Functions or Purposes of Taxation

The functions of taxation can be discussed from the activities of the government it is meant to achieve.

These are:

a.     Raise revenue

The revenue is required to pay for the goods and services which the government provides.  These goods are of two types - public and merit goods.  Public goods, such as defence and police are consumed collectively and no one can be prevented from enjoying them if he wishes to do so. These goods have to be provided by governments.  Merit goods, such as education and medical care, could be, and often are, provided privately but not necessarily in the amounts considered socially desirable and hence governments may subsidize the production of certain goods.  This may be done for a variety of reasons but mainly because the market may not reflect the real costs and benefits of the production of a good.  Thus, the public may be subsidized because the market does not take account of all the costs and benefits of the public transport system.

b.     Economic stability

These are imposed to maintain economic stability in the country.  During inflation, the government imposes more taxes in order to discourage the unnecessary expenditure of the individuals.  During deflation, taxes are reduced in order to enable the individuals to spend more money.  In this way, the increase or decrease helps to check the big fluctuations in the prices and maintain economic stability.

c.     Fair redistribution of income

A major function of taxation is to bring about some redistribution of income.  First, tax revenue provides the lower income groups with benefits in cash and kind.  Second, the higher income groups, through a system of progressive taxation, pay a higher proportion of their income in tax than the less well-off members of the society.

d.     Pay interest on National debt

Taxes are also levied by the government to pay interest on national debt.

e.     Optimum allocation of resources

Taxes are also imposed to allocate resources of the country for optimum use of these resources.  The amounts collected by the Government from taxes are spent on more productive projects.  It means the resources are allocated to achieve the maximum possible output in the given circumstances.

f.     Protection policy

Taxes are also imposed to give protection to those commodities which are produced in the country.  The government thus imposes heavy taxes on the import of such commodities from the other countries.  In the view of these taxes, the individuals are induced to buy local products.

g.     Social welfare

The government imposes taxes on the production of those commodities which are harmful to human health e.g. excise duty on wines, cigarettes, etc.