Taxes

16.2.1 Overview of the Financial Constitution

The financial section of the constitution contains rules on how the state generates income and which expenses are incurred. It includes not only the revenue of the state but also the expenditure, i.e.

16.2.1.1 Definition

The financial constitution contains the entirety of the basic financial regulations governing the allocation of tasks and revenues between public authorities and intends to ensure generation of income which is non-discriminating. Instead, the system should establish a fair source of income for the state and prevent the state from excessively impeding on the income of the citizens.

Taxes ought to be levied solely on purpose to finance the fulfilment of state tasks in the public interest. Accordingly, tax revenue is to be financed by the general public and businesses. Tax is defined as a common burden.^[1086]

16.2.1.2 Purpose and Function of the Rules

State revenue ensures that the State can properly carry out its tasks. Therefore, it needs to be established what tasks need to be accomplished and how many funds are needed to carry out these tasks. The tasks can differ from one fiscal term to the other, depending on the objectives of the government. Whoever needs to carry out the tasks, bears the burden. The body who needs to carry out the tasks depends on the constitutional system of the state and the legislative authority. Federal states need to distribute the loads between the country and its states. Otherwise, every task is carried out by the state itself.

As a minimum each country shall have a Public Financial Management System (PFMS) in place which includes the main regulations on public expenditure, public revenue, public debt, financial administration and federal finance in its constitution.^[1087]

16.2.1.3 Ways to Generate Income

Usually, three different ways generate income.

Public levies are the medium to obtain money from the citizens. A state levies taxes, fees, contributions and customs.^[1088] Tax is an amount of money citizens or businesses have to pay to the Government that is predominantly based on income or the cost of goods or services.^[1089] Beyond that, the tax object can be manifold. Fees are payments that citizens pay for a particular performance. In contrast to that, contributions are payments for a potential performance. Customs are levies that are payable on the import and export of goods at borders.

State owned enterprises allow a state to operate in the market and to generate profit.

Strictly speaking loans are not considered income because of the Government’s obligation to repay the money. However, it is a means to obtain funds to operate. How much money the Government needs to pay back depends on the term of the loan or bond, but effectively the gross domestic product (GDP) and the strength of the domestic currency if money is borrowed publicly.^[1090]

The necessity of public levies depends on the structure of the state.

If the state authority participates in the economics directly there is no need of public dues. The state must participate in the profits of the economy in order to finance the project. Participation can take different forms and depends on the structure of the state. On the one hand, the state can be the carrier of the enterprises of the economy and thus be directly favoured by the revenues. On the other hand, the state can guarantee a free economy and then participate in the economic success of the free economic subjects through public levies.^[1091]

Therefore, different factors contribute to the income of a country. A country must not focus on a single way to raise funds.^[1092]

16.2.1.4 Sovereignties Regarding Taxes

Three main sovereignties govern taxes.

Tax legislative sovereignty is the authority to legislate. This encompasses the question which taxes exist and on what matter taxes can be levied.

The distribution of income depends on the structure of the country. If it is divided in states the constitution ensures that a rule on the distribution of revenue between federal and states governments exist, amongst the individual states and allocating income to local authorities.

Administration of taxes is the right of authorities to collect taxes from the tax subjects.

16.2.1.5 Supervision

Supervision shall cover income and expenses at the same time. Practically the work is concentrated on the expenses because these change and depend on the objectives and budget for each fiscal year. It shall ensure that public resources are used in the authorized way and its limits.^[1093] It is more or less a control of the accounting. In most countries supervision is exercised by the ministry of finance and the control chamber.

16.2.1.6 Historical Context

Financial issues have always been of importance. Government debts and its effects were already subjects of political discussions in the ancient history. As early as before Christ public voices demanded a balanced budget. For thousands of years public income and expenses have mattered. Since existence there have been differences between human beings and the gentry who took earning from others to finance their standard. At the same time powerful institutions spent too much and thereby created debt. By spending they wanted to demonstrate their power.^[1094] In the meantime it has developed: In the beginning they took mostly products of the farmers or whatever the citizens produced and later it changed to money.

So ever since there was kind of participation in the earning of the citizens of a country. It is part of a common system to finance the state and their doing.

Debts crises developed and attracted. It got a new level of attention because it became evident that public debts effect economic, fiscal stability and stability of the financial sector.^[1095]

16.2.1.7 Procedural Questions

A financial constitution can be very detailed—such as the German constitution—as it can encompass regulation on different taxes. Most constitutions however have merely singled out some fundamental regulations and concentrate on the limitations of levies and expenditures and their controlling mechanism (Fig. 16.3).

16.2.1.8 Structural Approach and Guiding Questions

When drafting financial clauses several questions need to be answered. The clauses in Fig. 16.4 concentrate on generating income, the control of expenses and the audit. The budget clause is dealt with in a different chapter.

Fig. 16.3 Procedural questions when drafting constitutional taxation clauses

Fig.

16.2.2 Details of the Income Clause

16.2.2.1 Limitation of Public Debt

Government debt (also known as public interest, public debt, national debt and sovereign debt) is the debt owed by a government. It defines how much a country owes to external lenders. By contrast, the annual “Government deficit” refers to the difference between Government receipts and spending in a single year.^[1096]

Public debt is an important source of resources for a Government to finance public spending and fill holes in the budget. Even though it is a proven mechanism it has its limitations, see Table 16.6. States cannot have infinite debts. State debts help the economic growth by investments. But Governments tend to invest too much and are then stuck with a high debt rate. This becomes critical once the rate amounts to such a high level that refinancing is utterly expensive. Such a scenario could lead to a sovereign debt crisis and eventually to the de-facto insolvency of a country. Whether debt ceilings are advisable is controversially debated. Keynes argues against such ceiling with reference to an anticyclical budget policy, others argue with Adam Smith for a sustainable debt.^[1097]

Table 16.6 | | Limitation of public debts

In review of the sovereign debt crisis in Europe unfolding after 2009, states should have a constitutional regulation which limits the admission of new debt.

Creating debt is an established pattern for a country to stay solvent. Therefore, it need not be discussed whether the possibility of incurring debt exists. Rather, its limits should be defined. Those can be set by constitutional or primary legislation— as acts of Parliaments, laws, and decrees. Constitutions tend to be the primary legal framework for debt management, even though the levels of detail differ.^{[1098] [1099]}

[...] Public debt is [naturally] limited by the amount of interest that the Government can service. [...] Debts with contract terms of being owed only in domestic currency are always payable. Countries can’t run out of their own money. But countries can get into hot water by running short on other people’s (foreign) money.^[1100]

However, this natural limit is insufficient. A debt brake is a prime example to limit debt as states gained good experiences in the past, such as Switzerland.^[1101] Other debt brakes that some countries have established is an expenditure rule which sets a limit on expenditure both during boom and during recession periods and applies to the federal budget and account.^[1102]

In conclusion a regulation like a debt brake with exceptions is preferred over other mechanisms. A debt brake sets an ultimate limit and is more practical because a decision by Parliament or a decision by law that may take a long time is not necessary. Even though the debt brake is a fix limit in numbers and has exceptions it is preferred because an annual expenditure limit does not exclude new debt and is not as effective as a debt brake.

Finally, as already outlined under the budget (Sect. 16.1.2.4 in this chapter) the Constitutional Court of Hungary is no longer permitted to review laws on the budget, taxes or other financial issues when the national debt exceeds half of the national GDP, which amounts to a significant departure from checks and balances in a democratic order.^[1103] Obviously, in a functioning democracy expenditure ought to be monitored by all three powers, including the judiciary.^[1104]

Table 16.7 | Review of allocation of taxation

16.2.2.2 Limitation on Burdening Citizens

Countries fulfil tasks for their citizens, therefore it is accepted to make them carry the loads. But a limitation on the burden the citizens is generally required in many constitutions to prevent the country from exploiting their citizens.

Usually countries do not implement special limitations. Limitations are more or less expressions of fundamental rights and are made up of the basic principles of the constitution. The most important standard is the tax justice as a principle from the principle of equality as vested in most constitutions (e.g. art. 3 sec. 1 Germany). It implements the principle of individual capability as the guiding formula for taxation. In other words, low-income earners should not be taxed highly.

Another principle, which however is rarely adhered to, is proportionality. Most constitutions do not implement this as a principle. The principle is based on constitutional state principles and therefore does not need to be worded as a separate constitutional clause. But some countries do implement such a clause, e.g. Ethiopia’s (art. 100 sec. 1 and 2) and Switzerland’s (art. 127 sec. 2) constitution includes that the rate and amount of taxes shall be proportional to the tax object. This is an open limitation as it has no fixed number as a limit. In many jurisdictions it is an unwritten law that the tax must not overrun half of the amount of the tax object. For example, a person that earns 2000 $ gross, must not pay more than 1000 $.

Double taxation shall be avoided within a state. A state on its own struggles to avoid double taxation by another state. This is usually achieved by bilateral state agreements.

In conclusion it is preferable to use fundamental rights and general constitutional principles to provide limitation because they are more flexible. They need to be implemented in the constitution as they are not specific for levies. Moreover, setting a fix limit is difficult, it needs to be flexible.

16.2.2.3 Duration of Taxation

Tax legislation sovereignty is part of the general legislation sovereignty in most countries. But the duration of the validity of tax laws can differ, see Table 16.7.

It can be appropriate to connect the duration of tax legislation to the duration of a fiscal year because the amount of income needed depends on the amount of expenses. From a point of time the expenses often do not coincide with the income stream that a country has. But usually each (fiscal) year is similar so the state needs a similar pattern of income. Usually expenses are contingent to the public tasks and are repetitive, however they do not need to be the exact same. Nevertheless, the tax income does not differ enormously. Unlimited acts save time and labour cost, however annual laws are more elaborate and provide more accountability.

16.2.2.4 What Provisions Need to Be in the Constitution?

Regulations on finance can vary. The constitution can be very detailed or simply mention the need of regulations and make it a matter of primary legislation. This applies especially for the different kinds of taxes. It is common to implement a clause which states that the financial system shall be structured by law, e.g. Portugal (art. 101), Suriname (art. 155), Estonia (art. 113) and Georgia (art. 98). But some countries have very detailed clauses and list every way of income and every taxes. For examples Germany (art. 105) has very detailed regulations as well as Lithuania (art. 127).

None of these solutions is preferred over the other. However, a long and compre­hensive list in the constitution is not implicit necessary. A simple clause which allows regulations by law is more practical as it is easier to change it. Constitutional amendments are more complicate, elaborate and often take long time.

However, a constitution needs to ensure that a financial system, especially regarding the generation of income, is regulated even by a simple clause unbedded in the financial constitution of the state.

16.2.3 Details of the Control Chamber Clause

16.2.3.1 Control and Revision of Expenses

Various organizational structures of a chamber to control expenses exist. An audit chamber can be established either as branch of the legislative or under the execu- tive.^[1105] Generally accounting control is exercised by these two bodies or an indepen­dent constitutional institution. If the control chamber acts under the executive it is part of the ministry of finance and controls the finance reports. The control will often be divided when the country has a decentralised system. In this case the control chamber is the accounting department of the ministry of finance and in addition an independent agency. An agency is an independent body who is responsible for reviewing the expenditures.^[1106]

Even though the control chamber is an extension of the legislative or the execu­tive, in most countries it is an independent body.

In conclusion three different types of control chambers exist: The control audit of the ministry of finance, an independent court of audit and a combination of a control audit and an agency.

The control chamber is named differently by the countries: It is named court of audit, court of auditors, audit of state and national audit office. But in fact, it means all the same, namely an independent control chamber.

To control a mechanism, it is always best to have an independent party involved. In most countries an institution is inserted to perceive the control function. However, the independence of the members of the control chamber is achieved in different ways. Germany (art. 114), for example, gives the members of the control chamber judicial independence even though they are no judges.

However, each of the mechanisms implement an independent party. The only difference is the annexure. That means that the bodies work under different powers, some under the executive, namely the ministry of finance, others under the Parlia­ment and others are an individual state organisation. Each mechanism can help improving the expenses by using the results of the audit.^[1107]

As both executive and legislature are involved in creating expenses it is a benefit to have an independent control chamber. But if the legislature sets up the budget and the executive makes expenditures it is a circle if the legislature controls whether the expenses are in the limits of the budget. To ensure a balanced system the review should be conducted by an external body. A non-governmental organisation can be helpful as it is independent and plays an important role in public debates by supplying and stimulating legislative oversight of executive actions.^[1108]

Ultimately an independent body can help fragile states to have a solid control of expenses even if an external agency extends the control period. A third party leads to separation of responsibilities and fits into a system of checks and balances.^[1109]

16.2.3.2 Scope of Review

Different types of control mechanism exist in a financial system. The focus of the supervision is on controlling the accounting. That means that the chamber of control ensures that expenses are recorded and fiscal reports and financial statements are drawn up.^[1110] Generally speaking, supervision in this context is an ex post control. However, some countries implement ex ante control by controlling the expenses during the fiscal term. Even if ex ante control has its limits and is more useful in the short run, it is necessary to create transparency in relation to public expenses.^[1111]

Primarily it is important for a constitution to include some type of regulation concerning the necessity to report to the control chamber. Whilst there is the possibility to structure this as a right of the control chamber to receive reports on

Table 16.8 | | Appointment of members of the control chamber

expenses regularly (e.g. art. 90 clause 3 Finland) or on request of the control chamber (e.g. U.S.), it can also be structured as a duty of the authorities to report after each fiscal term. A third option is to include an authorization in the constitution for the Parliament to lay the rights and duties down by law as in art. 114 sec. 2 clause 3 Germany or art. 150 Slovenia.

In the end the options lead to the same result: The control chamber gets an overview on the expenses, checks them and then the chair of the control chamber reports the results to Parliament.

In addition to the external competence of a control chamber the internal oversight (oversight committees, hearings in committees, the power to dismiss or impeach, the power to summon, oral and written questions, special commissions and the power to approve executive appointments) has been compiled into an index of legislative ex-post oversight tools on public finance where Nordic countries score particularly well.^[1112]

16.2.3.3 Composition of the Control Chamber

The control chamber needs to have a chair and a structure. Therefore, the constitu­tion contains clauses which include regulations regarding designation and term of office of the chair of the control chamber and perhaps deforming the number of members (see Table 16.8).

In most countries which have a constitutional regulation Parliament and President are involved in the appointing-process of the members of the control chamber. Some countries limit the appointment to the Parliament. Having Parliament involved is

Table 16.9 | | Duration of office of members of the control chamber

preferable as Parliament has a strong legitimation. The question is then how new members can be appointed: is a simple majority required or a qualified majority or can the President appoint single-handedly? Questions of appointment and duration are of vital importance in particular with respect to an anti-corruption policy of a country. In this context we point to the deliberations under chapter 4.2.5 (opposition) in Vol. I of Writing Constitutions.

Regulations on the duration of the member’s terms of office are not necessarily a constitutional matter (see Table 16.9). In general, it is important to have regulations on these matters but they can be laid down by law as well as in the constitution. Each country however needs to ensure that the members cannot be removed from office and enjoy independence.

The concept needs to ensure that a time period is fixed so that the governing party cannot dismiss the chair and simply replace the chair as done by Mr Trump in the U.S., who dismissed a member and simply replaced him with his choice. The countries which have a constitutional rule limit the time period of appointment. An unlimited appointment would lead to a strong power.^[1113] In connection with finance giving an authority such a power can result in an abuse of power because financial issues can have a significant impact on policy and state affairs. An unlimited appointment would promote corruption as well. When the members are appointed for a limited time their power is equally limited.

In conclusion it is preferable to appoint the members of the control chamber just for a limited time. However, the countries have different time periods which start. at 5 years and last up to 12 years. The difference of length originates from the possibility of re-election. If countries have implemented a longer time period, they usually do not foresee the possibility of re-election.

The possibility of re-election depends on the time period or the other vice versa. If a country chooses a shorter time period, like 5 or 6 years, a re-election is a good feature when the work of the members was satisfying. If the time period is longer it is required to exclude re-election to avoid a concentration of power to the same members.

However, a longer term of office is preferable to strength the position of the members of the control chamber and remains its independence. The term shall be preferably longer than the legislative term to ensure the (political) independence of the members.

Even though a constitution does not have a regulation, the above mentioned has effect to federal laws as well, as the principles are the same.

16.3