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Essay One: Background On Taxation
Essay One: Background On Taxation
Introduction
Taxation is regarded as a major source of a countrys revenues. Countries use
revenues from taxes to secure funds for their growing expenditures. Tax revenues
could, for instance, be used to finance infrastructure projects, healthcare systems,
education systems, and social security systems. Taxes are, therefore, considered a
financial tool used by countries to boost economic development. In addition,
governments could utilize taxes in order to encourage or discourage the production or
consumption of certain goods and services. Finally, taxes could be used as an
incentive for investment, especially foreign direct investment, since tax exemptions
and/or reductions in a certain sector could encourage foreign investors to invest in this
sector.
This essay provides a background on taxation. The first part of this essay
demonstrates the definition of taxation, its characteristics, and its distinction from
other concepts that might confuse with it. The second part discusses the evolution of
taxation throughout history. The third part analyses the different types of taxes.
Finally, the last part explains the importance of taxation
1. Definition of Taxation
Taxation is a compulsory levy imposed by the government according to the law on
either receiving income, using income, or on capital assets. Taxes are imposed in
return for nothing in specific; they are used to secure funds for a variety of public
purposes, including, for instance, the provision of public goods.
1.1 Characteristics of Taxation
Based on this definition, we conclude that taxation is characterized by a number of
distinct features as follows:I.
Taxes are involuntary payments. This means that a taxpayer does not have the
choice of whether or not he pays taxes. In addition, a taxpayer does not have
the right to object tax levy and any attempt to evade paying taxes is punishable
by the law;
II.
A levying authority, usually the government, imposes taxes. This means that
the government is the sole authority that enforces and collects taxes. This
feature, however, does not contradict with the fact that certain types of taxes,
especially indirect taxes, are collected by businesses on behalf of the
government. The main criterion here is that these taxes will be eventually
supplied by these businesses to the government;
III.
Taxes are imposed by the law. This means a law must be enacted by the
parliament of the state in order to impose a tax. No taxes shall be imposed by
regulations or by administrative decisions;
IV.
V.
VI.
Taxes are paid in return for nothing in specific. This means a taxpayer pays
tax based on his status as a member of the community and taxes represent
his/her contribution to the burden of the state. Taxes, therefore, are not paid to
obtain benefits or services in return.
VII.
Taxes are imposed based on the ability to pay. This means taxes, especially
income taxes, are paid by persons who achieve a certain level of income. This
explains why tax policies determine a minimum level of income for a person
to be eligible as a taxpayer.
types of duties, excise duty and customs duty. Excise duty is imposed on the
production of goods in the country. Customs duty, in contrast, is imposed on the
imports or exports of goods. A duty, therefore, is a type of indirect tax. It is imposed
on production and the import or export of commodities. On the other hand, a tax is
imposed on individuals, wealth, transactions, and services.
2. History of Taxation
Taxation is a product of human history. It has been subject to continuous evolution
throughout history. The current tax systems have resulted from changes in economic,
political, social circumstances. This explains why taxation is regarded as merely a
reflection of the change in both society and economy.
2.1 Taxation in Ancient Civilizations
Taxation emerged in the ancient civilizations, including Egyptians, Mesopotamia,
Romans, and Greeks. Taxes were imposed in ancient times in order to secure funds
for military expenditures, public services, food stocks, and gold.1
The first known taxation system dates back to the Mesopotamia civilization in the
year 6000 B.C. according to tax records in the form of clay tablets. 2 These tax records
revealed that taxation system relied on property tax. The scope of application of this
tax was somehow limited, except during times of wars or crises.3
The ancient Egyptian civilization also adopted taxation systems. Tax revenues were
used to secure funds for the central government. One example of taxes that were
imposed in ancient Egypt is an indirect tax on the consumption of cooking oil.
Taxpayers were audited by tax collectors (known as scribes) to calculate the exact
amount of cooking oil consumed.4
The Greek Empire adopted poll taxes in addition to taxes on goods and property.
During stable times, a monthly poll tax was imposed on foreigners with no Athenian
decedents. Tax rate of the Athenian poll tax was one drachma (Athenian currency) for
men and half drachma for women.5 During periods of wars and conflicts, a tax was
imposed on everyone in order to finance military expenditures. Any surplus of tax
BA Kiprotich, "Principles of Taxation," in Tax Justice and Poverty (Germany, Zambia, and Kenya:
Jesuitenmission, Jesuit Centre for Theological Reflection, and Jesuit Hakimani Centre, 2016), 3.
2
World
Taxation,
"History
of
Taxation",
Accessed
29
September
2016
http://www.worldtaxation.com/uncategorized/history-of-taxation.html.
3
Ibid.
4
Tax
World,
"A
History
of
Taxation",
Accessed
29
September
2016
http://www.taxworld.org/History/history.pdf.
5
Ibid.
revenues would be resent back to Athens once the war is over, since spoils gained
from war would be used to finance this tax.6
In the Roman Empire, the scope of application of taxes was somehow wide as
compared to the Greeks and the Egyptians. This resulted from the increase in the
power of the empires central government.7 The excessive reliance on taxation during
the 4th and 5th centuries is thought to be the major cause of the Roman Empires
economic collapse.8
During the reign of Caesar Augustus, an inheritance tax was found to finance military
pensions. The rate of inheritance tax was 5% on all inheritances excluding gifts to
children and spouses.9 In addition to the inheritance tax, a sales tax was adopted with
4% rate on slaves and 1% on everything else.10 Although taxes were collected by the
central government, cities also acted on behalf of the central government in collecting
these taxes. The rate of sales tax during the reign of Julius Caesar was, in contrast,
1%.11
Ancient Chinese enforced a property of tax during the year 600 B.C. The tax rate was
10% of the cultivated land owned by an individual. The production of this 10% of
cultivated land would then collected by the central government.12
2.2 Taxation in the Middle Ages
Several tax systems were introduced in Europe during mediaeval times. For instance,
an income tax was implemented in most European states on the income of craftsmen
and tradesmen based on their ability to pay. In addition, some states imposed taxes on
salaries, professional gains, and rents of land. These types of income taxes were
imposed beside property taxes in most European states.13
Ibid.
World Taxation, "History of Taxation".
8
Bruce Bartlett, "How Excessive Government Killed Ancient Rome," Cato J. 14 (1994): 299.
9
Tax World, "A History of Taxation".
10
Ibid.
11
Ibid.
12
Edward Harper Parker, "Land and People," in Ancient China Simplified (Chapman & Hall, Limited,
1908).
13
Kiprotich, "Principles of Taxation," 3.
7
Muslims also applied some kind of a poll tax in many parts of Northern Africa and
the Mediterranean Region during the 14th and 15th centuries. 14 This poll tax was
applied on non-Muslims, including Jews and Christians. This means that citizens of
the societies that did not convert to Islam had to pay a tax. In addition, nomads were
taxed for waiting in specific locations and for utilizing resources in these locations,
such as water supplies.15
In the pre-colonialism era, most African kings imposed taxes in the form of a portion
of harvest and/or livestock. These taxes were seen as a contribution of the citizens
towards their kingdoms. The main objectives of such taxes were to finance military
expenditures and the expansion of these kingdoms and empires.16
In the colonialism era, one of the early comprehensive income tax systems was
introduced by Britains Prime Minister William Pitt in 1799 during the Napoleonic
wars.17 The British income tax was collected annually with a 10% on annual incomes
exceeding 200 and between 110% on annual incomes ranging between 60200.18
In colonial America, an excise tax was applicable on imports of sugar, wine, and other
commodities in 1764 under the Sugar Act. 19 A new Stamp Act was introduced in
1765 due to the insufficiency of revenues from the Sugar Act.20 Under the Stamp Act,
a direct tax was imposed on newspapers, commercial, and legal documents that were
being printed in the colonies.21 The first income tax that was proposed in the United
States was during the war of 1812 between the United States and the United Kingdom
to secure military funds. 22 This tax was based on the British income tax system
introduced by William Pitt. It enforced progressive rates in which a 0.08% rate was
applicable on incomes above 60 and a 10% rate on incomes above 200.23 Such
income tax was not implemented due to the Treaty of Ghent in 1815 that ended the
14
15
conflict, and therefore the need for such tax. The beginning of the Civil War in 1861
called for the implementation of an income tax to finance war expenditures. The USA
Tax Act of 1861 proposed that there shall be [tax] levied, collected, and paid, upon
annual income of every person residing in the U.S. whether derived from any kind of
property, or from any professional trade, employment, or vocation carried on in the
United States or elsewhere, or from any source whatever.24
In Africa, a number of tax laws were introduced to secure funds to administer the
British colonies. For instance, a hut tax was introduced by the British colonialists
between 1900 and 1904. 25 This tax was calculated per hut or on household basis.
Taxpayers could pay this tax in the form of money, labour, grains, or in any other type
of commodity. This tax helped the British colonialists in raising revenues for both
administration and development purposes.26
24
Anne Michle Bardopoulos, Ecommerce and the Effects of Technology on Taxation: Could Vat Be
the Etax Solution?, vol. 22 (Springer, 2015), 24.
25
Kiprotich, "Principles of Taxation," 4.
26
Ian Henderson, "The Limits of Colonial Power: Race and Labour Problems in Colonial Zambia,
19001953," The Journal of Imperial and Commonwealth History 2, no. 3 (1974).
3. Classifications of Taxes
Taxes can be classified according to different bases. Taxes differ according to tax
base, tax incidence, size of the tax base, and tax rate.
3.1 Tax Base
An initial method to differentiate between different types of taxation is to classify
taxes according to the tax base; that is, the aggregate value of the financial streams or
assets on which tax can be imposed. Taxes are generally imposed on any of the
following tax bases: income, expenditures, and capital.
Taxes on income include personal income tax and corporate tax. Main sources of
income include salaries, wages, income from property, income from business, and
capital gains. Income tax could be imposed on gross or net income. 27 In practice,
income tax is imposed on the net income that is received by a taxpayer during a tax
year according to specific tax rates. Capital gains tax is also regarded as an income
tax despite what its name might resemble. It is levied on the profit that results from
investment over time. However, this type of tax in levied only when the profit is
achieved at the time of the sale of the investment.28 One feature of taxes on income,
including taxes on wages or salaries and capital gains taxes, is that the income is
generally taxed at source. This means that a taxpayer receives his salary, wage, or
capital gains after the tax has already been deducted.29
Taxes on expenditures include value-added tax, excise duties, customs duties, and
sales tax. They are imposed on income when it is used in expenditures related to the
production, consumption, imports, or exports of goods and services. In addition, they
are imposed once the transaction occurs. A value-added tax is a type of consumption
taxes that is imposed incrementally on a product whenever value is added at different
stages of production and at the final sale. It is known is some countries as Goods and
Services Tax (GST). A sales tax, in contrast, is a type of consumption tax that is
27
For a wage or salary earner, gross income is the amount of wage or salary received by the individual
without any deductions. Net income, in contrast in the amount of wage or salary received after
deductions, including taxes and payments for pension funds.
28
Simon James, The Economics of Taxation (Great Britain: Pearson Education Limited, 2000), 13.
29
Dora Hancock, Taxation Policy and Practice (UK: International Thomson Business Press, 1998), 12.
imposed on the sale of goods and services at the point of sale. This tax is generally
collected and forwarded by retailers to the levying authority.
Finally, taxes on capital are levied based on ownership, wealth, or capital. Examples
of taxes on capital include inheritance tax, wealth tax, and automobile property tax.
3.2 Tax Incidence
Taxes could be classified based on tax incidence into direct taxes and indirect taxes.
Tax incidence refers to the burden of tax that is beared ultimately by the taxpayer. A
direct tax is the tax that is paid directly by the taxpayer who is intended to bear its
burden. Consequently, the tax burden in direct taxes is not shifted; the taxpayer bears
the tax burden fully. An indirect tax, in contrast, is the tax that is paid indirectly by
the ultimate taxpayer through an intermediary who collects that tax and forwards it to
the levying authority.
A direct tax includes income tax, capital gains tax, corporate tax, inheritance tax, and
wealth tax. All these taxes share a specific feature; they are imposed on some kind of
income once it is earned, and they are paid directly by the taxpayer who earns this
income. For instance, a tax on salary is collected directly from a person who earns a
salary. In contrast, indirect taxes include sales tax, excise duty, value-added tax, and
customs duty. Indirect taxes are, therefore, imposed on the production and distribution
of goods or services. For instance, a sales tax is imposed on all the retailers and
businesses involved in the sale of a good or service for consumers. Consequently, a
sales tax on a specific good or service will result in an increase in the price of such a
good or service. In that case, a sales tax will not be collected from the consumers
themselves, but from the businesses involved in the sale process. These businesses act
as an intermediary in collecting the tax, as they will eventually forward the collected
tax to the levying authority. Tax burden in an indirect tax is, therefore, shifted
completely from the actual taxpayer (consumers) to the businesses involved in the
sale process.
One important distinction between direct and indirect taxes is that levying direct taxes
takes the individual circumstances into consideration. Individual circumstances might
include the taxpayers commitments, level of income, and family size. A direct tax,
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2200
1000
2800
1000
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60
0
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800
240
0
240
1200
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0
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900
13.3
27.2
32.1
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4. Importance of Taxation
During our explanation of the history of taxation in the second part of this essay, we
concluded that the main aim of taxes was helping governments in performing their
conventional functions. Another exceptional aim of taxes was securing funds for
military expenditures during times of conflicts.
The contemporary objectives of taxation are not different. Governments use taxes as a
major source of public revenues to finance their growing expenditures. In fact,
taxation is one of the most effective sources of revenues if compared with other
alternative methods. Alternative methods used to mobilize public revenues include
currency devaluation, fees, and borrowing.31
Governments might resort to currency devaluation by printing more money and using
it to finance public expenditures. This process is not a straightforward one and might
lead to further complications. Raising funds by printing more money eventually leads
to inflation, since the value of money decreases and its purchasing power, therefore,
decreases. In that case we say that this method transfers purchasing power from
individuals to the government. This is why lead economists, including Johnson,
Friedman and Friedman, called this method of raising funds an inflation tax.32
The second method of raising funds is by charging fees on the services provided by
the government. Although fees could represent an important source of public
revenues, it becomes extremely difficult to charge fees on some of the services
provided by the government considering their nature. It would be impossible to
charge individuals on services like defence, law enforcement, fire services, and the
likes. For this reason, fees become an ineffective method to raise funds for the
government.
A final method is by resorting to loans. Governments can borrow nationally from
citizens and banks or internationally from other states in addition to international
organizations and international funds. The main problem with borrowing is that debt
repayment, which involves paying the principle plus interest, results in a heavy
burden that might be shared by many generations. This is why it is thought that the
31
32
Ibid., 7.
Ibid.
13
Ibid., 8.
14
nonrivalrous, and with zero marginal cost. Nonexcludable means that no individual
can be excluded from consuming it even if he does not want it or does not pay for it.
Nonrivalrous means that all individuals consume the same amount of this good; a
consumption by an individual does not reduce or affect the consumption of the others.
Finally, a public good is provided at zero marginal cost, meaning that the
consumption of an extra individual does not imply an extra cost.
National defence, law and order, fire services, are all examples of public goods.
National defence is provided for all the citizens in the society; no one can be excluded
from national defence, no one can reject it, and it is provided at zero marginal cost.
Markets become inefficient in providing such goods because everyone can enjoy them
without having to pay for them. It becomes, therefore, the function of the state to
provide public goods. Provision of public goods is based on the revenues obtained
from taxation.
Merit Goods: Merit goods are those provided free of charge for the benefit of all
individuals of the society. They are different from public goods in sense that they can
be provided privately by the market. However, merit goods, if left entirely for market
forces to provide them, they would be under-produced and under-consumed. Merit
goods include health and education. Based on the governments role in promoting
social and economic welfare, it is the responsibility of the government to provide
merit goods so that all the individuals can enjoy health and educational services. In
contrast, governments discourage the consumption of de-merit goods, including
tobacco. Revenues from taxes are used by the government to finance the provision
merit goods. In contrast, governments could impose taxes in order to discourage the
consumption of de-merit goods, such as taxes on tobacco.
External Effects: Market forces do not take external effects into consideration.
External effects include external benefits and external costs. An external benefit refers
to the benefit obtained by a third party from the production of a good or service. An
external cost refers to the cost incurred by a third party for the production of a good or
service. A third party refers to the individuals outside the production and consumption
process. An example of external benefit is immunization campaigns. These
campaigns result in external benefits because they not only reduce the vulnerability of
the immunized person, but also they reduce the risk of transmitting diseases to other
15
16
income tax in addition to reducing its expenditures. This would result in a decrease in
the aggregate demand accompanied by less inflationary pressures.
Development: Taxation is regarded as a means of development. Tax revenues could
be channeled to establish development, infrastructure projects, and Research and
Development. In addition, Taxation could promote investment through establishing
and granting tax incentives to free zones, industrial zones, and economic zones. Tax
incentives could result in encouraging investment in these zones. Tax incentives could
also be provided in vital sectors like agriculture in order to promote agricultural and
crop production. Certain sectors like education and health could be exempted from
taxes to encourage investment in these sectors and promote the quality of the services
provided. Furthermore, custom duties could be imposed on imports of goods that are
also produced locally. This could help local industry to grow and protect them from
foreign competition.
17
Essay Recap . . .
Taxes are imposed in return for nothing in specific; they are used to secure
funds for a variety of public purposes, including, for instance, the provision of
public goods.
Taxes might be confused with other forms of public charges, including fees
and duties. Although the difference between taxes and these public charges is
not completely clear, there is always a fine line through which the difference
between them emerges.
18
Important Terms
Taxation: Taxation is a compulsory levy imposed by the government
according to the law on either receiving income, using income, or on
capital assets. Taxes are imposed in return for nothing in specific; they
are used to secure funds for a variety of public purposes, including, for
instance, the provision of public goods.
Fees: Fees are payments imposed by the government on the
individuals in return for a specific service provided by the government.
Duties: A duty is a type of tax that is paid to the government and
enforceable by the law on commodities and financial transactions.
Tax Base: The aggregate value of the financial streams or assets on
which tax can be imposed.
Value-added Tax: A value-added tax is a type of consumption taxes
that is imposed incrementally on a product whenever value is added at
different stages of production and at the final sale.
Sales Tax: A sales tax is a type of consumption tax that is imposed on
the sale of goods and services at the point of sale. This tax is generally
collected and forwarded by retailers to the levying authority.
Tax Incidence: Tax incidence refers to the burden of tax that is beared
ultimately by the taxpayer.
Direct Tax: A direct tax is the tax that is paid directly by the taxpayer
who is intended to bear its burden.
Indirect Tax: An indirect tax, in contrast, is the tax that is paid
indirectly by the ultimate taxpayer through an intermediary who
collects that tax and forwards it to the levying authority.
Unit/specific Taxes: Unit/specific taxes are generally imposed based
on the weight or volume of the tax base.
Ad Valorem Taxes: Ad valorem taxes are imposed on the value of the
tax base.
Public Goods: Public goods are those enjoyed by all the individuals in
the society at no marginal cost. A public good is characterized by
being nonexcludable, nonrivalrous, and with zero marginal cost.
Merit Goods: Merit goods are those provided free of charge for the
benefit of all individuals of the society.
External Benefit: An external benefit refers to the benefit obtained by
a third party from the production of a good or service.
19
20