Revenue Choices: Principles and policies

What is revenue?
What is legal basis for revenue?
What are the basic revenue types?
We are also going to look at something we call principles of revenue policy

 Revenue- resources gathered by public organizations. How do we gather

resources? We gather resources in many ways. Purposes of gathering
revenues:
-acting to expenditures of resources
-regulating behaviour of individuals
-allocating resources
-distributing costs and benefits of public goods and services
-regulating the economy
 Revenue is very important. In most basic level, you gather revenue to pay
for things. It is very easy to say gathering revenue but the question is how
to gather revenues. In Azerbaijan, the major source of revenue is oil and
gas.
 Taxation is theft (that is what he personally thinks).
 Taxation can be ridiculous and unfair.
 Let’s look at 9 types of revenue:
1) Income taxes- tax on incomes. It is basically taxing your income (20%
of your income GONE). Income tax can be very unfair.
2) Consumption taxes- these are your sales and excise taxes. You
purchase something and you pay tax. This can also be unfair.
Everybody usually pays the same tax rate when it comes to
consumption tax. 18% sales tax in Azerbaijan; no matter what you
buy; it is always 18%. But nobody is forcing you to buy something; you
choose to buy. You go purchase phone and you pay tax.
3) Wealth taxes- this is your property tax. You have a house and you pay
property tax.
4) Business activity taxes- For example, in the US there is franchise tax.
Let’s say you have opened up little McDonalds and you pay a tax for
running a business, not for the products you are selling but for
running the business itself.
5) Quid pro quo payments- service charges/fees. You use metro you
pay and that is service charge. Bus is a service charge; electricity is a
service charge; water is a service charge.
6) Penalty payments & forfeitures- fines/tickets.
7) Intergovernmental transfers- grants. Federal government provides
aid to states that do not have the money to pay for services. You
remember how Greece went bankrupt four times. The European
Union was the one that gave money.
8) Gifts- endowments/any kinds of donations. Billionaires like Warren
Buffet and Bill Gates are the people who write a check to the
universities.
 9) Debt- money borrowed from some sources. Debt is quite a primary
source of revenue now for many countries, many states, and many
local governments.

 Let’s talk about basic revenue calculation formula. KISS principle- keep
it simple stupid. It states that most systems work best if they are kept
simple rather than made complicated; therefore simplicity should be a
key goal in design and that unnecessary complexity should be avoided.
 Your house is worth 100,000 manats and the rate is 2%. What is 2% of
100,000$? 2000 $ is your revenue. You might purchase a phone for 1000
manats; 18% tax; what is the revenue? 180 is your revenue. You take the
rate and multiply by the base and that is your revenue.
 Base is the number of transactions or entities that are taxable, as defined
by law. That is what is worth. Your house is worth 100,000 manats, so
that is your base. You purchase a phone for 200 manats, that is a base.
You’re making 14,000 manats a year, that is your base.
 Let’s look at the rate. It is the percentage set by the law. You make 20,000
manats and the rate of taxes for you is 20%. How much revenue? 4000
manats is your simple revenue. The hardest part is deciding the rate. How
do we get the rate to function in a way that doesn’t affect people,
economy, or the administration.
 Principles of revenue policy:

-Equity means fairness (treatment of people in the same manner).

Fairness and equality is not the same thing. Fairness is that a rich person
can get tax more than a poor person. But if you say equality, then they
have the same tax rate; everybody gets the same treatment.
-Neutrality or efficiency (also known as economy basically; how your
decision-making is going to affect economy). Whatever the decision you
make is going to affect your economy. You raise prices on transportation,
how does it affect your economy? First, you are going to look at if it is fair,
second, you are going to look at how this affects your economy and thirdly
you are going to look at effective administration.
 We increase rate on electricity. Let’s look at fairness. Are all groups going
to get paid the same way? Some groups will be suffering while others will
not be affected. If you are making every month 10,000 manats, if they
increase tax on electricity even they double it you are going to pay 200
instead of 100 and you still have 9800 left. But if you are making 600
manats it is not fair. That is not fair for poor people or people who don’t
make much money. Let’s look at neutrality part. People who don’t make
much money will stop using electricity that much. They are going to cut
their electricity consumption as much as they can, which means you will
probably have a decrease in revenue now because people will try to avoid
that tax. Third one is that how expensive it is going to be to increase or
decrease taxes.
 What is equity of revenue policy? Equity is usually understood as an
ability-to-pay principle: the more wealthy you are, the greater
proportion of tax you pay.
 Vertical equity versus horizontal equity. Fairness is not just about the rich
and the poor. Fairness is also about poor and poor. Let’s first talk about
vertical equity. This is usually what you think of (rich versus poor).
Whenever paying increases, people have to pay more.
 You could be today an orphan and then in 30 years you could be a
president of America. That is the idea. It is the freedom of become
something even if you are nobody. Vertical equity argues that the rich
pays more, middle class pays okay, poor class pays less.
 Horizontal equity is different. It argues that even people at the same
situation should not be treated the same. You might be rich but you could
have a condition that does not qualify you to pay the same amount of
money like somebody else. Let’s give an example. Let’s say there are five
vice-presidents of the university. They all have the same amount of salary;
four of these people are single (no children), and you are the only vice
president who has got five kids and your parents living with you. Is their
situation the same? You may make the same amount of money and you
may live in the same private house (neighbourhood) but the situation is
different. So, you should have equity and fairness towards people even on
the same bracket. At this point one is not richer than the other; it is just
one spends more than the other.
 Benefits-received principle- the amount of tax you pay should be in
proportion with the benefit you receive. This is more about your
consumption. The money you pay for gasoline; nobody is asking you to
drive too much; if you choose to drive too much, if you choose to buy
larger house, if you choose to purchase 5000$ phone then you should pay
more.
 Let’s talk about revenue policy from treatment of individuals. There are
three of ways of looking at them:
-Proportional burden- Everybody pays the same proportion of their
income. You make 10,000 manats this month and you pay 20% tax, you
make 100,000 manats you pay 20% tax, you make 100 manats you pay
20% tax; everybody pays the same rate. Your income might rise but your
tax still stays the same (basically in proportion with what you make).
-Regressive burden- Low-income groups pay more in proportion to
higher income groups. For example, he lives in the state of Texas and in
the state of Texas, sales tax is 6.25% and plus 2% cities and counties; so it
is 8.25%. When he was a student, he was not making much money. When
he wanted to buy food or laptop or anything he paid 8.25% taxes. Then he
started teaching at the university; still the same situation, but little higher
income. But a friend of mine was making 20,000$ a month. Regressive tax
means poor income people get affected much more than rich people. To
control the regressive tax, which is sales tax usually, the states of Texas
for example will cancel sales taxes on uncooked food. That is how they
control fairness.
-Progressive burden- High-income groups pay more in proportion to
lower income groups.
 So, the first principle is equity: fairness, fairness, and fairness. It is up to
the country or local government to decide on its fairness. Usually fairness
is decided by law.
 The next one is neutrality: the impact that a tax has on market behaviour.
We call it micro level, which affects individuals. And we call it macro level,
which affects residential or commercial whatever. The best tax rate is the
least impact on the economy. The best one is the least tax. But you will
never have perfect neutrality/perfect efficiency. You job is to make sure
to limit that as much as possible. For example, increasing taxes on
property will if it is too high stop purchasing properties (which will affect
your economy negatively), what you are going to do is to decrease a little
bit. And to make up for it you will increase for example sales taxes or
income taxes.
 How we can minimize the impact of taxes? Tax incidence or tax shifting-
whenever you increase something (let’s say business tax) somebody will
be paying this tax one way or another. There are three actors involved in
here that will be paying this tax: consumers; owners; employees. Let’s
say you have a restaurant and the government decides to impose a tax on
your business (increasing tax by 10%). You don’t want to pay this tax. You
have an option to shift this tax burden to the consumers; you increase the
prices. What if consumers start saying that restaurant is very expensive
and they decide to go to another restaurant. How does it affect you; you
are losing money now. But you have second option; backward to the
owners- resulting lower profits. And the third option is to shift downward
to the employees, which results in lower wages. So, these are the three
ways that will shift a tax in public administration.
 What affects the ability to shift the tax burden? Price elasticity of supply
and demand. If there is a high demand for a product and consumers will
purchase no matter what, that is inelastic. What about the elastic part,
which means if there is a high demand and the demand changes based on
prices, that is elastic (phones or laptops or going to restaurant is elastic).
 What affects elasticity?
-Availability of substitutes
-Necessity
-Competition among business
 Let’s talk about the second thing about neutrality, something we call tax
exportation. Somebody increases taxes to a level that people go
somewhere else. Imagine clothes are very expensive in Azerbaijan and
you go to Turkey and purchase clothes. That is tax exportation. Instead of
purchasing here, you purchase somewhere else. For example, it is cheaper
to go to Alanya to spend a week there in five star hotel than actually to
stay in the same five star hotel in Baku.
 The third one within the tax neutrality is tax capitalization- how it is
going to affect your property value. How asset value is changed when the
cash flow is changed by an increase or decrease in the tax liability for that
asset. Increasing taxes affects the value of your property in a positive or
negative way.
 The third principle is called effective administration. How much money
are you making and how easy it is to enforce the tax?
 Yield is the amount that taxes can be collected. How high do you increase
the tax rate to bring in more money? That is the question we are asking.
 Laffer curve- you bring in, you increase your tax little by little, and you
increase your revenue, and then it will get to a point where tax rate is high
and then people start purchasing less because of the tax rate, as a result
your revenue start decreasing. This is where economists come in and this
is where they have to make a decision on which rate is the most optimal
rate, which rate will bring most amount of money. For example, in the
United States, income tax is broken down by brackets: depending on how
much money you make, you pay a different tax. If there is the same tax for
everyone, that is not the optimal tax.
 Tax base is the transaction or entity upon which a tax can be levied. Your
income is a tax base (how much money you make). How much money is
your house worth is a tax base. What affects tax base?
-Population change: out migration refers to the loss of revenue. Before
you change the revenue tax you need to understand how it is going to
affect people. Before you change the tax rate you need to understand how
it is going to affect your job, your economy and people will start moving.
-Income change: you have to understand how income is going to affect
your revenue. If people make more money they do not care about how
much money they spend on tax. If people don’t make that much money
you should not have high tax rate.
-Bracket creep- different levels pay different taxes. Whenever you make
more money, you switch from one level to another, and you pay more tax.
 Tax overlap is when more than one taxing entity taxes the same base and
all competing for revenue from the same rate. There is something we call
vertical overlap- different level of government taxing the same base. For
example sales tax; state government and local government take tax (tax
by different governments).
 Horizontal overlap is when the same levels of government use the same
tax base. Economies of scale- it is more than one entity taxing you, then
it becomes cheaper that way. Instead of one particular local government
coming and individually assessing you, what you do is you just have one
assessment; everybody pays the same; it is cheaper this way for the
administration.
 Tax enforcement- the enforcement of tax payment. How do you enforce
the taxes?
1) Tax delinquency- whenever you are late on your taxes. This is a first
problem when it comes to effective administration.
2) Tax avoidance- legal use of exemptions or non-payments. People
legally finding out a reason not to pay their taxes.
3) Tax evasion- illegal use of exemptions or non-payments
4) Administrative cost- cost to the taxing entity. You decrease visa
requirements; a lot of tourists come in but then you have to provide
security so you start spending money on that. You are spending more
money than you are bringing in.
5) Compliance cost- taxpayer cost of compliance.