Taxation is almost always the main source of income for a government. How taxes work is an important part of how a government functions.
A hierarchical tax system means that each level of government taxes its subordinate governments. In this way each individual need only worry about local taxes. A portion of the local taxes are paid to the next level of government, and so on up the government hierarchy. Such a system is best combined with a loose democratic republic model, which allows each level of government to choose its superordinate government and to accept or deny potential subordinate governments. Such a model of government structure will be described in greater detail elsewhere.
A hierarchical tax system has the primary advantage of reducing paperwork and eliminating redundant tax collection infrastructure. This could potentially save taxpayers and the government money. The individual may also benefit from additional privacy as only the local government need concern itself with the finances of the citizens.
Some may be concerned that a hierarchical system fails to collect the taxes of citizens justly. If it is left to the local government to collect taxes, then the local government can set whatever tax rate it likes. Some local governments may charge higher taxes than others. Likely the governments will tax as much as they need to in order to maintain local government function and pay their superordinate taxes. The problem is that poor localities tend to require more government than rich localities. There appears to be a lack of redistribution of wealth in such a system.
The problem of socio-economic justice can be solved in several ways depending on whether the nation is fundamentally capitalist, socialist, or a little of both. The first priority for all societies however should be the nationalization of education funding, and to ensure that every school is funded equally, or if not equally then skewed in such a way that demonstrably improves the quality of struggling schools. Let me further clarify that it is the government program itself which must demonstrably improve the quality of struggling schools, if the government program that skews equal funding does not demonstrably improve the quality of struggling schools then equality of funding should be restored, this is not to be taken as an argument to cut funding to schools that are struggling, unless you can prove that there is some improvement gained from doing so, which I find highly unlikely. Educational funding will be discussed in greater detail elsewhere. In this way each individual has a fair start such that poor localities are not socio-economic traps inherited by each new generation. This should be true for all societies, whether capitalist or socialist. Only the political philosophy of aristocracy argues the justice of an unfair start to life.
In capitalist nations the problem of socio-economic injustice can be further offset with private charity or, even better, with private or possibly government issued micro-loans, which have been proven effective in some impoverished countries. This may not be sufficient to solve these problems, but a capitalist nation should not be overly concerned with that. Poverty is a symptom of poor economic decisions, thus impoverished localities should change their attitudes and behaviors or continue to be impoverished. Subsidizing poor economic decisions only hinders the evolution of our culture, encourage stagnation and wastefulness. This is of course assuming a fair start, which again implies an effective and fair nationalized education system, which should be a top priority even for such a conservative capitalist nation.
In socialist nations poor local governments with great needs can be subsidized with national funds. This increases the costs of the national government which increases the taxes paid by subordinates all the way down to the individual. Thus all individuals will pay higher taxes in such a socialized nation, but the poorer localities will reap the greater benefits from those heavier taxes. The result is the redistribution of wealth that is desirable in a socialist nation.
In semi-socialist nations there may be nationally funded organizations that provide consulting services and supplemental education and training programs to help struggling localities get back on their feet. This requires a more involved government than the ultra-capitalist would condone, but does not give out the kind of hand-outs that ultra-socialists may be in favor of. Again there are higher taxes on average, but there can be some accountability regarding the success of organizations that run these rehabilitation programs, rather than either disregarding accountability by providing funds purely based on need, or punishing localities for their failure to overcome their own poverty by providing funds only to localities that show progress, thus punishing poverty with poverty.
Drawing from different sources of tax revenue can have a profound effect on the kinds of behavior the government encourages even inadvertently. Some of the major types of taxation are described below, as are their effects on the economy and individual behavior.
The simplest form of tax is a flat tax. Every employee pays the same percentage of their income regardless of age, occupation, income, or special "incentives". The problem with a flat tax is that taking a flat percentage of ones income has a greater effect on quality of life and livability for low income individuals as compared to high income individuals.
One way to offset this problem is to only collect taxes on a persons income after a certain set amount of income. So for example, the first $20k a person makes is untaxed, and all income after that point is taxed by 50%. This ensures that low income individuals are not taxed beyond their means to purchase food, shelter, and other essentials. Of course the untaxed portion of income should be related to the modern sufficient but minimal standard of living (SMSL), and may increase with inflation.
A fixed untaxed income does not, however, account for the number of children a person has, or the number of income earning members of a household. A simpler system may be able to solve this problems with even less government intervention and expenditure. Instead there could be a flat tax for all individuals with no untaxed income. Instead at the beginning of each year the government sends a check to every individual for the tax rate adjusted amount of the SMSL. In other words if the SMSL is currently $20k and the tax rate is 50% then each person would receive $10k. If the SMSL is $20k and the tax rate is 20% then each person would receive $4k. This money is provided to the legal guardian of each child as well, and if multiple individuals are the legal guardians of a child, then this money is divided among them evenly. Such a system means that there are no games that can be played to avoid taxes, short of not declaring income. Everyone pays the same percentage, everyone gets the same "refund".
A hardcore capitalist might argue that such a system results in a form of welfare, which is a bad thing. First, the amount of money provided is only a percentage of the legal SMSL, meaning that an individual could not comfortably live on that amount of money, and would need to get a job to even have a sufficient but minimal standard of living, so this system does not generate the kind of apathy that ulta-conservatives argue a true welfare system creates. Second, the amount of money the government would save on this simplified tax system would more than make up for any loss in the system to welfare. Overall more of your tax money will be spent on running the government, and lest will be wasted, so it would be irrational to complain about tax money being wasted on a welfare state. Finally, such a tax system provides a good substitute for the existing social security and welfare systems, thus saving the government even more money on paperwork and bureaucracy. Ultimately such a tax system results in smaller government, so there's no need to complain about the small welfare side-effect.
Income tax is one of the most difficult types of taxes to collect. Income is not always easily tracked, and the complexity of modern income tax laws generates massive paperwork and an unending need for enforcement. This can be partially offset by using a simplified tax system but even with a simplified tax system income tax is still the hardest kind of tax to collect and enforce. As a result a system relying on income tax will be more expensive to maintain, requiring higher taxes. Furthermore, an income tax system encourages the government to oversee the finances of every single citizen, which for some people may raise concerns of privacy. On the other hand, income taxes effects people based on their income. Someone earning a lot of money will have to pay a large tax. Someone who is down on their luck or even retried may have to play little or no tax. Other tax systems tax people regardless of their income status, to varying degrees.
In terms of how a government taxes its subordinates, income tax makes a great deal of sense. That is a government can institute a flat tax on all of the income of its subordinate governments. All the money that those governments make from taxes, fines, or services will already be well documented and the superordinate government can just take a percentage of that. There shouldn't be much extra paperwork so it's a simple means of subordinate government taxation.
One of the biggest advantages of sales tax is that it seems to be easier to administer than income tax. It seems that it would be easier to monitor and keep records of sales by companies than income by individuals. This makes a sales tax system cheaper and easier to maintain than an income tax system, though not as cheap and easy as other tax systems.
As mentioned, sales tax is based on the financial records of businesses, thus using a sales tax system encourages government oversight of businesses, which may or may not be a bad thing. A conservative capitalist society may feel that government oversight of business intrudes on the freedom of the market. On the other hand most other people might understand the importance of watching business activities to ensure legality and fair business practices. If the legislature chose to implement an oversight sales tax, it should be a flat tax on all transactions and the income should have an exclusive relationship with the cost of business oversight. That is to say the money from such a sales tax should go exclusively to fund business oversight and business oversight should be exclusively funded by the money gained from such a sales tax.
Sales tax can also be used as an alternative to illegality and restrictions. Instead of making drugs illegal, tax them and only permit their use in licensed establishments, and of course ensure the soberness of those who leave the establishment. This discourages drug use while giving the government power to oversee drug use, instead of pushing it underground where it cannot be controlled, and finally provides funding to the government for this oversight. All in all this is a far better solution to “victim-less” crimes than making them illegal. Of course if the legislature chooses to implement such a tax, the money should be used exclusively for the oversight of these activities, and the oversight of these activities should be exclusively funded by this tax.
Taxing specific activities can also be a means of generating positive human impact incentives. An example of this would be to tax pollution. Pollution has no natural economic consequence to the polluter, unless those affected by the pollution sue and win, which is not common enough considering the harm that pollution can cause and is causing to global society. To create an economic reason to not pollute governments can levy taxes based on the severity of the pollution in terms of its negative impact on global ecology and human society. This gives pollution an economic cost to correspond with the human cost and creates a more natural economic incentive to pursue less polluting means of production than do restrictions and requirements. Restrictions and requirements are too inflexible and are often criticized as such and they require oversight but do not generate funds to pay for that oversight.
Likewise government can use subsidies to encourage activities that are beneficial to humanity, like curing contagious diseases. Such activities should be subsidized relative to the amount of money they save compared to not doing anything at all, again creating a natural economic incentive to pursue activities that are beneficial to humanity in the long run. Similarly, governments can subsidize food, other human necessities, and proactive human programs like education. This may be a better alternative, or at least a more capitalist one, than direct socialism, it takes some of the burden off the poor and encourages human progress without giving money to the poor directly, which, as the conservative capitalist might argue, could very well simply go toward continuing to fund the same poor decisions that led to poverty.
These sorts of taxes and subsidies are best used on a global scale and not a local one. If such taxes and subsidies are left to the localities then a locality that profits from its pollution will not levy a tax on it, even though the locality down the street suffers the consequences of that pollution. If such taxes and subsidies are instituted they should pay for themselves. That is, all taxes of this type should collectively go toward oversight and the paying of subsidies, and the subsidies and oversight should only be funded by the taxes of this type.
Of course the problem with the social control powers of sales tax is that anything can be taxed or subsidized. What's to stop an NRA fan from subsidizing guns, or a detractor of modern medicine from taxing life-saving pharmaceuticals? Ultimately this power is placed in the hands of the legislature, and the power is only as useful as our legislature is wise. If we have a means of election that we trust and our politicians can be trusted with this power, then it is a great power to wield for the benefit of humanity. If our politicians are tools of special interest groups and major corporations then it is probably best to not employ sales tax, or simply enact a flat business oversight tax.
Some might argue that sales taxes have a negative effect on the market for supply and demand. I would counter this by saying that taxes have to come from somewhere, if they don't come from the consumer supply and demand market then they come from the human resource supply and demand market in the form of income tax or the property supply and demand market in the form of property tax or some other part of the economy. Is there any evidence to support that hindering one market has a better or worse effect on the economy than hindering the other? It seems the only possible difference would be a psychological effect on how the consumer feels about their money. Of course this is all merely speculation, I am not a professional economist and have no data to back up these thoughts, I merely ask these questions in the hopes that they will spark social and political interest.
Sales tax between government layers generally makes little sense. Governments don't usually sell things. One could correlate this to import and export taxes, but such taxes discourage trade, which is bad for everyone.
Property tax and per capita tax are the easiest kinds of tax to collect. Simply determine who owns the land, or who lives in the locality and collect the money from them. No paperwork, no oversight, no bureaucracy. Also, a government is essentially a localized monopoly of violence and law. So it seems most appropriate that government should be paid for based on the land or people that it governs.
Both of these types of taxation discourage retirement and make unemployment far more difficult. With income tax, if you aren't making money, you aren't getting taxed. With sales tax, if you limit your spending, you can limit how much you get taxed. With property and per capita taxes you pay the same taxes regardless of your current economic situation. With property tax your only option is homelessness or freeloading. With per capita tax there is no option.
Discouraging retirement may not be a bad thing. It is for an economy based on working a job you don't like for 40 years so that you can retire and finally do what you want. For a healthier economic perspective it is important to understand that a person can and should contribute to society throughout their life, perhaps in changing ways. This keeps the mind and body healthy and can give the individual a sense of accomplishment.
This problem of punishing retirement and unemployment is also based on the assumption of the contemporary nuclear family and individualized society. Overall property tax discourages solitary living and encourages communal living. A culture comfortable with community or extended family may have no problem with relying on a property tax system. Those in the community that are currently successful can carry more of the tax burden, helping those who are currently down on their luck.
The other concern with these types of taxation, particularly a per capita tax, is that they don't provide the redistribution of wealth that income tax can. With a per capita tax, every individual gets taxed the same, regardless of wealth. Ownership of property is no longer as greatly correlated with wealth as it was in an agrarian or even an industrial society. As a result the wealthy may not be expected to pay much higher taxes than the poor. Of course supply and demand will dictate that as the cost of living goes up, demand for higher paying job goes up. Unfortunately in contemporary society the wealthy hold a great deal of power and may block the natural workings of supply and demand for their own financial benefit. However, this appears to be more of an argument against corporatism than it is against property taxed. In an employee owned or small business economy this would not be as serious a problem.
Property tax between government layers means charging taxes on subordinates based on the amount of land under governance of those subordinates, or the total value of the land under governance of those subordinates. This is not a bad system, but an income tax approach may be more appropriate, taking the same percentage of income from each subordinate, as some subordinates may have overvalued land compared to the taxes they collect relative to other subordinates, which could generate tension.
Per capita tax between government lays means charging a set amount of tax for each subordinate government body. This is a bad choice for a static government hierarchy because it punishes small poor subordinates. However, for a dynamic hierarchy where subordinates can pick their superordinate, and a superordinate can accept or deny subordinates, this can be a means of ensuring that all subordinates are at least of a given size or wealth. This would be the main purpose of such a tax, whether such a purpose is desirable or not is up to the people and their government.
Tax money goes to the government. The government uses this money for hopefully beneficial social programs including police, military, education, oversight, welfare and more. What if the people don't agree with how the money is being spent? In a democratic society one could argue that the people could then elect new politicians to office with more representative priorities, however, it seems that all governments are plagued by inefficiency and bureaucracy no matter who is in power. What causes this? It could be argued that lack of competition is one of the major factors. There seems to be sufficient evidence to suggest that bureaucracy is reduced when competitiveness is a necessity. Is there a way to use competition to reduce government bureaucracy? What we need is some way in which money will be channeled away from the government and government programs when the people see such programs as ineffective, or at least other programs as more effective and more desireable.
One solution is charity. If a powerful system of tax deductible charitable donations exists, it can force competitiveness upon the government. When the government becomes fat and lazy, spending unnecessary quantities on programs that the public is not interested in, the public should have a right to channel their tax money elsewhere, if this is, in fact, a government by the people for the people. This threat of financial redirection forces governments to efficiently engage in social programs. Not only that, but it more easily allows for the privatization of charitable causes, which generates more competition, more efficiency, and more choice. Such charitable organizations are necessary for social functions that are difficult, if sometimes impossible, to make capitalist like education, environment controls, parks, art, scientific progress, medicine, and more.
Donations are the classic means of charity in American society. Unfortunately donations require a large overseeing government infrastructure to manage tax deduction paperwork. Additionally, donation based charity only allows for income tax deductions as granting tax relief to sales tax seems impossible.
An alternative is that for every dollar you give to a (government approved) charitable institution the government promises to give some appropriate fraction of a dollar to that institution as well. This has the same practical effect as the simple donation system but an unfortunately different psychological effect. Instead of giving $2 to a charity and getting a $1 tax break, you give $1 to the charity and the government gives $1. In both cases you and the government both spent $1 and the charity received $2, however in one instance you appear to be getting something back from the government, which feels good, and in the other the government's contribution is relatively invisible to you.
An alternative to simply donating is to have a system where citizens basically vote on where their money goes. Such a system would be difficult to administer without computers, but with computers it is relatively simple. A government agency could maintain a website, or public voting stations, where users can go to make their selections. This does not require as much human oversight since there is less paperwork done by the individual civilian which may be fraudulent. Instead the main problem would be preventing hackers from artificially inflating or deflating the supposed income of an individual, or the amount of money that is being channeled to which charitable organizations. Again this system does not seem to work with sales taxes.
An alternative to tax forwarding is a system where instead of the voting power of each individual being based on the amount of taxes they paid, each individual has equal voting power. This voting power can be divided any number of times among the available government approved charitable organizations. The government then must send the appropriate proportion of the taxes they receive to the various institutions. Since this system is not based on income it works for both a sales and income tax system.
Two governments existing side by side in the same territory can be very dangerous due conflicting military and police activities. Obviously there must be a single military/police entity or else gang-like warfare is not only likely but inevitable. However, why should there be a single education system, welfare system, or environmental protection system? Many such systems may package themselves into political bodies rather than government bodies. Such an idea works extremely well with a tax forwarding system. If the central elected government appears to only be interested in building up military power, and that seems unnecessary to you, then you may choose to forward your portion of tax money to some more liberal organizations or possibly a single liberal organization that will distribute the money to its programs. Likewise, if the government is moving toward a welfare state, and that seems unjust to you, then you may choose to forward your money to more conservative institutions, maybe involved in economic incentives that will eventually trickle down to benefit you, or maybe involved in research for government military programs that will help your nation maintain its peace. As a third example, maybe the national government is just bloated with inefficiency and nepotism, in which case you can forward all your money to alternative means of supporting the same social functions, forcing the central elected government to rethink its methods (especially when they stop getting paid because there's no money to pay them with). Again I must stress that I am not suggesting the privatization of military/police entities. There should be only a single clearly defined police hierarchy for a given physical territory, and it is probably best that this entity is made accountable to the people by democracy.
These suggestions would move society closer to a true democracy, rather than a republic, which is the system we currently employ. Of course one of the reasons we have representative government is because we don't completely trust the people. Most individuals are pretty smart, but people in aggregate can make some bad decisions. Furthermore there may be a concern that such a system creates a different kind of inefficiency. Without unilateral support for funding programs, programs may be in competition in a way that leads to redundancy. Furthermore programs may not receive sufficient funding to be truly effective, and there may be many such programs side-by-side that if they were able to combine resources would be more effective. Finally, it may also be possible that individuals will send their taxable income solely to programs that benefit themselves in the short run, with no regard to society or the functioning of government. These are all serious concerns, mainly having to do with the foundation for why we have a representative government instead of a democratic one. If we think we can trust in the wisdom of the people, then these concerns are void and limited parallel government is an effective means of bringing competitiveness to the government level, and ensuring that the people's money is truly spent by the people and for the people.