The Philosophy of Taxation

Pirjo Karhu
Konsu Group

The philosophy of taxation is not often discussed in the business community. Public finance and taxation’s role in it are perhaps not very familiar to the average participant in public discussion. Even books about public finance are quite often written in technical language and are more aimed at scholars than at general readers, including business people. But we would like to be able to learn why we and our businesses are being taxed as they are, and so it would be beneficial to study such topics as:

• What arguments have been used to justify taxation?

• What are the most important functions of the government?

• What is considered a fair tax?

• Is it viable to base tax on the taxpayer’s ability to pay?

• What benefits does the taxpayer get while paying taxes?

• Are some taxes better than others?

Funding the State

How, then, should state activities be funded? We need to start an interdisciplinary dialogue on the topic, taking into consideration aspects of political philosophy, economics, law and social policy. Every country has to make choices when creating its taxation system and consider issues like: What the relationship is between corporate taxation, personal taxation and social justice; between direct and indirect taxation; how “fair” it is to try to avoid paying taxes and whether it should be allowed; whether there is such a thing as corporate social responsibility; the practice of using offshore companies; whether it is a good idea to use taxation as a means of redistributing income; and whether social benefits should be taxed the same as any other income.

Average taxpayers, whether individuals or companies, should be able to figure out in any system what and how much their taxes are, since they are the ones who have to pay them. A tax system should not be unnecessarily complicated beyond what is required to fulfill its main targets. Every tax system diverts a part of its tax revenues to pay the cost of administering and collecting the tax. In a well-planned tax system these costs are minimized. A tax system is transparent when the taxpayers can clearly see how much the government is costing them and what they are paying for.

Taxing SMEs

Small and medium-size enterprises (SMEs) make up the majority of businesses and also provide most jobs in industrialized countries. The influence of taxation on SMEs is thus of great importance for the economy of many countries, including Russia. However, in Russia, taxation of small enterprises is much lower than in comparable countries. Income tax and social security add to the burden on SMEs and, in addition, the business decisions and opportunities of a single owner or worker of an SME are affected by the average statutory tax rates. SMEs often face a higher tax burden compared to larger businesses, and so their situation could be made lighter by discussing adjustments to administrative approaches and/or policy.

Consumption Taxes

Consumption taxes are an important source of revenue for governments. A few decades ago, consumption taxes were mainly taxes on specific goods and services, but today general consumption taxes, mainly VAT, provide most of the consumption tax revenues.

During the last decade, received VAT amounts have stabilized as a percentage of both GDP (gross domestic product) and total taxation. These ratios vary considerably between countries — in most countries general consumption taxes bring in more than 15 percent of total taxation.

VAT Developments

VAT is a tax innovation that has spread widely and rapidly in half a century — more than 130 countries have adopted it. VAT has become the most used general tax on consumption, mainly because it can bring tax revenue in a neutral and transparent way. The only OECD (Organization for Economic Cooperation and Development) country without VAT is the United States, although even it has sales taxes at the subfederal level.

VAT became popular with the growth of world trade. Globalization in the 1990s also meant the beginning of a period of rapid change that created certain uncertainty and inconsistency in the application of VAT. Differences such as how the place of taxation is determined and the scope of the VAT have had a notable impact on international trade — they have sometimes created uncertainty for business or caused double taxation, etc. One special issue for VAT is the rapidly expanding electronic trade, and especially how to define the place of taxation.

VAT in Russia

The rate of the Russian VAT is 18 percent. There are reduced rates: 10 percent, which applies to food products, specific goods for children, books and periodicals, pharmaceutical and other medical products; and 0 percent, which applies to exports of goods and related services, services related to transit of goods through Russia, international passenger transportation, and fuel for ships and aircraft. Certain goods and services are exempt from VAT, for example, lease of premises to foreign companies accredited in Russia, medical services and certain medical products, training and educational services, public transportation, sale of securities, banking and insurance services, rent of apartments and sale of apartments and residential property.

Changed VAT Procedure for Diplomatic Representatives and Consulates in Russia

A new regulation (No. 498) about applying the 0 percent VAT rate for goods and services sold to diplomatic representatives and consulates was issued June 15, 2009. Until then, suppliers of goods and services to diplomatic representatives and consulates did not have to include VAT in their invoices but had to collect documents for the tax authorities to prove that the 0 percent rate had been used.

According to the new regulations that became effective for agreements starting after Oct. 1, 2009, suppliers have to include VAT (18 percent or 10 percent) in their invoices for goods and services sold to diplomatic representatives and consulates. The diplomatic representative or consulate will then have to apply to the tax authorities to claim return of the paid VAT. For 0 percent VAT agreements between suppliers and diplomatic representatives and consulates started before Oct. 1, 2009, the old order can be used until these agreements’ obligations have been fulfilled.