Taxes, Doctrinal Issues In

Individual Income Taxes

Most countries impose some form of individual income tax. Such taxes are justified in part as a means of allocating the burdens of government in ways that reflect the citizen's ability to pay and, some argue, that put a heavier burden on those who most benefit from the stability afforded by effective government. While perhaps serving in this respect as a surrogate for a wealth tax, which would more directly allocate tax burdens according to the ability to pay, an income tax in general avoids the burden of continually determining the value of a taxpayer's property interests.

Some have proposed a “true” income tax, one that determines income during the relevant period by measuring the difference in the net worth of the taxpayer from the beginning to the end of the taxing period and adding consumption expenditures. This approach has never been adopted, however, in part because it would also require the periodic evaluation of property interests, creating substantial burdens of administration.

Perhaps ironically, income taxes in most countries are not based on the actual income of the taxpayer. Rather, the income tax is normally imposed on an amount, often called taxable income, which is calculated using a formula involving a series of factors. In the United States, for example, taxable income for individuals is equal to gross income, less business deductions, less personal deductions, less personal exemptions. After the tax rate or rates are applied to taxable income to determine the basic income tax liability, credits against that liability may be available to certain taxpayers.

Each element of the formula raises doctrinal and conceptual issues. Gross income involves an initial economic or accounting determination about whether the taxpayer has realized an amount that increases the taxpayer's wealth. Financial and accounting practices determine the time when increases in wealth should be counted. Normally, for example, increases in the [Page 1458]value of the taxpayer's property are not counted as gross income, even though wealth has been increased. Only when the taxpayer sells or exchanges the property—so that its value is converted into cash or other property—is the profit “realized” and, therefore, counted as part of gross income. Some criticize this result because it allows taxpayers who enjoy the benefit of increasing wealth to defer taxes for a substantial period of time, and perhaps indefinitely. Proponents of the realization requirement emphasize that it avoids difficult issues of valuation and might place a taxpayer in the position of having to liquidate a profitable investment prematurely to satisfy income tax obligations.

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