What is Taxable Capacity?
Taxable Capacity is the maximum capacity of the people of a country to bear the taxation burden without many problems. Simply put, it is the maximum limit to which the government of a country can tax its people. Therefore, if the government of a country exceeds its taxation limit, it will lead to over-taxation harming the long-term interests of the community. Besides, it may also pose a serious threat to the political stability of the country.
The term taxable capacity holds an important place in public finance. Also, it has great practical importance for every country’s Finance Minister. It is because, the Finance Minister of a country while imposing new taxes or increasing the existing tax rates, keeps taxable capacity in mind. If the Finance Minister of a country levies taxes above the taxable capacity, then it will produce discontent among people on a large scale and those people will start to oppose it. Similarly, if the tax levied is way below the taxable capacity, then it would mean that the Finance Minister is unnecessarily denying the share of revenue out of the taxes to the government. Therefore, it is the duty of the Finance Minister to levy taxes based on the taxable capacity of the country.
Taxable Capacity is an important concept, both during peacetime and during wartime. During peacetime, the concept of taxable capacity proves to be indispensable in terms of mobilisation of maximum financial resources for the planned development of the economy. However, during wartime, the concept of taxable capacity lays down the maximum limit to which the government can tax people. It is done to ensure adequate resources for war prosecution. Thus, the concept of taxable capacity can be interpreted in two senses:
- Absolute Capacity of one single community
- Relative Capacity of two or more communities
1. Absolute Taxable Capacity
It is the absolute limit up to which the government can tax a community. Simply put, absolute taxable capacity represents the maximum tax that the government can collect from the citizens of a specific country. Different economists have interpreted the meaning of absolute taxable capacity in different ways. For instance, according to Sir Josiah Stamp, absolute taxable capacity is total production minus the amount required to maintain the population at the subsistence level. However, his definition has two drawbacks; i) measuring the subsistence level of a community is not possible. While concretizing the subsistence level of a community the chances of facing differences are high. ii) If the total amount calculated after subtracting the subsistence level from total production is taken away from the citizens of a country in the form of taxes, then their living standards will be affected, resulting in a decline in their efficiency. This will also reduce the production of goods and services, further causing a fall in the future productive capacity of the community.
After realising these issues with his definition, Sir Josiah Stamp presented an alternative definition of absolute taxable capacity. The new definition states that the absolute taxable capacity of a country is represented by the difference between total production and total consumption. He also states two limits to a country’s taxable capacity. i) check to the total production. ii) check to total revenue yield because of the higher tax rates.
If an increase in the tax rates leads to lower production of goods and services in a country and does not bring any additional revenue to the government, then it should be presumed that the country has reached its taxable capacity.
2. Relative Taxable Capacity
As compared to absolute taxable capacity, the term relative taxable capacity is more concrete, definite, and intelligible. It refers to the proportionate contribution that two or more than two communities can make in the form of taxes with the motive of meeting some common expenditures. Simply put, it is a community’s capacity to make a contribution to some common expenditures in relation to other communities’ capacities. The possibility of laying down the proportion in which two or more communities should provide a contribution to meet some common expenditure according to their respective ability to pay in advance is high. Besides, it is only viable that the richer community should be called upon to bear the larger share of these common expenditures. Also, if the common expenditure rises, the contribution of the richer community shall increase at a higher rate than the increasing rate of the poorer community.
For instance, the total expenditure of the United Nations organisation is distributed among different member nations according to their relative taxable capacity. The richer nations are asked to contribute a larger proportion of the expenditure. Therefore, the relative taxable capacity should be expressed as the ratio of the taxable capacity of one unit or section of the community to that of the other unit or section of the community.
However, Professor Musgrave relates taxable capacity’s notion with the concept of income per capita income. Simply put, he states that if the per capita income is higher, then the relative taxable capacity will also be higher.
There does not exist any relationship between the relative taxable capacity and the absolute taxable capacity. It means that there might be a possibility that a country is contributing towards its common expenditures more than its relative taxable capacity. But, it does not mean that the absolute taxable capacity of the country has been reached.
Similarly, it might be possible that a country has been taxed above its absolute taxable capacity. However, it does not mean that the relative capacity of the country has been exceeded in its contribution towards a common expenditure.