In a democratic country, the policies of the Government should be based on the principle of justice otherwise the people will protest against the unjust policies of the Government. The taxation policy of the Government should be based on justice and equity. How justice can be achieved is a very crucial element of taxation system. Theories of Taxation which the government adopts should be equitable so that tax avoidance is decreased.
A number of theories have been put forward by different economists explaining how justice in taxation can be achieved among which the following are important theories of taxation and are discussed as follows :
- Benefit Theory of Taxation
- Cost of Service Theory of Taxation
- Ability to Pay Theory of Taxation
1. Benefit Theory of Taxation: This theory explains that every citizen should be called upon to pay taxes in proportion to the benefits derived by him from services provided by the Government. It is implied that the state provides certain facilities to its civilians who should, therefore, contribute to the cost or value of these facilities in proportion to benefits received by them. The more the benefit a citizen derives, the more taxes he should bear, is the main assumption of the theory.
The principle justifies the payment of taxes. It also measures benefits received by the individuals in the case of certain special taxes such as petrol tax, betterment tax etc.
2. Cost of Service Theory of Taxation: This theory implies that the Government should tax the citizens according to the cost of service rendered by it. The Government renders certain services to citizens and the cost of such services should be collectively met by the citizens The tax, an individual should bear, must be equal to the cost of benefit be receives.
3. Ability to Pay Theory of Taxation: The ‘ability to pay’ theory suggests that every citizen should pay taxes according to his ability to pay, to meet the cost of Government expenditure. If everybody pays taxes on the basis of his ability to pay, it would be an ideal system of taxation.