Theories of taxation

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Several theories of taxation exist in public economics. Governments at all levels (national, regional and local) need to raise revenue from a variety of sources to finance public-sector expenditures.

Adam Smith in The Wealth of Nations (1776) wrote:

"The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. The expense of government to the individuals of a great nation is like the expense of management to the joint tenants of a great estate, who are all obliged to contribute in proportion to their respective interests in the estate. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation." The Wealth of Nations#Book V: Of the Revenue of the Sovereign or Commonwealth

In modern public-finance literature, a whole economy of the tax system has developed (tax system economics), which can be defined as "the overall management of public revenue of a state or integration grouping's public revenues and expenditures in order to shape smart economic policies that stimulates economic growth and development and safeguards against functional risks for present and future generations."^[1] A narrower view of the theory of taxation reduces the system to two issues: who can pay and who can benefit (Benefit principle). Influential theories have been the ability theory presented by Arthur Cecil Pigou^[2] and the benefit theory developed by Erik Lindahl.^[3][4] There is a later version of the benefit theory known as the "voluntary exchange" theory.^[5]

Under the benefit theory, tax levels are automatically determined, because taxpayers pay proportionately for the government benefits they receive. In other words, the individuals who benefit the most from public services pay the most taxes. Here, two models adopting the benefit approach are discussed: the Lindal model and the Bowen model.