It is the start of the academic year and those taking tax law, whether at undergraduate or graduate level, will probably now be introduced to Adam Smith’s canons of taxation. The idea is that a good tax system will comply with several benchmarks. These are helpful for getting students to think critically about the design of tax systems. But they are not only useful for that – they can be used by tax authorities in order to determine how to go about the task of collecting taxes. In this way the benchmarks can be demonstrated to have practical utility in terms of understanding how tax authorities ought to act. In this blogpost I wish to first set out different benchmarks for designing tax systems and thereafter explore how one set of benchmarks, Adam Smith’s canons, can be used in understanding tax administration.

Designing tax systems

It is orthodox to begin tax modules by mentioning Adam Smith’s four canons of taxation. Taxes ought to be equitable (though there can be much debate about what this means, such as whether it requires progressive taxes or whether ability to pay refers to money available to pay taxes or the ability to work to pay taxes and so on), taxes ought to be certain and not arbitrary, taxes ought to be levied conveniently from the perspective of the taxpayer and taxes ought to be economical (leaving for the taxpayer all but that which is required to be given to the State)

The Meade Committee on the other hand, albeit in the context of direct taxes, produced different criteria for judging tax systems. The focus there is upon the effects on taxes:

• Incentives and economic efficiency – we should take into account for instance the income effect (the idea that one must work harder to increase income as tax rises) and the substitution effect – (the desirability of substituting leisure for work, which would be more pronounced as tax rates increase);
• Distributional effects – how the tax burden is and should be distributed across taxpayers;
• International aspects – there is a need to take into account the fact that taxpayers and the effects of taxes are not limited by borders;
• Simplicity and costs of administration and compliance
• Flexibility and stability – from both an economic and political perspective. The tax system must leave room in a mixed economy for the operation of effective incentives for private enterprise. The tax system must at the same time give scope for effective modification of the distribution of income and property, which would otherwise result from the unmodified operation of the “free markets”;
• Transitional problems – major upheavals should be avoided for myriad reasons, such as the significant costs which will be incurred as well as the distortion to taxpayers’ activities.

The Mirrlees review meanwhile made a unique contribution by adding three rules of thumb for designing tax systems: neutrality, stability and simplicity. As they are rules of thumb, they are not inflexible and so departure from them is permissible provided that there is a good justification for doing so.

These three sources are the ones I use in introductory classes, but there are others that can also be used. For advanced courses for instance, it would seem appropriate to introduce students to Murphy and Nagel who challenge us to look at tax systems in a different way – focusing upon after tax outcomes that we would expect to see in a just society. Viewing taxes in this way means that the utility of the aforementioned benchmarks is limited to the extent that they can be used to produce just outcomes.

Tax Collection

Taking the UK as an example and testing it against Adam Smith’s canons of taxation, it would not take long for us to realise that UK taxes are not always equitable, certain, convenient and economical. But looking at the way in which HMRC operates, we can see examples where the canons can be said to apply.

Equity: HMRC strives in its administrative practice to treat like people alike and unlike people differently (though it may be difficult in practice to determine who should fall into which category). Take for instance the case of Hely-Hutchinson where a taxpayer claimed that he was entitled to be treated in accordance with certain guidance. The problem for the taxpayer was that he was seeking to rely upon 2003 guidance, but his case was still “open” (i.e. subject to an open enquiry) in 2009 when HMRC replaced the guidance. He wished to be treated in the way as others had been treated (i.e. in accordance with the 2003 guidance). But HMRC distinguished between the taxpayer and those others on the basis that his case was “open” and theirs were “closed”. To this end, they treated him the same way as those whose cases were “open” and differently to those whose cases were “closed”.

Certainty: in order so that taxpayers acquire certainty as to tax outcomes, HMRC engages in a wide array of initiatives such as providing informal rulings and general guidance. This is in spite of the fact that HMRC is under no general legal obligation to provide advice to taxpayers (though in specific circumstances, some taxpayers have a right to apply for binding rulings as in TCGA 1992, s. 138).

Convenience: there are many examples of instances where HMRC will work with the taxpayer, such as through payment plans, to ensure that tax is collected in a reasonably convenient manner. HMRC will generally not exercise its powers where to do so would cause hardship for taxpayers[1] (see for instance here in the context of tax credits).

Economy: It is one of HMRC’s key priorities to provide efficient tax administration, whilst at the same time striving (even if not succeeding in doing so) to collect from taxpayers no more than that which is due until the law (which is at times unhelpfully put as “maximising revenues due”). This can be seen for instance in the notorious Litigation and Settlement Strategy. This is a policy which should reduce the costs of collecting tax, by providing a streamlined system for dealing with disputes. The policy document and the commentary regularly refer to “efficiency” in administration. At the same time, it is made clear that HMRC should only seek to collect the taxes properly due.

This exercise could be undertaken in respect of different benchmarks, such as those set by the Meade Committee, Mirrlees, and Murphy and Nagel. Of course, the different benchmarks can also be used to further effect to critique whether in fact tax authorities are acting in a normatively desirable way by testing whether tax administration complies with the benchmarks. But in order to do this, it would first be necessary to recognise that each set of benchmarks in fact comprises values, each of which would have to be justified on their own terms. For instance, before we can say that tax authorities ought to act equitably, we would first have to define equity and justify why it is a “good thing”. Only then could we properly test whether tax authorities do act equitably.

[1] I must admit, I am yet to fully investigate the legality of this power. It is longstanding – there are references to the hardship ‘discretion’ in some 19^th century Inland Revenue documents. If I were to hazard a guess, I would say that today it would be justified on the basis of statutory interpretation – Parliament would surely not legislate so as to impose hardship.