Taxation tax provisions in line with an ideal tax

Taxation should be neutral and equitable between all forms of commercial activity. Tax neutrality refers to the tax provisions in line with an ideal tax system. Tax provisions that are consistent with such an ideal system is described as “neutral” (Kahn, 1990). Neutral tax will increase efficiency by ensuring optimal distribution of means of production. A distortion and the corresponding deadweight loss will occur when changes in price trigger different changes in supply and demand than would occur in the absence of tax (OECD, 2014). In this sense, the principle of tax neutrality includes two aspects. First, the loss of taxation should be less than the taxation amount and should not create additional tax burden and efficiency loss. Second, taxation should not affect the effective allocation of resource and the normal operation of market economy. For the specific application, it can be summed up as two parts: equity and efficiency. Tax equity requires collecting the same tax rate for all economic activities and reducing the impact of taxation on the effective allocation of resource. Tax efficiency requires minimizing the excess burden of taxation and reducing the loss of taxation.

2.2 Three major theories of tax reform

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After the middle of 20th century, there came out the theory of equitable taxation between 1950s and 1960s, the theory of optimal taxation in 1970s and the theory of fiscal exchange in 1990s. Since then, the tax reform around the world is directly or indirectly influenced by these three theories.

(1) Theory of equitable taxation: The theory of equitable taxation was first mentioned by Henry Simons, which includes two most commonly referred equity: horizontal equity and vertical equity. The former requires that taxpayers in similar situations should receive similar tax treatment, and taxpayers earning the same amount of income or capital should be handled in the same way. The latter means that taxpayers in different situations should be treated differently, and taxpayers with more income or capital should pay more tax. The core idea of the theory of equitable taxation is to achieve the goals of equity and efficiency by a wide tax base and low nominal rate. This opinion was confirmed by the tax reform in the industrialized countries in 1980s.

(2) Theory of optimal taxation: The theory of optimal taxation is to study the design and implementation of a tax revenue, reducing the inefficiency and distortion of the market under the given economic constraints (Slemrod, 1990), which studies how to levy major taxes with an economical method. The key problem of tax research is how government levies tax to ensure the effective allocation of resource and equity in the income distribution system with asymmetric information. Due to the theory of optimal taxation requiring a lot of information and a high level of collection management in reality, it has less influence on tax policies and tax reform.

(3) Theory of fiscal exchange: The fiscal exchange theory suggests that the existence of government spending may encourage compliance and that governments can increase compliance by providing citizens with more efficient and accessible manner to goods(Ali, M. et al., 2013; Tilly, 1992; Moore, 2004). Therefore, the main concern of taxpayers is what they receive directly in return for their tax payments in the form of public services. From this perspective, taxation and the provision of public goods and services are interpreted as the contractual relationship between taxpayers and the government (Ali, M. et al., 2013; Moore, 2004). The theory can be dated back to the research on voluntary exchange theory by Knut Wicksell and James McGill Buchanan, which includes two aspects mainly: one is to achieve the effective allocation of resource, it is necessary to collect benefit tax as wide as possible; the other is to minimize the private interest of authorities, it should emphasize the important role of political process in the budget decision.