It is common that whenever the budget is going to be read, people anticipate some tax increase announced by the government on goods and services. Sometimes, some unscrupulous businesses take advantage of this situation to raise prices of goods even when the budget has not yet been implemented.
In case of taxes, the businesses always increase prices of commodities by huge margins, a burden that is always borne by consumers. This would in effect mean that they do not pay taxes in away as they would have been cushioned by those big commodity price increases.
A friend of mine amused me on the eve of the budget reading when he bought a number of items and stocked, arguing that prices were bound to be increased the next day. I wondered if the items would take him through even a month.
Thus the question is if corporations simply transfer their income tax burden onto consumers, why should they be taxed income tax and not expenditure tax?
Many tax experts have scratched their heads, trying to find answers to such a question (on how to tax companies) with little success.
The classic theory of taxation has been that since corporations are separate legal entities from the shareholders, companies should pay taxes separate from the shareholders. Therefore, it pays tax before paying shareholders a dividend. Remember, the shareholders, too, are required by law to pay income tax on the dividend.
The main challenge to this classical theory has been that it leads to double taxation as the same source of income is taxed twice; one at the corporate level and then at the shareholder level.
Therefore, an ideal taxation regime would have been a situation where corporate firms are not taxed, with the shareholders bearing the burden of taxation because they are the ones that enjoy the benefits of the company business called ring fencing as any money, which is still in the company coffers is not taxed.
Economists realised that companies sometimes do not pay shareholders a dividend. If they are not taxed, then a lot of revenue would be lost. Thus this total integration theory has been found to be radical and, thus, not followed.
The method of taxation that has been followed throughout the world, besides the classical theory, is the partial integration theory. Here both the company and shareholders share the tax burden. Where the company has been taxed, the shareholder is given some tax credit, and will pay lower tax.
In the all the systems outline above, companies have always been getting their way to dodge or pay minimal taxes. They either increase the price of their goods or reduce salary of workers or value of their shares. The question is what if governments changed the strategy and started taxing only the expenditure of the corporate firms.
One obvious advantage will be that it generate fairness in taxation because the tax paid will be proportional to the money spend by companies. Consumers will less likely be burdened with price increases. There is already a move across the world to reduce corporate income tax, which means that in the long-run income tax will not be a major source of tax.
However, it is difficult to monitor company expenditure, some shareholders do not spend their money in the country in which they reside and there is capital gained on acquired machines.
So, thorough research needs to be done on the expenditure patterns of the company impact of abolishing income tax. For instance, accounting procedures will need to be change to focus on taxation of company expenditure instead of the income. What should remain taxed is the capital gains tax. Foreign companies will also pay the income tax.
Once income tax for corporate is successfully removed and replaced with expenditure tax, the same idea can be extended to the individuals.
Some may argue that tax is the main source of revenue for governments and that if income tax is abolished, governments may lose billions of money. The opposite may also be true. Once people‘s income is not taxed, they will have more money at their disposal to spend.
Research and experience show that it is easier to spend money than to keep it. Therefore, government will easily get its (expenditure) tax. If one does not want to spend the money, he will save it in the bank. The bank will lend it to other entrepreneurs to spur investment in the country.
The writer is a lawyer