Regarding fundamental tax reforms, the tax reform principles often play a vital role. They function as the pathfinder for fundamental tax reforms.
There have been a large number of debates regarding what comprises the ideal tax system or tax infrastructure. According to Adam Smith, the famous classical economist, there are four established rules or principles of tax reform and he articulated these principles in his notable book, "The Wealth of Nations", written in the year 1776. These principles are popularly known as the "Four Canons of Taxation".
The principles delineated by Adam Smith are the following:
- Equality or the capacity to pay: People should pay tax according to their ability or level of income
- Certainty: The amount of tax payable, the method of payment and the time for payment should be specific
- Convenience in payment: The taxpayer should find it comfortable in paying his taxes
- Economy in collection: The collection of tax should not create a burden on people in terms of expenses and at the same time, the government should receive the least possible amount of tax from the people
Besides these, the principles of tax reform should focus on the following:
- The tax reform should enhance economic performance in terms of economic growth rate. Economic development is influenced by tax infrastructure through investment, savings rate, human capital investment, and entrepreneurship.
- The tax reforms that intimately connect tax payments to expenses would encourage a highly efficacious government.
- The tax reforms should fortify the federal tax system where the authority is delegated to the local governments and state governments and private organizations as far as possible.
- The tax system should be steady in nature and not complicated (free of doubts)
- Tax reforms should contribute towards a flourishing and steady economy
The principal decisions that are involved in planning an ideal tax system are the following:
- Tax rate(s): Progressive, flat, levels
- Tax base(s): Consumption, income, hybrid; transactions or people
- Time period of account: Annual, transaction, longer-horizon
- Unit(s) of account: Individual, family, transactions
