Definitions – What is a Tax, Purpose & Types of Taxes
Often the most popular knowledge about tax is that it is a nuisance and increases the price of a product. But why does a government, which exists for the welfare of the people, do something counter-intuitive to the cause as increasing the price of a product? There are many reasons.
Definition of a Tax
A tax is a statutory or a compulsory payment imposed by the government on a taxpayer.
A taxpayer could be an individual or a company of a country. The taxpayer is liable to make tax payments on various activities as defined by the regulatory authorities of the country, usually the government. The regulatory body has the right and the obligation to collect taxes, whereas the taxpayer has the responsibility to pay taxes. Failure to furnish appropriate tax payments is a criminal offense and is punishable with jail time.
Types of Taxes
The regulatory authority of a country holds the sole discretion into what is taxable and tax-exempted within the country. However, the most common types of taxes are listed below.
- Income tax (individual and corporate)
- Capital gains tax
- Wealth tax
- Property taxes
- Goods and services taxes (GST)
- Tariffs (taxes imposed on foreign trade)
- Environmental taxes
- Fees (Eg: tolls, tickets, government services)
Why Are Taxes Imposed?
There are several reasons why a government opts to impose a tax on an individual, corporate or a service.
(1) Source of Government Revenue
A government has the main duty of administering the welfare of its citizens. To do this, a government will have a massive labor force along with decision makers. The government will have to fund these administration activities by paying the parties involved salaries, and by implementing the decisions taken by these parties. The government is responsible for construction and maintenance of road networks, railway lines, power generation, education system, healthcare system, military and police system etc. All these projects usually require heavy investments which the private sector cannot afford. Hence, the government needs a source of income and taxing is their primary source of earning.
(2) Redistribution of Income and Wealth
The government has yet another key objective with imposing a tax. This is to minimize the unequal distribution of wealth or income among the general population.
Income Redistribution and Wealth Redistribution are two different concepts.
Income Redistribution has to do with leveling or minimizing the extreme gaps between income levels of people. Often governments adopt a progressive taxation method to put this economic policy into effect. Through a progressive taxation system, the percentage of tax will increase as the income earned increases. Thus persons earning a higher income will end up paying a higher tax amount, thus bringing down their take-home income.
Wealth Redistribution has to do with transfer of assets from the high net worth personnel to the lower. Through wealth redistribution, governments target for sustainable growth for the beneficiaries, than through income redistribution.
(3) As Means of Controlling Consumption
There might be instances where the government has to intervene into an economy’s consumption pattern. For an example, excessive import or selling of motor vehicles can cause many social issues such as traffic, pollution and fuel utilization. In such a case, the government might intervene and impose a tax on vehicles, thus making vehicle prices go up and reducing demand (Law of Demand). On the flip-side, the government might also want to encourage consumption. For an example, during festive seasons, prices of necessities could go up due to higher demand. In such a case, the government can reduce the tax on such a product and encourage people to satisfy their necessities.
Why Are Personal Taxes Important?
On an individual level, it is very important know the ABCs of taxes in order to comply and then minimize one’s tax expenses. The more taxes you pay, the lesser your purchasing power becomes. So it is mandatory to plan your taxes. The United States Supreme Court states: “The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted.”
There are many different ways of minimizing the taxes you pay through tax planning which we will look at in detail in a future article. In the meantime you can read the Royal Bank of Canada’s suggestions on tax planning.
