Taxation is the imposition of a mandatory levy on the citizens of a country by their government. In almost all countries tax revenue is the major source of financing for public services. History Despite the adage that nothing is certain in the world but death and taxes, taxation has not always been the chief source of revenue for governments. The Athenians, for example, had use of the revenues from publicly owned mines and tribute from conquered countries. In the feudal hierarchy of the Middle Ages, funds flowed upward in the form of rent fees and fees paid in lieu of military services. The distinction between taxes and other compulsory payments, however, was not clear cut. In modern times the great petroleum-producing nations of the Middle East realize enough revenues from their oil production to allow their citizens freedom from the burden of heavy taxation. A codified system of taxation was introduced by the Romans. In the early republic a \Tpoll tax\t was levied against each citizen, but as foreign tribute began flowing into Rome, the poll tax on Romans was forgiven. The emperor Augustus (r. 27 BC-AD 14) introduced \Lproperty tax\les and \Tinheritance\t \LTax\les at the beginning of the imperial period, and later emperors imposed taxes on a long list of products. During the Middle Ages kings derived most of their income from their feudal holdings and generally needed to levy taxes only to pay for their expensive wars. Because ordinarily such taxes could be collected only with the consent and aid of the nobles and other large landholders, monarchs found it necessary to call these landholders into session to approve such taxation. These sessions of landholders evolved into parliaments and other legislative bodies. Thus the need of the monarchy for tax revenues can be said to have been one of the causes of the rise of parliamentary government. In fact, many of the constitutional changes that have taken place in the modern world have resulted from the struggle between monarch and legislature over the collection of taxes. In Great Britain the Glorious Revolution of 1688 established Parliament's authority over taxation. "No taxation without representation" was one of the rallying calls of the colonists in the American Revolution. After independence was achieved, the United States tried to operate as a central government under the Articles of Confederation. Probably the major weakness of the new government was its inability to levy taxes on its behalf. The U.S. Constitution gave the federal government power to levy \Ltariff\ls (an exclusive right) and excises, but it required that direct taxes be apportioned among the states according to population. In 1913 the ratification of the 16TH AMENDMENT to the Constitution made possible the adoption of the federal \Tincome tax\t, which has remained the mainstay of the federal revenue system. In 1985, $396 billion in federal personal and corporate income taxes accounted for 54 percent of the total federal revenue of $734 billion. In the United States, state and local units of government also use the income tax but rely on other tax sources to a greater extent than the federal government. The \Tproperty tax\t has traditionally been the backbone of the local revenue system. In addition, most states and many local units of government impose sales taxes. Nearly all the states levy taxes on tobacco, alcohol, gasoline, and amusement. Most also impose \Tinheritance\t \LTax\les. Classifying Taxes Ultimately, taxes are the price paid for publicly provided services. In a democracy a majority of citizens (or their representatives) vote to impose taxes on themselves in order to finance, through the public sector, services on which they place value but which they believe cannot be adequately provided by market processes. Taxes, which drain money from the private sector, must ultimately be paid by a reduction in private consumption or investment expenditures. Determining which individuals or households actually reduce their private consumption or wealth as a consequence of a tax is not always straightforward. The economic units that are nominally assigned legal tax liability are often able to shift the actual burden of the tax onto other sources. Some taxes are not shifted at all; others may be only partially shifted. Whether or not a tax is shifted provides one basis for classifying taxes. A tax is said to be direct if the economic unit that is legally assigned tax liability bears the full burden of the tax. The personal income tax, for example, is generally regarded by economists as a direct tax. An indirect tax is one that is shifted either wholly or in part. Any tax legally imposed on a commodity (see \Tsales tax\t; \Tvalue-added tax\t) must be an indirect tax because ultimately only individuals (or corporations) can bear the burden of taxes. An indirect tax is said to be shifted forward if consumers of the taxed object bear the tax burden in the form of a higher price for the good. Backward shifting occurs when suppliers of productive resources to a taxed industry earn lower incomes as a result of the tax. In addition to the direct-indirect classification, taxes are also often classified as being either proportional, progressive, or regressive. These classifications depend on the relationship between the tax base--the value, income, or wealth being taxed--and the average tax rate--the amount of tax, usually expressed as a percentage, imposed on each unit of the base. If the tax rate remains constant when the tax base varies in size, the tax is a proportional one. If the rate increases as the base increases, the tax is progressive. A regressive tax is characterized by the tax base and average tax rate varying in opposite directions. A slightly different definition of progressive, proportional, or regressive taxation is useful for analyzing the equity characteristics of indirect taxes. Under the equity definition, the tax burden is traced to the actual bearer and then related to income or wealth. A tax is progressive in this case if the tax burden expressed as a percentage of the income of the taxpaying unit rises with income. It is proportional if the tax burden is a constant proportion of income, and the tax is regressive if income received and the percentage of income paid in taxes vary in opposite directions. Excess Burden The direct burden of a tax borne by the individual taxpayer is the transfer of individual purchasing power to the public sector. If, in addition, the tax distorts the taxpayers' choices in ways that prevent their attaining maximum satisfaction with their remaining income, the tax is said to have generated an excess burden. The personal income tax can provide an example of this problem. Suppose an individual is earning an hourly wage of $5 and, given that wage, chooses to work 50 hours per week. In his or her opinion, the $5 received for the 50th hour of work exactly compensates for the hour of leisure activity foregone in order to earn it. The additional $5 that could be earned by working a 51st hour is not enough in his or her view to compensate for that additional hour of leisure activity foregone. Now, suppose that an income tax of 10 percent is imposed. For each hour the individual works, the government collects 50 cents in tax revenue. At the lower net hourly wage of $4.50, the individual may choose to reduce his or her work effort to 42 hours per week. That individual's gross earnings are now $210, out of which $21.00 in tax revenue is collected. To see how an excess burden may have been generated by the income tax, consider the following alternative way of collecting the same amount of tax revenue from the individual. Suppose that the taxing scheme simply assessed a fixed tax liability or lump-sum tax (also called a capitation, or head, tax) of $21.00 on the individual regardless of how large or how small his or her money income was. Now he or she might well choose to work more than 42 hours per week under this taxing scheme because the net monetary reward for the 43d and each successive hour of leisure foregone is now $5 rather than the $4.50 obtained under the income tax. Given the fixed tax liability of $21.00, the individual now possibly might choose to work the same 50 hours per week as he or she was working prior to imposition of any tax. Tax revenue, and, implicitly, publicly provided services remain the same under both the income tax and the lump-sum tax; but with the latter tax, in this case, the individual is able to make a better allocation of time between work and leisure. The choice to work the extra 8 hours per week under the fixed tax indicates that he or she prefers 50 hours of work per week with a net income of $229.00 to 42 hours of work and weekly income of $210.00. The inability to achieve this preferred position with an income tax is an indication of the excess burden of that tax. Unfortunately, almost all taxes have the potential for generating excess burden. Taxes may alter the relative prices of commodities, discouraging consumption of those goods as they become relatively more expensive after the tax. Some taxes also affect business firms' choice with respect to the combination of capital and labor to be used in production processes. The only tax that does little to impede efficient resource allocation in the private sector is a lump sum tax of the type described above. Individual choices are not distorted by this type of tax because tax liability is fixed and cannot be altered by any change in the taxpayer's behavior. The efficiency advantages of the lump-sum tax, however, are offset by its failure to measure up to the standards of equity or fairness commonly used to evaluate tax instruments. Good and Bad Taxes What constitutes a good tax? This issue has always stirred lively debate among tax scholars, legislators, and concerned taxpayers. Efficiency is one criterion against which a tax might be evaluated. The best tax by this standard is the one that generates the least excess burden. Most experts would be unwilling to accept efficiency as the sole indicator of a good tax, however, because the most efficient tax is the lump sum, or head, tax discussed above. Despite the desirable properties of this tax from the standpoint of efficiency, most people would undoubtedly disapprove of the inequity of a tax that imposed identical tax burdens on the richest and poorest members of society. The best tax systems seek a balance between the often conflicting objectives of efficiency and equity. The principle of horizontal equity is widely accepted as a desirable feature of a tax. Stated simply, this principle requires that equals be treated equally with some measure of economic capacity or well-being, such as income or wealth, typically regarded as the relevant index of equality. Despite its apparent straightforwardness, problems do arise in applying the standard of horizontal equity. If the household is the basic taxpaying unit, for example, does a household with four family members have the same economic capacity for taxpaying purposes as a single-member household with the same income? What if two individuals have identical opportunities to earn income but one chooses employment with a high monetary reward and the other opts for a job with lower money income but greater nonpecuniary advantages (for example, social prestige)? A corollary to the principle that equals be treated equally is the principle of vertical equity, which suggests that unequals be treated unequally. According to this principle, individuals should be taxed in accordance with their ability to pay. Unfortunately, although the ability-to-pay principle generally requires that taxpayers with greater economic capacity pay a greater share of total tax burden, it is a subjective standard and does not provide clear guidelines with respect to the precise allocation of tax shares. A proportional, a progressive, or even, within limits, a regressive income tax, for example, can collect more in total tax revenue from the rich person than from the poor person. The concept of minimum aggregate sacrifice in the ability-to-pay principle recognizes that a tax, considered independently of the public services it finances, involves a loss of welfare as a consequence of the taxpayer's loss of private purchasing power and seeks to minimize the aggregate welfare loss. Based on the assumption that a $1 reduction in purchasing power entails a smaller welfare loss the greater the individual's (or the corporation's) total income, minimum aggregate sacrifice requires extreme progression in the tax system in the form of a leveling off of after-tax incomes. A weakness of the ability-to-pay principle, however, is that, by dealing only with allocation of a predetermined aggregate tax burden, it fails to link the tax and expenditure sides of the public budget. An alternative tax principle that remedies this problem is the benefit principle of taxation. Under the benefit principle, an individual's tax burden is based on the benefits that he or she receives from public services. The benefit principle is, in most instances, difficult to follow with great precision because of difficulties with actually measuring individual benefits from public services and because the people who most need services are often the least able to pay for them. In some cases, however, an attempt to follow the general guidelines of the benefit principle would appear to underlie particular taxes, as, for example, an excise tax on gasoline, the proceeds of which are used to finance highway building and maintenance. In addition to generating revenue to finance public services, taxation can be employed to serve other objectives, among the most important of which are income redistribution, economic stabilization, and the regulating of consumption of certain commodities or services. Altering the distribution of income in society is a function that many governments perform. Although it is not the only means of performing this function, taxation is the most explicit, with the revenue collected by taxing one group in society transferred directly to another group. The size of the government deficit--the difference between expenditures and tax revenue--is an important policy variable for purposes of economic stabilization (see \Tfiscal policy\t). Adjustments in tax rates are an important means of manipulating the deficit. Finally, excise taxes are often imposed on goods and services with the objective of reducing consumption by raising the price of the taxed commodities. Tobacco and liquor are two commodities often subject to this sumptuary taxation. Marilyn Flowers Bibliography: Break, George F., and Wallin, Bruce, Taxation: Myths and Realities (1978); Buchanan, James M., and Flowers, Marilyn R., The Public Finances: An Introductory Textbook, 5th ed. (1980); Coffield, James, Popular History of Taxation (1970); Due, John F., and Friedlaender, Ann F., Government Finance, 6th ed. (1977); Groves, Harold M., Financing Government, 7th ed. (1973) and Tax Philosophers: Two Hundred Years of Thought in Great Britain and the United States, ed. by Donald J. Curran (1974); Herber, Bernard P., Modern Public Finance, 5th ed. (1983); Lee, Dwight R., ed., Taxation and the Deficit Economy: Fiscal Policy and Capital Formation in the United States (1986); Maxwell, James A., and Aronson, J. Richard, Financing State and Local Government, 3d ed. (1977); Musgrave, Richard A., Public Financing in a Democratic Society, 2 vols. (1986); Netzer, Dick, Economics of the Property Tax (1966); Rosen, Harvey S., Public Finance (1985). See also: \Teconomy, national\t; \Texcess profits tax\t; \Tincome, national\t; \Tsingle tax\t.