Understanding Tax Terminology: Tax Base

Many students often find tax policy confusing. This is probably because it uses complex terms. The tax base is one such term that is often used in tax literature. The meaning of this term is often not completely understood by tax students. This creates further confusion.

In this article, we will clarify the meaning of the term “tax base,” as well as the application of this term in the tax policy.

What is a Tax Base?

Tax base can be defined as the total amount of assets or revenue on which the government can levy a tax. This is best understood with the help of an example. For instance, in the case of income tax, the tax base is all the income that is earned by the people of the state. Similarly, in the case of property taxes, the tax base is the total value of the property, which changes hands in a given period of time.

Hence, the tax base can be thought of as the number to which a percentage rate is applied to reach the dollar amount of the tax that needs to be paid. For instance, if a 30% tax has to be applied to $100000 income, then the $100000 is the tax base.

Now, this seems to be quite simple and straightforward. However, it needs to be understood that there are many different types of taxes in the world that have many different types of tax bases. This is what makes the behavior of these taxes different. In this article, we will study some of the common types of tax bases.

Types of Tax Bases

1. Value-Based: The most commonly used type of tax base is value-based. This is used in taxes, such as income tax and sales tax. Here, if the dollar-denominated value of the tax base increases, the amount of tax collected will also increase. For instance, if the salary of a person goes from $100000 to $200000 and if the tax base remains the same, then the amount of tax collected will be increased. This kind of tax base is also referred to as “ad-valorem,” which means value-based.

2. Quantity Based: Unlike income taxes, there are certain other taxes, such as excise, where the value of the goods manufactured does not make any difference. In such cases, taxes are levied on per unit of goods produced. Hence, if 100 units are produced at $10 or 100 units are produced at $20, the tax will remain the same since the base is the number of units, which is 10! Hence, rising inflation will not automatically lead to rising taxes in such cases.

3. Market-Based: Even if a tax is value-based, the true value of many goods and services are difficult to determine. For instance, in the case of property taxes, people tend to under invoice and show a lower value to the government as compared to the value at which the transaction has taken place. In order to protect themselves from such under-invoicing, governments all over the world use circle rates, which provide an approximation of the market value. In such cases, the circle rates are used to derive the tax base instead of the market price. This is because the market price is subject to manipulation.

4. International Base: Many countries like the United States reserve the right to charge taxes even on the foreign income earned by their citizens. For instance, even if an American earns money in Australia, they are supposed to pay taxes on the same in America. This makes the American tax base bigger. However, there are other countries that do not even levy taxes on their residents if they stay out of the country for a long period of time. Their tax bases are smaller as compared to America.

5. Broad-Based: A broad-based tax is one that applies to a lot of items. For instance, sales tax or excise is applicable to many different categories of goods and services. Hence, computing these tax bases becomes quite complex. A broader tax base also means that the state is looking at all economic activity through the same lens. It will not discriminate between different forms of activities.

6. Narrow Based: Narrow based taxes are one which applies only to a few items such as housing. Since these taxes apply only to fewer items, determining and managing their tax base is relatively easy. Using a narrow tax base is also recommended sometimes. This is particularly true when items such as food are excluded from the tax base in order to make the tax less regressive.

Why Tax Base Matters?

The tax base is often found to be inversely proportional to the tax rate. When the tax rate is decreased, more corporations start moving their economic activity to the country, and the total tax collected is increased. This inverse relationship continues till a certain point beyond which it ceases to exist. This relationship has been explained in detail in a concept called the “Laffer Curve,” which will be explained in a separate article in this module.