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Though fairness (i.e., the first criteria of a good tax system) is not always easy to define, economists suggest inclusion of two elements in the tax system to make it fair namely, horizontal equity and vertical equity. Individuals in identical or similar situations paying identical or similar taxes is known as horizontal equity. When ‘better off’ people pay more taxes it is known as vertical equity.
Efficiency of a tax system is its potential to affect or interfere the efficiency of the economy. A good tax system raises revenue with the least cost on the taxpayers and least interference on the allocation of resources in the economy. The tax system affects the economic decisions of individuals and groups by either encouraging or discouraging them to save, spend, invest, etc. Taxes can improve efficiency of the economy—taxes on pollution or on smoking give revenue to the government and serves broader social purposes, too. This is known as the double dividend of a tax.
This is the third criterion which includes factors like computation, filing, collection, etc. of the taxes that all should be as simple as possible. Simplicity checks tax evasion too. Tax reform in India has simplification of tax as its major plank—also recommended by the Chelliah Committee.
A good tax system has the scope of desirable modifications in it if there is any such need.
How much tax taxpayers are actually paying and what are they getting against it in the form of the public services should be ascertainable, i.e., the
transparency factor.