Course No.

4135:

Taxation

Taxation: An Introduction
(Tax)

Key Words / Outline

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Issues to be discussed:
Definition of Tax Characteristics of Tax Objectives of Taxation Principles of Taxation Characteristics of a Good Tax Elements of a Tax Role of Taxation in Economic Development

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Definition of Tax
Tax is derived from French word taxe which also means tax. Etymologically Latin word taxare is related to tax, which means to charge, i.e., to demand or exact as a price etc. Tax is a contribution exacted by the state.Chambers English Dictionary Taxes are what we pay for a civilized society. Justice Oliver Wendell Holmes, Jr. (mentioned in the verdict of Compania de Tabacos v. Collector case in 1927) Taxes, after all, are the due that we pay for the privileges of membership in an organized society. US President Franklin D. Roosevelt (1936). a tax is the quota each citizen has to pay towards the cost of public services. in the opinions of Adam Smith, Jean Baptiste Say, and David Richardo. The term taxes is confined to compulsory, unrequited payments to general government. OECD (1988).

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Definition of Tax
A tax is purely and simply a contribution, whether direct or masked, which the public authorities impose upon inhabitants or goods for the purpose of defraying government expenditure. Paul Leroy-Beaulieu (1906). a tax is a compulsory contribution imposed by a public authority, irrespective of the exact amount of service rendered to the tax payer in return, and not imposed as a penalty for any legal offence. Hugh Dalton (1971). A tax can be defined meaningfully as any nonpenal yet compulsory transfer of resources from the private to the public sector, levied on the basis of predetermined criteria and without reference to specific benefit received, in order to accomplish some of nations economic and social objectives. Ray M. Sommerfeld, H. M. Anderson and H. R. Brock (1980).

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Characteristics of Tax
Nonpenal Compulsory levy Sources of public revenue Direct unrequited Representation: No tax shall be levied or collected except by or under the authority of an Act of Parliament (Article 83 of the Constitution). Transfer of resources from the private to the public sector Predetermined criteria: A tax can be distinguished from an outright
confiscation of resources because a tax is levied on the basis of predetermined criteria and on a recurring basis. Predetermined criteria hopefully make a tax more equitable than confiscation, but this depends on the governmental body determining the criteria. In the free-world democratic countries, taxes must generally have a socially acceptable result.

Instrument for achieving special objectives: through influencing the reallocation of resources necessary to achieve a nations economic and social objectives e.g.,
investment decision towards to particular sector enhancement of the price level for demerit goods to discourage their production or consumption curbing or maintaining price levels, etc.

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Elements of a Tax
1. 2. 3. 4. 5. 6. 7. 8. 9. Compulsory contribution Imposed by a government only Involvement of the element of sacrifice Welfare of the community as a whole is the aim Benefit is not the condition of tax payment Tax not imposed to realize the cost of benefit from the taxpayer Tax is actually paid out of income Tax is actually paid by individuals Legal collection

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Various Terms Related to Tax

Duty: Tax on commodity, i.e., goods and services (e.g., excise duty).
Toll: Tax given for using property of other person (e.g., toll on use of road or any bridge). Cess: Tax in relation to any goods for specific purpose (e.g., cess on sugarcane in
India).

Tariff: Tax or duty on goods imported and exported. Rate: Tax imposed by a local authority.
Assessment: refers to tax and something in addition to tax usually, any tax against which there is a direct return (e.g., National Insurance Contribution in the UK).

Imposition: Tax or duty imposed according to legislative provisions or any Act passed by the Legislative Assembly.
Levy: Any tax, assessment, or fee imposed or collected. But fee is not a tax. The term levy may be used for both imposition and tax-determination. Charge: The price taken for providing any goods and services. In case of pure public goods, it is difficult to take price, but their cost is borne by collecting tax and hence, tax is a charge.

Impost: Tax given for entry into a country. Octroi: Tax given for entry into a city or municipal area. Sur-tax/Surcharge: Additional tax given on the basis of usual tax.

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Objectives of Taxation
Taxation is linked with the government economic activities. Three major types of economic activities of the government [Musgrave and Musgrave (1989)]: 1) To remove the inefficiencies in allocation of economic resources under the market system; 2) To redistribute the income and wealth for the purpose of equitable distribution as per social consideration; and 3) To remove the cyclical fluctuations and ensure high level of employment and price-stability.

According to Margaret Wilkinson (1992), in case of the first of the above three, taxation has its most important role.
The allocation of resources to satisfy consumer wants is the principal objective of taxation.

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Objectives of Taxation
Market System & Market Failures
The market is very good in directing production in line with what people want. When this happens welfare is maximized and we say that the outcome is optimal, or efficient. But there are instances where market fails. There are some goods and services for which there is demand but which the market is unable to provide, and there are others which are under- or over-provided. Margaret Wilkinson refers to this situation as market failure, where the market system fails entirely to provide some goods (e.g., pure public goods), or underprovides (e.g., external benefits, or outputs supplied by monopolists) or overprovides (e.g., external costs).

Objectives of Taxation
Market Failure & Role of Taxation THE (1)
Consumption: non-rival and/or exclusion not feasible

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CAUSES (2)
Positive Externality

OF

MARKET

FAILURE (3)

(4)
Monopoly
Market underprovides: output restricted to raise price and produce monopoly profits

Negative Externality Market cannot take Account external cost & over-provides Goods whose production/consumption imposes cost on others

Market fails entirelyno output

Public Goods

Market cannot take account external benefit & under-provides Mixed goods which benefit both consumers & others

THE
Tax provides govt. with resources to supply these goods

R O LE

OF

TAXAT I O N
Regulation rather than taxation enables the public sector to control monopoly price and output decisions; taxation can be used to redistribute monopoly profits

Either subsidies, negative taxes, to reduce price & raise output to the social optimum; or taxation provides resources for public provision of optimal quantity

Taxation to raise price and reduce sales and output (and external costs) to the social optimum (or legal controls)

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Objectives of Taxation
Objective of taxation can be enumerated as follows:
Achievement of government social objectives: such as provision of merit goods (e.g., health care, education, etc.), endowment allowances for the poor and destitute, etc., mainly through financing those expenditures. Achievement of government economic objectives: such as expanded industrialization, more economic growth, price-stability, employment generation, etc. through influencing savings, investments, price level & motivation to work more. Discouragement of some consumptions: through imposition of indirect taxation to raise the prices of demerit goods (tobacco/alcoholic products), to discourage their consumption. Financing the public expenditures: the most important sources of public revenue for financing govt. expenditure (supplying public goods in case of market failure, providing subsidies to supply merit goods at lower cost for social reasons). Redistribution of income and wealth: to ensure social justice and equity, taxation through various ways (such as progressive direct tax rates, rate differentiation, exemption, zero-rating, or other discriminatory treatment in case of indirect taxes) Increase in economic efficiency: taxes should be imposed and collected by the government in such a way, excess burden of a tax (or distortions) should be kept minimum, so that economic efficiency can be enhanced.

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Principles of Taxation
Principles of taxation suggested by Adam Smith (1776):
Equity: Canon of equity states that the subjects of every State ought to contribute towards the support of the government, as nearly as possible, in proportion of their respective abilities, that is, in proportion to the revenue which they respectively enjoy under the protection of the State. Here, in proportion of their respective abilities refers to that the feeling of tax burden should be equal to every taxpayer. Certainty: This canon states that the tax, which each individual is bound to pay, ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person. Convenience: Every tax ought to be so levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it. Thus, the mode and timing of tax payment should be convenient to taxpayer. Economy: This canon states that every tax ought to be contrived as both to take out and keep out of the pockets of the people as the little as possible over and above what it brings into the public treasury of the State. That is, the cost of collecting tax should be minimum.

Principles of Taxation
Comprehensive List of Principles of Taxation:

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A. Financial Principles: Related to requirement of government revenue. 01. Principle of Adequacy [adequate revenue] 02. Principle of Flexibility [with respect to coverage and rates of tax to reconstruct the tax-structure]

B. Economic Principles: Related to reaction on the national economy due to imposition of any
tax.

03. Principle of Choosing Correct Sources of Taxation [not to tax income generating capital] 04. Principle of Diversity [multiple types of taxes and rates of taxes]

C. Principles of Justice:
05. Principle of Universality [everybody should pay tax] 06. Principle of Equity

D. Principles of Tax Administration:

07. Principle of Determinancy/Certainty 08. Principle of Convenience 09. Principle of Economy 10. Principle of Buoyancy [automatic increase in tax with the increase in GDP without changing the tax rate or/and tax base] 11. Principle of Simplicity [simple to understand and administer] 12. Principle of Consistency [consistent with national macroeconomic policy] 13. Principle of Productivity [productivity of revenue].

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Characteristics of a Good Tax

(1) (2) (3) (4) Equity Efficiency (effort to reduce extra tax burden) Certainty Simplicity and Evidence (simple enough for taxpayers to understand and should be evident whether taxes represent the costs of public goods and welfare benefits) Economy Flexibility and Stability (flexibility to alter tax rates and the size and composition of tax revenues for stabilizing the economy or to fit an incoming governments philosophy and to fulfill their promises; stability enables individuals and companies to plan for tax ahead) Expenditure Restraint (to reduce Tk. 1 private expenditure due to Tk. 1 tax, so that public spending can be undertaken without inflationary pressure) Convenience Motivation (for effort to work more, savings, investment, entrepreneurship) Consistency Productivity Macro Economic Consideration International Effects

(5) (6)

(7)

(8) (9) (10) (11) (12) (13)

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Role of Taxation in Economic Development

In the light of the purposes of taxation (achievement of government social and economic objectives; discouragement/encouragement of some consumptions; financing the public expenditures; redistribution of income and wealth; increase in economic efficiency), following roles of taxation can be identified with respect to economic development: Financing public projects Ensuring price stability Generation of employment Encourage private sector industrialization Encourage export and discourage imports to make the country self-dependent Encourage savings and investment Encourage foreign exchange remittance

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End of the Presentation

Thank you.