CHAPTER 2
TAXES AND TAX SYSTEMS
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TYPES OF TAX
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CONT..
The revenue from tax includes the following:
A. Tax on Income:
The Government imposes two types of taxes on
income. They are:
a). Tax on personal income, and
b). Tax on corporation profits.
The personal income tax is levied on the net income
of individuals, firms and other association of persons.
The tax on the net profits of the joint stock companies
is known as corporation tax.
B. Taxes on Property:
It is the tax revenue from properties including
rental income tax, land use tax etc.
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TAXES ON COMMODITIES:
The important taxes levied by the Government on
commodities are:
a) Customs Duty: includes both import and export duties.
These duties are levied when the goods cross the
boundaries of the country.
b) Excise Duty: are levied on the commodities produced
in the country.
c) Value Added Tax: is levied by the Government on the
commodities sold at a specified percentage on the value
of sales.
d) Turnover Tax: is levied by the Government on the sales
which are not covered under VAT.
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1.NATURE OF TAXATION:
The nature of taxation influences the distribution of tax among the different sections
of the society. It includes proportional regressive and progressive nature of
taxation.
(a) Effects of Regressive Taxation on Distribution: Under regressive taxation, the
burden of taxation falls more heavily upon the poor than on the rich. Regressive
taxation may increase the inequalities on the distribution of income and wealth.
Hence, the burden of taxation is higher on the poor than on the rich. In effect, this
system widens the gap between the rich and the poor.
(b) Effects of Proportional Taxation on Distribution: Under the proportional
taxation, taxes are levied uniformly upon the rich and the poor. When the tax rate
remains the same, it creates inequalities between them. However, if there is any
increase in the income of these sections, the inequalities in distribution of income
will also increase. The burden of taxation falls more heavily upon the poor than on
the rich.
(c) Effects of Progressive Taxation on Distribution: Under the system of
progressive taxation, the tax rates go up with the increase in the income. Thus, in
this system, the inequalities in the income and wealth will be reduced. The major
portion of the income and the wealth of the rich is taken away by way of higher tax
rates. Hence, the progressive tax system tends to reduce the inequalities in the
distribution of incomeACFN
and641wealth.
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EFFECTS OF TAXATION ON THE BASIS OF KINDS OF TAXES:
The effects of taxation on distribution depend upon the
kinds of taxes i.e. direct or indirect taxes.
(a) Effects of Direct Taxes on Distribution: Direct taxes take
the form of taxation on the income and property. It
attempts to reduce the income of the richer sections and
transfers the income to the Government. The Government
may use these resources to raise the standard of living of
the poor. Therefore, all those taxes, which fall heavily
upon the higher income groups, can have favorable
distributional effects.
(b) Effects of Indirect Taxes on Distribution: Indirect taxes
are levied on commodities. They fall heavily on the lower
and middle-income groups who spend a large portion of
their income on commodities. In such a situation, indirect
taxes have adverse distributional effects.
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EFFECTS OF TAXATION ON CONSUMPTION:
Taxes increases the price of the taxed goods relative to the
prices of untaxed or lower taxed goods.
The increase in the relative price affects the taxpayer in
two ways.
1. Income Effect: The tax reduces the taxpayer's purchasing
power or real income. It takes resources away from the
taxpayer and transfers them to the government. This is
often referred to as the direct burden of the tax.
2. Substitution (or Price) Effect :
The tax creates an incentive for the taxpayer to substitute
less preferred but untaxed or lower-taxed goods for the
more-preferred taxed good. The loss in consumer utility
from this substitution is the excess burden (or welfare cost)
of the tax. ACFN 641 Advanced Taxation 01/16/2024 7
TAX SYSTEM
The tax systems may be summarized as follows:
1. Proportional Tax System.
2. Progressive Tax System.
3. Regressive Tax System.
4. Digressive tax system
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1. PROPORTIONAL TAX SYSTEM:
A proportional tax, also called a flat tax is a system
that taxes all tax payers at the same rate (as a
proportion on income).
The term “Flat Tax rate ” is the tax rate is constant
as a function of tax base ( income) increases.
In this tax system ,all income are taxed at a single
uniform rate and it does not matter if the tax
payers income is low or high.
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....
Example: Proportional Tax System:
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MERITS
1. It satisfies the principle of certainty and
simplicity.
As the tax rate are the same for all the tax
payers the tax payers can easily and quickly
calculate the amount of tax they have to pay
for the government.
2. It is neutral with regard to income and
wealth distribution
3. The tax rate is same for all tax payers
4. It will avoid mistakes in tax calculation.
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DEMERITS
1. Inequitable Distribution:
It will benefit the rich at the expense of the poor. The
burden of tax fall heavily on poorer section of society than
rich that means lower-income people will pay a higher
proportion of their income. It would not lead to an
equitable and justice direction of the burden of taxation..
It does not reduce the income and wealth inequality
between rich and poor that is the gap of income and wealth
inequality increases between the havens and have not.
2. Inadequate Resources:
Since the burden heavily fall on poor , the system suffers
from adequate funds. The government cannot obtain from the
richer sections of the society as much as they can give.
.
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2. PROGRESSIVE TAX SYSTEM:
The progressive tax system can be defined as
"a system in which rates of taxation would
increase with the increase in income i.e.
higher the income, higher would be the rate
of tax".
The term progressive refers to the way the
rate progresses from low to high.
.
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....
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MERITS OF PROGRESSIVE TAX SYSTEM:
1. Equality in Sacrifice: the rate of taxation increases as the tax base
increases. That is, the burden of taxation is heavy upon the rich Tax Base -
Income (Birr) than on the poor. People with higher income tend to have a
higher percentage of that in disposable income, and can thus afford a greater
tax burden. Thus, this system secures equality in sacrifice by ensuring the
principle of ability to pay.
2. Reducing the Inequalities of Income and Wealth:
Progressive tax system serves as a powerful instrument for reducing the
inequalities of income and wealth.
3. Economy:
In the progressive system, the cost of collection does not increase with the
increase in the rate of taxes. Hence, it is justified on the grounds of economy.
4. Stabilizing the Economy:
Progressive tax system may be helpful in preventing the inflationary trends in the
economy as it reduces the disposable income and purchasing power of the
people. Thus, the inflationary trends can be checked and the economic stability
can be achieved.
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:
LIMITATIONS OF PROGRESSIVE TAX SYSTEM
1 . Disincentive to Work: It is argued that too progressive a tax rate acts
as a disincentive to work.
2. Discourages Savings and Investments:
Since a major portion of the income is taken away by the state in a form
of taxes, the incentives to produce more and earn more are lost. This
will discourage savings and investments.
3. Shifts the Total Economic Production of Society:
The progressive tax system shifts the total economic production of
society away from capital investments (tools, machinery, infrastructure,
research etc.) and toward present consumption goods.
This could happen because high-income earners tend to pay for capital
goods (through investment activities) and low-income earners tend to
purchase consumables.
Smithian theory says that spending more on consumption goods and
less on capital goods will slow the rise of the standard of living.
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3. REGRESSIVE TAX SYSTEM:
Regressive tax is a tax, which taxes a larger
percentage of income from people whose
income is low.
It places more burden on those with lower
incomes. It is the system in which the rate of
tax declines with the increase in the income
or value of property.
"The tax rate decreases as the tax base
increases“.
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THE FOLLOWING TABLE AND DIAGRAM EXPLAIN THE CONCEPT OF REGRESSIVE TAXATION.
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DIGRESSIVE TAX SYSTEM
Under this system, the rate of tax is mildly increases
but at a decreasing rate, that is the marginal tax
declines with each incremental tax base.
Tax base Tax rate (%) Amount of tax
0-2000 5 100
2000-4000 10 300
4000-6000 14 580
6000-10000 17 1260
12000-15000 18 1800
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TAX ADMINISTRATION (TA)
Tax administration may be viewed as a
production process, where the inputs consist of
manpower and information and the outputs
consist of revenue for the government and
taxpayer equity
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TA CONT. ..
This process may be broken down into a number of
separable components.
First, a tax administration must of course have
adequate resources in terms of manpower,
infrastructure and an appropriate organizational
structure.
Second, a tax administration needs an information
system to ascertain the existing and potential tax
base.
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TA CONT…
The second component of the information
system is by far the most important from the
point of view of producing revenues.
It includes the collection of information from
potential taxpayers themselves, from third
parties, and from internal sources of the tax
administration through the internal
communication system.
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TA CONT…
Third, a tax administration needs a system of
penalties for non-complying taxpayers and
perhaps also a system of rewards for complying
taxpayers.
It must also define what constitutes sufficient
proof of non-compliance in the legal context of
the country.
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TA CONT…
Fourth, a tax administration must select
strategies and set out administrative rules to
counter each type of non-compliance by
different groups of taxpayers e.g. by requiring
new or non-filing potential taxpayers to file;
preventing or punishing tax avoidance;
preventing or punishing incorrect tax base
reporting by files; recovering taxes due but not
paid voluntarily by taxpayers and imposing
penalties when required; and preventing or
removing further resource reallocations of
resources by taxpayers in the face of tax
administration action.
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TA CONT…
Finally, since no tax administration is all-
knowing, provision must be made to redress
mistakes. Two sub systems are required for this
purpose:
One to redress taxpayer grievances (appeals,
administrative remedies, ombudsmen), and one
to identify and correct (or prevent) errors by
the tax administration (internal reviews,
inspection and anti-corruption).
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TA CONT.…
Implicit in each of these steps in the production
process are labor and capital allocation
decisions which give rise to direct administrative
costs of tax collection.
Furthermore, since tax collection is an on going
process, decisions must be made in each of these
stages continually rather than at only one point
in time (Bird, 2004).
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TAX COMPLIANCE
Compliance can be understood as acting in
accordance with the law and non compliance is
deviation from the law.
Based on the above expressions the definition
of tax compliance can be shortly refined as the
desire or willingness of the taxpayers to act in
accordance with the tax law and the voluntary
effort they exercise to pay their tax liability on
timely basis.
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FACTORS DETERMINING TAX
COMPLIANCE BEHAVIOR
Jackson and Milliron (1986) listed fourteen
main factors that have influenced tax
compliance as discussed by various
researchers.
These factors are age, gender, education,
income, occupation or status, peers’ or other
taxpayers’ influence, ethics, legal sanction,
complexity, relationship with taxation authority
(IRS), income sources, perceived fairness of the
tax system, possibility of being audited and tax
rate.
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TAX COMPLIANCE CONT.….
A comprehensive review of determinants of tax
payers’ voluntary compliance with taxation
such as
Cultural background of tax payers
Awareness level
Fairness/equity
Tax payers’ attitude towards government
Socio-political factors
Organizational strength of tax authority.
ETC
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End of chapter 2
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