5. Taxation

Taxation is the level of compulsory taxes that a government imposes on its citizens and businesses in order to fund necessary aspects of its functioning, such as public and social policies, infrastructure, security, and health. The term “taxation” applies to all forms of taxes, ranging from income taxes to capital gains and estate taxes.

There are two main types of income tax systems: proportional and progressive.

A proportional or flat tax is an income tax system that applies the same tax rate to everyone without taking into account the income level of an individual. As a consequence, the proportional tax rate is equal for low, middle, and high-income taxpayers. For example, if person A has an income of 10,000 USD and Person B earns 100,000 USD, with a proportional tax rate of 10%, A will pay 1,000 USD while B will pay 10,000 USD. Some examples for countries with flat tax systems are Kazakhstan, Russia, and Hungary.

On the contrary, the progressive tax system imposes a lower tax rate on people with low-incomes than on high-earners. Progressive tax systems are characterized by their redistributive effect which varies based on the tax rates which are applied depending on the income level. For example, a country employing a progressive taxation scheme could have the following tax rates:

If now, let’s say, person A has an income of 10,000 USD and person B earns 100,000 USD, different tax rates would apply: In the first case, A pays no income taxes at all as his/her income does not reach the lowest income level at which a positive tax rate would apply. Person B, on the other hand, does not simply pay 40% on the 100,000 USD. Instead, each tax rate applies once B´s income reaches the required level, i.e. he owes 10% on income between 20,001 and 40,000, 20% on income between 40,001 USD and 60,000 USD, 30% on income between 60,001 USD and 80,000 USD and 40% on income between 80,001 USD and 100,000 USD, resulting in a total tax liability of 20,000 USD for B. Most countries nowadays have a progressive tax system with some examples being South Africa, Canada, Sweden, and Australia.

Socialism

As a perfect socialist economy is based on the social ownership of the means of production, it should not require taxes as all businesses are already owned by the state. Through those publicly-owned assets, the state would have a steady source of revenue for public services and goods and would not require the implementation of a tax system. Real socialist nations, however, often featured tax systems to achieve different goals. The Soviet Union, for example, hosted a variety of taxes, even including income taxes which were drastically lower than their capitalist counterparts.

Social Democracy

In social-democratic states, the tax system is progressive and the level of taxation is medium to high in order to fund the functioning of the state and to redistribute income to reduce social inequalities. Citizens pay taxes according to their income level; the ones with higher incomes must contribute more compared to citizens with lower incomes. Main examples of social-democratic governments with high levels of taxation and progressive tax systems are Scandinavian countries, such as Sweden, Denmark, and Norway.

Neoliberalism

The supporters of neoliberalism propose more proportional or flat taxation systems in which everybody pays the same low tax rate regardless of income level. The priority of neoliberal governments is to ensure the unhindered operation of businesses and to attract new investors, that is why the level of taxation is very low for corporate entities in order to make the market a “level playing field” and to incentivize the creation of new companies. Supporters of this school of thought believe that through proportional tax systems entrepreneurship and hard work are being rewarded and people are not being “punished” for their success by being forced to pay a higher tax rate.

Debate on Taxation

In theory, socialism does not require taxation, yet, as shown by the example above, real socialist nations often featured tax systems. In the capitalist framework, however, socialists tend to have mixed opinions about the level of taxes implemented. In general, socialists would favor an exponentially increasing progressive tax system, nonetheless, while emphasizing that taxes that were paid by capitalists still originate from the labor power of the working class, or specifically, from the surplus-value created by its unpaid labor which would be taken from them either way. Their main focus, though, would be on how those taxes were spent. If the government used the revenue in order to improve the material conditions of the working class, socialists would likely support high taxes. If, on the other hand, they were used to support the interests of the wealthy members of society, socialists would disapprove of them.

The main argument of social democrats against low levels of taxation is that they will not enable the adequate function of the government. Additionally, a flat taxation system limits the redistribution of income and, hence, deepens social inequalities as rich members of society are burdened much less financially through taxes than poorer individuals (as they are required to spend a significantly higher share of their total income on basic goods). A progressive taxation system, according to supporters of social democracies, is socially more just.

On the contrary, neoliberals criticize social democratic governments for imposing high levels of taxation as, according to them, this limits the activities of entrepreneurs, drives away investors, and takes money out of the market. Although, they argue, this money eventually finds its way back into the market through governmental spending, it could be used much more efficiently if it stayed there in the first place and would be kept in circulation by private actors. While not necessarily in favor of proportional tax systems, they generally propose low levels of taxation throughout all income groups so as not to punish more “successful” individuals through higher tax rates.