor hinder economic efficiency?That is, to what extent doesthe tax system distort taxpayerbehavior by imposing highmarginal tax rates on labor,saving, or other activities?Does the tax system createa bias against the domesticproduction of goods andservices? To what extent doesit promote economic growth?”Economic efficiency of taxchanges should be considered.Transparency andvisibilityMinimum tax gapTransparency of “tax calculations,logic behind tax laws, tax burdenand compliance.”“ The potential for tax evasion andavoidance should be minimizedwhile keeping counteractingmeasures proportionate to the risksinvolved.”“ Taxpayers understand theextent to which the tax laws areenforced.”Accountabilityto taxpayers3Appropriategovernment revenues“ Taxation should produce the rightamount of tax at the right time.”A more detailed explanation of each of the guidingprinciples is provided in the next section. Some of thechallenges in following the principles are also described.3“ Can some individualssuccessfully avoid their legalliabilities?”Despite the challenges, proposals for changes to the taxlaw should strive to consider all guiding principles. his principle ties to one of nine specified by the National Conference of State Legislatures (NCSL). This group’s explanation of this principle states: “The essenceTof accountability is that tax laws should be explicit, not hidden. Proposals for changes should be well publicized to stimulate debate.” National Conference of StateLegislatures, Principles of a High-Quality State Revenue System, Fourth Edition, June 2007.5
6 Guiding principles of good tax policy: A framework for evaluating tax proposals6
Explanations of the guidingprinciples of good tax policyEquity and fairnessSimilarly situated taxpayers should be taxed similarly.The principle of taxing similar taxpayers similarly is typicallydescribed in terms of equity. The concept of horizontalequity provides that two taxpayers with equal abilities topay should pay the same amount of tax. If a taxpayer hasa greater ability to pay than another taxpayer, the conceptof vertical equity comes into play, which means that theperson with the greater ability to pay should pay more tax.Of course, how much more tax to pay is a common topicof debate and, over the decades, has resulted in a varietyof ranges of graduated tax rates and exemption amountsleading to varying levels of progressivity of the tax systems.The principle of equity is often viewed as a fairnessprinciple. That is, many people view a tax as fair if taxpayerswith the greatest ability to pay have the highest tax burdens.Nevertheless, the term fair tends to have different meaningsto different people. For example, with respect to an incometax, consideration of a fair income tax system might arise if:1. All taxpayers are taxed at the same tax rate (a flat tax)because those with higher incomes will pay more thantaxpayers with lower incomes.2. Taxpayers with higher incomes pay tax at higher ratesthan lower-income taxpayers (a progressive tax).3. Many types of income are taxed the same (meaning, forinstance, that few or no types of income are excludedfrom taxation).4. It combines the elements of items 1 and 3 above.5. It combines the elements of items 2 and 3 above.Therefore, use of the word fair in describing a tax is betterused in the context of whether a tax system is perceivedas fair. This approach acknowledges some of thesubjectiveness of the term fair. Yet, as explained in the JCTand GAO reports, various measures exist to examine equityincluding distributional analyses of annual taxes, lifetimetaxes, and more.Generally, in evaluating the principle of equity, givingconsideration to the entire range of taxes a taxpayer issubject to, rather than to just one type of tax, is a must.CertaintyThe tax rules should clearly specify how the amount ofpayment is determined, when payment of the tax shouldoccur, and how payment is made. Certainty, rather thanambiguity, of a person’s tax liability is vital. The tax rulesshould specify the amount of the payment, when the taxis due, and how payment is made. A tax system’s rulesmust enable taxpayers to determine what is subjectto tax (the tax base) and at what tax rate(s). Taxpayersshould have the ability to determine their tax liabilitieswith reasonable certainty based on the nature of theirtransactions. If the transactions subject to tax are easy toidentify and value, the principle of certainty is more likelyattained. On the other hand, if the tax base is dependenton subjective valuations or transactions that are difficultto categorize, attaining the principle of certainty might nothappen. In addition, spelling out how the taxes are paidand when the taxes are due under the applicable laws, aswell as in the tax forms and instructions, is essential.Certainty is important to a tax system because it helpsto improve compliance with the rules and to increaserespect for the system. Certainty generally comes fromclear statutes as well as timely and understandableadministrative guidance that is readily available totaxpayers.The principle of certainty is closely related to the principleof simplicity. The more complex the tax rules andsystem, the greater likelihood that the certainty principleis compromised.7
Convenience of paymentFacilitating a required tax payment at a time or in amanner that is most likely convenient for the taxpayeris important. For example, assessment of tax upon thepurchase of goods should occur at the time of purchasewhen the person still has the choice as to whether tobuy the goods and pay the tax. Convenience of paymentis important in helping to ensure compliance with theConvenience of payment is importantin helping to ensure compliance withthe tax system.tax system. The more difficult a tax is to pay, the morelikely that payment will not happen. Typical paymentmechanisms include withholding (such as the withholdingof income taxes from employee paychecks) and periodicpayments of estimated tax liability. The appropriatepayment mechanism should depend on the amount ofthe liability and ease of collection as well as the equityof collection from all taxpayers. Also, consideration ofappropriate use of secure technology is important.Effective tax administrationCosts to collect a tax should be kept to a minimumfor both the government and taxpayers. Minimizingadministrative and compliance costs is critical.4 Thesecosts include the administrative cost to the governmentthat is influenced by the number of revenue officersnecessary to administer the tax. Consideration oftaxpayer compliance costs is also a must. This principleis closely related to the principle of simplicity. The morecomplex a tax, the greater the costs of governmentadministration and the greater the compliance costs fortaxpayers to determine and report their tax liability.4Consideration of appropriate use of secure technologyis also necessary. The benefits of any reform shouldoutweigh the costs of adoption, including transitional andimplementation costs.Information securityTax administration must protect taxpayer informationfrom all forms of unintended and improper disclosure.This includes, but is not limited to, adequate “firewalls” forsecurity of the tax agency’s internal system, safeguardsnecessary to prevent degradation of the system viafraudulent claims resulting from identity theft, as well assufficient controls to ensure that taxpayer information isonly disclosed to the appropriate parties as permitted bylaw. A tax administration’s responsibility for informationsecurity should extend to its employees, representatives,agents, and any contracted or affiliated party. Thisprotection must extend throughout the period theinformation is held, and must accommodate changes intechnology and threats against the information. Failureto provide adequate security ultimately results in erosionof the principles of equity and fairness, effective taxadministration, and appropriate government revenues.SimplicitySimple tax laws are necessary so that taxpayersunderstand the rules and can comply with themcorrectly and in a cost-efficient manner. Simplicityin the tax system is important both to taxpayers andtax administrators. Complex rules lead to errors anddisrespect for the system that can reduce compliance.Simplicity is important both to improve the complianceprocess and to enable taxpayers to better understand thetax consequences of transactions in which they engagein or plan to engage. Adam Smith’s maxims referred to this principle as “economy of collection.”8 Guiding principles of good tax policy: A framework for evaluating tax proposals
NeutralityMinimizing the effect of the tax law on a taxpayer’sdecisions as to how to carry out a particular transactionor whether to engage in a transaction is important.Minimizing the effect of the tax law on business andpersonal decisions is appropriate. The primary purposeof a tax is to raise revenue for governmental activities,rather than to influence business and personal decisions.Economic growth and efficiencyThe tax system should not unduly impede or reducethe productive capacity of the economy. All taxesreduce economic efficiency and create distortions, butgood tax policy minimizes these effects. The tax systemshould not hinder a jurisdiction’s economic goals, suchas economic growth, capital formation, and internationalcompetitiveness. The principle of economic growth andefficiency is maximized by a tax system that is alignedwith the economic principles and goals of the jurisdictionimposing the tax. For example, a jurisdiction’s tax rulesshould not pose competitive disadvantages for firmsresident in that jurisdiction relative to non-resident firms.Economic growth and efficiency are impeded by tax rulesthat favor a particular industry or investment, therebycausing capital and labor to flow to such areas forreasons not supported by economic factors. Such actioncan potentially harm other industries and investments, aswell as the economy as a whole.The principle of economic growth and efficiency isrelated to the principle of neutrality in that tax rulesthat distort taxpayer behavior may hinder economicefficiency. Evaluating a potential tax structure withrespect to neutrality between different forms of businessactivities to ensure that the enactment would not resultin discrimination in favor or against particular ways ofdoing business is vital.5Transparency and visibilityTaxpayers should know that a tax exists and how andwhen it is imposed upon them and others. Visibilityenables individuals and businesses to know the true costof transactions. It also enables them to see what theirtotal tax liability is and to which level of government it isbeing paid. When a tax is not visible, it is easily retainedor raised with little, if any, awareness among taxpayersabout how the tax affects them.Minimum tax gapStructuring tax laws to m
Guiding principles of good tax policy The guiding principles, listed below, are commonly cited and used as indicators of good tax policy. The first four principles are the maxims of taxation laid out by economist Adam Smith in his 1776 work, The Wealth of Nations.1 These principles, along with the additional
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