ACC5003 - Evaluating Income and Consumption Tax for a Fair System

This essay provides a comparative analysis of income tax and consumption tax, evaluating which system offers a fairer basis for levying personal taxes. It references Adam Smith's four canons of taxation (equality, certainty, convenience, and economy) to assess each system's merits and drawbacks. The essay discusses the structure and operation of the UK tax system, highlighting the role of Her Majesty's Revenue and Customs (HMRC) in administering both direct and indirect taxes. It explores the practical implications of each tax type, considering factors such as income distribution, tax compliance, and administrative efficiency. Ultimately, the essay aims to determine the extent to which income tax and consumption tax align with the desirable characteristics of a 'fair' tax system, drawing upon relevant examples and academic research to support its conclusions. Desklib provides a platform to access this document along with numerous study tools.

Running head: GOOD TAX SYSTEM
Good Tax System
Name of the Student:
Name of the University:
Authors Note:

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GOOD TAX SYSTEM
Her Majesty’s Revenue and Customs (HMRC) is a Government agency of the
United Kingdom (UK) responsible for collection of taxes and regulation of other
administrative matters. Subsequent to the merger of Inland Revenue and Her
Majesty’s Customs and Excise (HMCE) HMRC was formed on April 18, 2005.
HMRC is a non-ministerial agency of the Government operates under the
statutory rules of Majesty’s Revenue and Customs.Members of Executive
Committee and Non-executive Committee combined to form the Board of HMRC.
The members have the responsibility to develop and approve the overall strategy
of HMRC with the objective of maximizing Government revenue from direct and
indirect taxes in the country. Chief executive, chairman, executive chair and
permanent secretary, non-executive board members and other personnel
combine to administer and collect taxes under HMRC. Income tax and
corporation tax collection are the primary responsibilities of HMRC. Both
administrative and collection aspects of direct taxes are overseen by the
department. There are number of taxes which are part of direct and indirect taxes
such as capital gain tax, inheritance tax, indirect tax, value added tax,
environmental tax, excise duty and other taxes are administered and collected by
HMRC (McGowan, Thomson and Hardwick, 2016).
HMRC consists of cadre of criminal investigators as well as investigating officers
for income tax and other tax related matters who have been given wide variety of
powers to administer and investigate tax related matters and tax related frauds in
the country. Since HMRC has been formed with the merger of HMCE and Inland
Revenue hence, both direct and indirect taxes are administered by the officers of

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HMRC with the wide powers given to them by the department (Pogge and Mehta,
2016). In 2016/17 HMRC collected ₤557 billion on behalf of the Treasury with
estimated theoretical tax liabilities of ₤590 billion in the year. However, the gap
between the tax liabilities and the amount of tax collected, i.e. ₤33 billion is due
to the tax gap that is allowed as per the income tax provisions in the country.
Thus, approximately 95% of the tax liabilities are collected by HMRC successfully
by using its administrative powers. The tax collection of HMRC over the years
have been increased significantly with proportionate reduction in tax gap. The
actual tax gap over the years in the country has reduced due to the effective
administration of HMRC (James and Nobes, 2016).
Taxes in the country are primarily classified into two different types of
taxes, these are direct taxes and indirect taxes. Direct taxes primarily consists of
income tax on the residents of the country including individuals and corporations
(Sikka et. al. 2016).Income tax is the tax paid by individuals, sole proprietors and
corporations on their taxable incomes. Generally the following incomes are
considered in calculating income tax of individuals and others.
I. Income from employment such as salary wages and other employment
benefits received by the employees and workers.
II. Profits earned from business by self-employed individuals.
III. State benefits received by individuals in the country.
IV. Rental income received by residents and non-residents in the country.
V. Other benefits received from professional services.
VI. Income from trust.

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VII. Interest income on savings from banks and other public financial
institutions.
Income tax allowances and reliefs are allowed to the individuals and other tax
payers to calculate the taxable liabilities of individuals and other tax payers to
reduce the taxable income and resultant income tax liabilities of the tax payers in
the country. Total HMRC receipts over the years have increased significantly with
continuous increase in total collection of the Department. HMRC has managed to
increase its overall collection every year since 1999-2000. The collection of
income tax by HMRC over the years have increased significantly. The primary
source of revenue for the HMRC is income tax and as can be seen from the
above chart that each year HMRC has managed to increase the collection from
income tax. However, the collection from capital gain tax in the country has
fluctuated significantly over the years (Amir, Lazar and Levi, 2018).
Apart from direct tax HMRC is also responsible to collect and administer
indirect taxes in the country. The indirect taxes include customs, excise,
international trade duties, environmental tax, Value Added Tax and Insurance
Premium Tax in the country.
Excise and customs duty is payable by the corporates and other business
organizations for movement of goods from European Union to United Kingdom.
Not all goods are liable to customs and excise duty thus, it is important to have
knowledge about different goods which are subjected to Excise and Customs
duty as non-compliance with customs and excise duty attracts significant penalty

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on the part of business and corporates. Rates of excise and custom deities vary
with the nature of goods hence, it is important to use appropriate rates to
calculate the liability in respect of customs and excise duty and pay as per the
rules and regulations of HMRC (Chen, Chung and Novy, 2018).
One of the important component of indirect tax in the country Value Added Tax
has been collected by HMRC. In 2017-18 HMRC collected ₤125,363 million.
Adam Smith introduced four canons of taxation to make an effective tax
structure in the country to ensure effective and proper imposition and collection
of taxes to maximize the revenue of the Government. Thus, the objective of four
canons of taxation is to improve the tax collection system in the country to
maximize collection of tax and reduce tax avoidance and tax evasion the country
(Kay and King, 1990). Building a simple and effective tax structure to collect tax
in the country is the main goal of a country. In his book “Wealth of Nation” Adam
Smith has discussed about four canons of taxation which are essential to build
an effective and simple tax system in a country. A brief discussion about the four
canons of taxation is made here (Downer, 2016).
Generally equality means treating each and every one equally however, in
respect of four canons of taxation equality means ability to pay taxes. Equality in
case of taxation would result in huge burden on low income earners thus, in this
case equality means imposition of higher rate of tax for high income earners and
low rate of tax for low income earners to maintain general living of standards for
low income earners. Hence, the tax system in a country must divide its tax

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payers in different groups based on the taxable income of those tax payers. Tax
payers with higher taxable income should pay tax at higher rate and low income
earners should pay low income tax. Adam Smith has urged that tax system must
have equality to reduce the gap between the rich and the poor (Hallsworth et. al.
2017).
Canon of certainty is another canon discussed by Adam Smith in his famous
book “Wealth of Nation.” According to the author the taxes to be paid must be
certain and arbitrary. Certainty in respect of the following is essential in building
an effective tax system within a country:
I. The amount of tax to be paid.
II. The payment method and manner.
III. The authority to whom tax is to be paid.
IV. The due date for payment of taxes.
The above must be certain in order to ensure that there is no confusion amongst
the tax payers in the country in respect of above important aspects in tax
structure in the country (Hopkins, 2014).
Third canon of taxation in “Wealth of Nation” by Adam Smith talked about
canon of convenience. Convenience in general means easy, comfortable and
simple for the tax payers to report taxable income and pay taxes in the country.
Adam Smith talks about the importance of imposition of tax at correct time and in
correct manner to make it convenient for the tax payer to pay such tax. The tax
payers must feel convenient to pay tax in the manner to ensure effective and

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easy payment of tax without any problem. Throughout the globe the countries
which have most convenient taxation systems for the contributor have managed
to increase the tax revenues each year significantly. Thus, Adam Smith has
specifically given importance to the convenient aspect of taxation system in a
country (Idowu et. al. 2017).
Canon of Economy is the last and final canon of taxation discussed by
Adam Smith while discussing about canons of taxation in his book. The
importance of reducing tax collection expenses has been mentioned by Adam
Smith as a key contributor to increasing the overall tax revenue in a country.
Thus all efforts should be made to reduce the cost of collection of taxes to earn
large amount of net tax revenue. The author has advocated that an ideal tax
system shall be the one which should contrive to minimize both the expenses of
tax payers as well as the expense of the government to maximize tax revenue for
the government (King, 2016).
Consumption tax is based on the concept of consumption rather than
income. Thus, tax payers in ta country is required to pay tax on the amount of
consumption and not on the amount of income. However, consumption tax will
not be an effective method to comply with the four canons of taxation as
generally consumptions does not necessarily reflect the element of equality
(Manaf et. al. 2016). This is especially considering that there would definitely not
be huge different in consumption between the rich and the poor as the
consumption would be similar especially for food and daily necessary items.
However, certainty, convenience and economy aspects of taxation system in the

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country would depend on the effective implementation of tax provisions by
HMRC.
Income tax is based on the concept of income over consumption. The
individuals need to pay income tax on the basis of taxable income computed as
per the provisions of income tax in the country. In order to comply with equality
canon income tax rates have been determined for individuals in the country
(Nguyen, Onnis and Rossi, 2017). Taxable income up-to ₤11,850 does not
attract any income tax liability in the country where as income in excess of
₤11,850 and up-to ₤46,350 is taxed at the rate 20% with taxable income between
₤46,351 and ₤150,000 taxable at the rate of 40% and taxable income over
₤150,000 is taxed at the rate of 45%. HMRC has made provisions which must be
followed and complied with while calculating taxable income of individuals (Daly,
2016). The payment of income tax needed to be made to the credit of the
Treasury of the country on or before the due date to avoid penal provisions.
HMRC has tried to ensure that the taxpayers find no difficulty in payment of
income tax in the country. In order to motivate the tax payers in the country to
pay income tax correctly all necessary steps have been taken to make the tax
system convenient. HMRC has a successful rate of 95% in collection of tax
liabilities in the country shows how effective the tax system in the country.
However, additional steps need to be taken to reduce the tax gap between the
tax liabilities and tax revenue further in the future (Parada, 2015).
The four canons of taxation described by Adam Smith in his book of
“Wealth of Nation” have number of desirable characteristics to make an effective

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taxation system in the country however, there are certain cons to the four
canons. A brief description below shall be helpful in understanding the pros and
cons of taxation system in the country (Toder and Rosenberg, 2010).
Pros:
Canon of Equality makes it possible to reduce the gap between the rich and the
poor that exists in the society. Without this canon it would have been a huge
burden on the low income earners to pay tax at equal rates as paid by high
income earners. Thus, the balance in society in terms of equality by assessing
the ability to pay tax of the individuals is maintained effectively (Procter and
Radnor, 2014).
Canon of certainty helps in ensuring that there is no confusion amongst the tax
payers in respect of tax provisions in the country. Thus when it comes to the rate
of taxes, the due date of payment of taxes, the method and manner of payment
and the authority to whom taxes are to be paid help individuals to pay taxes as
per the rules and regulations of HMRC.
Convenient canon is certainly helpful and inspiring for the tax payers to pay tax
correctly. Individuals will be motivated to pay taxes correctly and properly by
following the simple and effective tax structure in the country (Revenue and
Customs, 2014).
Reducing the expenditures to administer and collect taxes in the country has
helped HMRC to improve the revenue of Treasury. The economy canon has
ensure that the overall revenue of the government of UK increases to meet the

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requirements of planned expenditures in the country (Crawford, Keen and Smith,
2010).
Cons:
However, there are certain negative aspects of these canons for effective tax
structure in the country. The convenience aspect of four canons often used by
tax payers to avoid payment of taxation as well for tax evasion purposes. Thus,
the tax authority must make sure that convenience dos not contribute to tax
avoidance and tax evasion in the country (Russell, 2016).
Progressive tax in the country is about improving the tax revenue with
increase in taxable income. The progressive tax in a country is directly related to
the canon of equality as can be seen from the following income tax rate as per
the rules and regulations of HMRC in the country (Lymer and Oats, 2018).
Taxable income Tax rate in the country
Income up to ₤11,850 Nil
Income between ₤11,851 and ₤46,350 20%
Income between ₤46,351 and ₤150,000 40%
Income in excess of ₤150,000 45%
The progressive tax is in essence directly connected with equality canon of Adam
Smith.

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Consumption tax on the other hand is not in conjunction with equality canon as
the tax payers only pay taxes on the amount of consumption thus, whether poor
or rich all need to pay tax at equal rates on the amount of consumption.
However, administration of consumption tax is significantly easier with equal tax
rates applicable on consumption (Sandford, 2015).
Discussion in this document has certainly enlighten us about different
elements in administration and collection of taxes by HMRC in the United
Kingdom. The taxation system in the country has very much incorporated the
four canons of taxation as discussed by Adam Smith in his famous book “Wealth
of Nation.” The canons of equality, certainty, convenience and economy of
taxation have been mentioned as important elements in developing an effective
and simple taxation system in a country. The rules and regulations used by the
HMRC has helped the Treasury of UK to improve its revenue over the years with
increase proportion of tax payers complying with different provisions of income
taxes in the country. However, it is important to understand that canons of
taxation must be used in improving the taxation system and to reduce the tax gap
in the country.

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References:
Amir, E., Lazar, A. and Levi, S., 2018. The Deterrent Effect of Whistleblowing on Tax
Collections. European Accounting Review, pp.1-16.
Chen, N., Chung, W. and Novy, D., 2018. Vehicle Currency Pricing and Exchange Rate
Pass-Through.
Crawford, I., Keen, M. and Smith, S., 2010. Value added tax and excises. Dimensions
of tax design: the Mirrlees review, pp.275-362.
Daly, S., 2016. 'R.(Hely-Hutchinson) v HMRC: Fairness in Tax Law and Revenue
Guidance. Available at: https://papers.ssrn.com/sol3/papers.cfm?
abstract_id=2745622 [Accessed on 20 November 2018]
Downer, p., 2016. Taxation of Electronic Commerce (e-comm): Examination of
Canadian Government Tax Policies and Directives Application of Adam Smith's
Canons of Taxation. Journal of Financial Management & Analysis, 29(1).
Hallsworth, M., List, J.A., Metcalfe, R.D. and Vlaev, I., 2017. The behavioralist as tax
collector: Using natural field experiments to enhance tax compliance. Journal of
Public Economics, 148, pp.14-31.
Hopkins, G., 2014. United Grand Lodge of England v The Commissioners for Her
Majesty’s Revenue and Customs: [2014] UKFTT 164 (TC): First-tier Tribunal
(Tax Chamber): Charles Hellier J, Julian Stafford: 3 February 2014. Oxford
Journal of Law and Religion, 3(3), pp.527-528.