In a democratic society, it is a bet that if you ask any free market economist if governments really manage the economy, the answer will be no. Ask citizens if their government manages their economy and the answer will be more to the tune of, "no, but they sure know how to spend our money".

When governments overspend, while collecting less than anticipated revenue, current cash reserves deplete rapidly. New sources of funding have to be found. Land resource rich countries with oil reserves, dominant agriculture production, or mineral mines, for instance, can realise enhanced revenue from sales of these in-demand commodities. Renewable resource country coffers may thin out temporarily, but no worries for them, though, there is plenty more where that came from.

Countries not so naturally wealthy who plan do have choices, even in recessionary times: practice consistent conservatism, borrow prudently to cover minimal shortfalls, establish debt control procedures to reduce reliance on outside bondholders, build long-term good will that translates into revenue reserves, and as a fallback alternative, tax the people. The overall financial planning goal should be to bring the government budget back into balance with a minimum of deprivation to the country's citizens. When the debt load becomes extremely burdensome, the security guarantors of the last resort, the ones who will have to pay the mortgage (and interest) are the not the government (who incurred the debt in the first place) but its people. Every man, woman, and child will have to shoulder the responsibility for debt repayment far into the future. Increased taxation lightens everyone's pay cheque, increases inflation as citizens seek higher wages to compensate for tax losses, and is detrimental to businesses as less money is available for families to spend.

Bermuda has an existing tax structure, somewhat unseen, in a way, because taxes are assessed in various ways: at point of importation, layered onto a foreign currency transaction, added to mark-ups on retail purchases and mandatory on conveyancing of real estate and contracts. These traditional taxes are somewhat discretionary, rising and falling with economic activity and consumers' purchasing power.

Will Government impose additional taxes in the form of an income tax? Will it be progressive in structure, flat, or both? Our neighbours to the south in our family ancestral home Barbados, have an income tax regime, now were they on a list. Canada has a progressive tax and a Value-Added Tax; United States has a progressive tax, plus many states assess a sales tax, or an interest and dividends tax.

How does a progressive tax work?

The tax is assessed on an individual's cumulative annual income in progressive threshold computations, the theory being that those earning and saving in the lower income tax brackets will not pay as much as those in higher threshold brackets, i.e the first 25,000 of income has no tax; the next tier between $25,001 and $40,000 is taxed at 10%; the next tier between $40,001 and $60,000 at 20%; and so on up to a maximum say of 40% tax on all income sources. See simple income tax return table.

What kinds of income might be taxed? Wages, self-employment income, trust distributions, interest on savings and fixed deposits, dividends on publicly-traded and private company shares. No one missed the implications of the biggest one time cash infusion through the island when Bank of Bermuda was sold. Another untapped source of revenue - investment property rental income may be included along with retired individuals' monthly pension and annuity deposits.

Offsets against taxable income.

There will be a few deductions just to make things more equitable (always a debatable subject), such as giving credits against the tax liability for additional children, contributions to charity, investing in a government capital project, or leasing property under the rent controlled guidelines. Deduction and credit offsets help to minimise the individual tax burden, but the incentive for government is to raise revenue in a consistent and reliable way.

Our hypothetical composite taxpayer - George Smith's individual tax return.

George is 55 and hoping to work five more years then retire. His gross earnings are at $70,000 per year, but his take-home pay is less due to health insurance, payroll taxes, old-age contributory and National Pension scheme deductions. He is concerned he may be cut back to four days a week as his employer's business is slow. He has some savings, reflected in the interest earned in 2010.

The dividends are a nice extra - he inherited the local shares from his father. He has an apartment attached to his house that he keeps in good condition as he's planning to use the rent as part of his retirement income. While he is allowed to deduct his property tax, insurance and maintenance against the gross rental income, if he has to pay income taxes, he may not be able to retire when he planned.

How will an income tax program be enforced?

Government has the power. Once tax legislation policy becomes law, governments have the right to tax, demand payments, assess penalties and interest, prosecute and enforce. Collection methods can include garnishing wages, freezing bank accounts, placing liens on property, forcing sales of assets to satisfy tax assessments, prosecution, and generally, making life miserable for taxpayers caught in income tax complexities.

Advantages of an income tax system for governments. More control, and as long as a population is working, saving and investing, their taxable income is a reliable and renewable plum for the picking.

Expensive to operate adding to an already bloated governmental infrastructure

Income tax regime Disadvantages for the individual: expensive, intrusive, punitive, discriminatory, complicated, controlling, and a disincentive to save.

One thing about governments and taxes is a constant. When a new tax is added, current forms of taxation almost never are withdrawn.

The citizens' tax burden just becomes larger.

Next week: a look at the process of implementing a tax regime, other forms of taxation, budget, debt and social perspectives on taxation.

Martha Harris Myron, CPA, CFP(US) TEP (UK) JP- Bermuda is an international Certified Financial Planner practitioner. She specialises in independent fee-only cross-border tax, estate, investment, and strategic retirement planning services for Bermuda residents with cross-border and multi-national connections, internationally mobile people and US citizens living abroad. For more information, e-mail martha.myron@gmail.com or call 735-4720.