CHAPTER 1

AN OVERVIEW OF TAXATION

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

1. Define terms related to taxes and tax policy.

2. Distinguish tax revenues from other revenues of the government.

3. Give reasons why we have taxes.

4. Explain the principles of taxation.

5. Describe the major types of taxes.

6. Describe the standards of a modern tax system.

7. Describe the basic elements of a tax law.

1.1. CONCEPTS AND CHARACTERISTICS OF TAX
To many people, tax is considered to be something they have to pay to the
government but for which they receive nothing directly in return. So tax is just
understood as whatever (money or assets) a person or an entity has to pay
compulsorily to the government in order to finance the government’s activities. This
perception derives from the fact that people only see the act of tax payment from the
citizens to the government both in cash and by other assets such as rice or wheat etc.

According to the Mc Milan Dictionary of Accounting, “Taxes are compulsory levies

made by public authorities for which nothing is received directly in return. They are
used in part to provide public goods”. 1

The Longman Dictionary of Business English defines tax as “A payment of money

legally demanded by a government authority to meet public expenses”.2

In our opinion, tax is a part of income which is legally stipulated and compulsorily
paid by citizens to the government in order to finance the public expenditures.

From the concepts of tax mentioned above, the following characteristics can be seen:

Firstly, tax is a compulsory payment. This compulsory nature is attached to the

power of the government. The way to tax is very different from the way to get many
other revenues of the government which can be got voluntarily such as the sale of
government’s properties, loans, grants or donations, etc. If taxes were paid
voluntarily, very few people would pay because they would get no direct benefits in
exchange for paying taxes.

But unlike fines, taxes are not paid as punishment for breaking a law or rule. The
payment of taxes is not accompanied with the law violations but the apparent
responsibility of the citizens to the state.

1
R.H. Parker (2002): Mc Milan Dictionary of Accounting, second edition, page 279.
2
J. H. Adam: Longman Dictionary of Business English, page 433
Secondly, tax is an indirect compensation payment. Taxpayers get nothing directly
in exchange for paying taxes. Although taxpayers can eventually benefit from the
public goods and services provided by the government such as security, national
defense and roads. They get no immediate benefits in return for their tax payment.
They cannot demand the government to provide public services before they pay
taxes or right after they pay taxes. Also, the public services and the amount of taxes
are not positively related.

1.2. THE ROLES OF TAX

1.2.1. MAIN REVENUES OF THE GOVERNMENT’S BUDGET

This is the primary role of tax. In order to get the money for public expenditures as
well as to finance for the governments’ activities, the governments look for many
revenue sources such as the sale of the state’s property (natural resources, for
example), fees, voluntary donations, loans, etc., among which tax is the most
important source. Tax revenue is the core part of the government’s budget because tax
is compulsory and made by a wide range of payers whose incomes are produced by
their economic activities. Human beings cannot exist without economic activities
which people do to earn a living such as farming, fishing, mining, tourism and
manufacturing. Thus, as long as men exist, the sources of tax are available.

Tax has an important advantage concerning to its compulsoriness. With voluntary

donation, governments cannot be sure of how much they can get. Loans are not only
dependent on the willingness of the lender but also must be repaid at maturity date.
With its compulsoriness, tax revenue will be firmly paid to the government’s budget.

The wide range of payers makes tax superior to some other budget’s sources. While
natural resources and some other budget’s sources are limited, tax is endless. Even
though in some Gulf countries where crude oil, but not tax, is the main part of the
budget of the governments, these governments cannot rely forever on crude oil since
it may be abundant but not unlimited. Crude oil one day will become exhausted.
Fees can only apply to non-pure public goods and services such as roads and bridges.

In order to bring into full play of this tax’s role, the government has to deliberately
consider the elements of each tax among which tax base and rate count most. If the
base is not clear and sufficient, it can be eroded, and of course, the tax amount paid
to the budget reduces. Some may think that the higher the tax rate is, the higher the
tax revenue will flow into the state budget. Unfortunately, this is not always true. To
some extent, as the tax rate increases (up to a certain level), the tax revenue brought
in goes up. When the tax rate continues to rise, the tax amount brought in falls. This
law is known as Laffer curve which was named after an American economist who
drew the curve to illustrate his concept while he argued against President Gerald
Ford’s tax increase in 1974 although Laffer has never claimed to have invented the
concept, explaining that he has learned it from Ibn Khaldun and John Maynard
Keynes. Laffer curve can be seen as follows:

Tax revenue

0 100%
Tax rate

The importance of tax to the state budget can be seen in the following example:
 EXAMPLE 1.1: State budget revenue structures of EU and OECD (1998)

Group of Tax Revenues from compulsory

Others Total
countries revenue social contributions

OECD 70.6% 28.2% 1.2% 100%

EU 65.2% 32.7% 2.1% 100%

[Source: Herve Dutel, The socio-economic context of public finance, Lecture

of FSP, Hanoi 2003]

The above example shows that in 1998 tax revenue percentage is the largest part of
the total budget revenue of OECD and EU countries, reaching nearly three quarter
of the total state budget.

1.2.2. MACRO ECONOMIC ACTIVITIES ADJUSTMENT

As tax affects the income of enterprises and citizens, it can impact the motive of
labor and investment; therefore, it can adjust some major factors of the economy
such as the supply of labor, the demand of labor and capital, and the aggregate
demand and supply of the economy as a whole.

We will discuss how tax can help adjust the economic activities in the following
section.

Firstly, tax helps to regulate the economic cycle. As many economists have proven,
the global economy as well as each economy all over the world goes up and down
cyclically through four stages including recession, crisis, recovery, and prosperity.
Crisis, of course, does harm to the development of the economy but too fast
economic growth is also harmful to the development of the economy. Too fast
economic growth may cause some unbalances to the normal trend. For example, too
fast economic growth may cause lack of the labor supply or the exhaust of the natural
resources and so on. Therefore, to maintain an appropriate economic growth is of
great significance to every economy.
One of the functions of the government is to make the economy develop stably. In
order to fulfill this function, the government uses some tools such as public
expenditure policy, monetary policy, and tax policy.

How can tax help to regulate economic cycle? This is a very complicated issue but
here in this basic chapter of a textbook on taxation, we introduce two of the simplest
ways as below:

(i) If the economy shows a sign of too fast growing, the government can
increase the corporate income tax. An increase in the corporate income tax
can force firms to charge a higher price in order to shift tax burden to
consumers if possible or bear the tax themselves. Thus the rise in the income
tax may cause the rise in commodities’ price, which may discourage
consumer spending and firm’s production. As a result, businesses will see
their profit shrink and investment reduce.

(ii) If there are signs of economic recession, tax cuts would be the government’s
choice. The effect of this choice may be to create a reversal of the economic
situation. This means tax reduction may stimulate firms to invest more or
encourage consumers to spend as firms have more disposal income to invest
and to raise their workers’ income. Another way to spur the economy is to
refund taxes, may have similar impact as tax reduction on the development
of the economy.

EXAMPLE 1.2:
In 2007, when the US economy had some signs of recession, President Bush decided
to apply an income tax refund program to all income taxpayers. The aim of this
program is to leave the people with more income to spend which is believed to
stimulate the growth of the economy. This program helped Bush’s Administration
refunded over 370 billion US dollars. In accompany with other solutions such as the
rediscount rate reduction made by the Federal Reserve; this measure to some extent
did spur the US economy to recover in the following years.
Secondly, tax helps to balance the labor market and control inflation. Similar to the
way it regulates the economic cycle, an increase or decrease in taxes can help to
control inflation and to lower the unemployment. However, the use of tax to achieve
this target is similar to the use of a two edge sword. Misusage of tax could even
make inflation and unemployment worse.

EXAMPLE 1.3:
In the 1960s, the US economy was in recession with high inflation. In 1963 and
1964, all consultants of President Kennedy advised him to take many solutions
including income tax and corporate tax cut. But regrettably, no reduction in taxes
was done. Some years later, this advice was applied but it was too late and inflation
continued to rise.
Source: Paul A. Samuelson and William D. Nordhaus: Economics.

Thirdly, tax helps to stimulate the economy to develop in accordance with

government’s directions. By the use of tax rates and tax incentives, the government
stimulates businesses to invest in certain areas of the country or in some fields of the
industry or to constrain investment in certain fields. All of these help to efficiently
use the limited resources of a country and achieve the government’s set aims.

EXAMPLE 1.4:
In the 1950’s in order to spur the development of the industries, Japanese
government applied an accelerated depreciation rate to companies whose machinery
was newly invested or using new technology. The accelerated rate was up to 50
percent in the first year of usage of the machines. This solution strongly affected the
investment in new machine and technology of many firms in Japan and it was one
of the reasons explaining why the industry of Japan could sharply develop in the
following two decades after that.
Fourthly, tax protects the domestic production. The protection is done by imposing
high import duty. High import duty pushes the price of imported goods higher.
Because of the high price, the imported goods are in difficulty in competition with
the similar domestic goods.

However, in the context of the global integration where the import duty rate is
reduced considerably even to zero, the domestic production protection role of tax is
apparently lessened.

Fifthly, tax corrects problems caused by negative externalities. Market system does
not always work as well as we might hope. One of the weaknesses of the market
economy is that it causes negative externalities such as water and air pollution. This
is called market failure. By applying environmental tax on the pollutants a firms puts
into the air and water, the government can correct this market failure.

“Pollution problem arise because producers have to pay only part of the real
costs of making their products. Producers must pay for their raw materials. They
must also pay for labor, the machines they use in production and energy.
However, producers may put tons of waste into the air, or into rivers, lakes, or
oceans at little cost to themselves. In doing so, they pollute our water and air,
making both less valuable to society.

In these cases, taxes can correct this market failure. The government can collect
taxes on the pollutants a business puts into the air and water. The money from
that tax can be used to clean up the pollution. The tax may also make production
more expensive; thus, the firm’s cost will more closely represent the true cost
 of making the goods. This is just one way that a tax helps to correct a market
failure.”3

1.2.3. REDUCTION OF UNFAIRNESS IN INCOME DISTRIBUTION

Inequity in income distribution is regarded as an inevitable consequence of market

economy and it is a great challenge of every nation nowadays. This is also a market
failure. To cope with this challenge and to make the benefits of economic
development come to every man in society is an important responsibility of the
government.

Tax can be used to achieve this aim. By imposing high excise duty on luxurious
goods, the government can take much income of the rich as only the rich people are
able to buy these goods. By applying a progressive income tax, the government can
partly reduce the gap between the rich and the poor. Some tax incentives applicable
to the poor such as VAT exemption of necessities may help to achieve this goal.

1.3. TAX SYSTEM

1.3.1. CONCEPTS

There are two viewpoints on tax system. The classical point of view holds that tax
system is a complex of all taxes of a state which have interactive relations. The
modern view states that tax system is a complex of all taxes and the system of tax
administration of a state which have interactive relations. Thus, the modern
viewpoint is wider than the classical one.

1.3.2. TAX CLASSIFICATION

Based on ways to levy, taxes include direct tax and indirect tax.

3
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 423
Direct tax is a tax that is directly imposed on income and property and therefore it
is paid by the taxpayer direct to the government. Corporate income tax, capital gains
tax, land tax are examples of direct taxes.

“A direct tax is a tax paid by the person against whom the tax is levied. The tax
is levied against the individual taxpayer, and that taxpayer must pay the tax. A
personal income tax is levied against the individual taxpayer who, in turn, pays
the tax. Thus, the personal income tax is a direct tax. The individual who earns
the income must pay tax on that income. Shifting the incidence of a personal
income tax to another individual is difficult, if not impossible.” 4

Indirect tax is a tax that is not directly imposed on income and property and it is not
paid by the taxpayer direct to the government but is collected by suppliers,
shopkeepers, stores, etc. Value added tax, excise duty, export duty are examples of
indirect taxes.

“Taxes on business can often be shifted to the person who uses the company’s
products. For example, businesses must pay taxes on the sale of certain items,
such as cigarettes, liquor, and gasoline. Excise taxes function this way. These
taxes are indirect taxes because although they are levied on the business, the
consumer actually pays part of the tax. Other taxes on business, including
property taxes, can be shifted in part to consumers. Many times companies raise
prices in order to cover the cost of new taxes” 5

Based on bases of taxes, taxes include income tax, property tax and consumption
tax

Income tax is a tax the base of which is income. Corporate income tax and personal
income tax are apparently income taxes.

45
‘ J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 430
Property tax is a tax the base of which is property’s value. Land tax, house tax,
register tax, inheritance tax are property taxes.

Consumption tax is a tax the base of which is the value of the commodities sold
from sellers, shopkeepers to the consumer. This kind of tax is also called sales tax
for it is charged as a percentage of the price of goods or services. Examples of this
tax are value added tax, turnover tax, and excise tax.

Based on the proportion of tax to income, taxes include progressive tax, regressive
tax and proportional tax.

Progressive tax is a tax that takes a larger percentage from the income of high-
income earners than it does from low-income individuals. Individuals who earn more
pay higher taxes. Progressive tax means that the burden of tax is put more on the
rich than the poor. Personal income tax is often a progressive tax.

“Closely connected to the ability-to-pay principle is the concept of how the tax
burden is distributed among people in relation to their level of income. A
progressive tax is a tax that takes a larger percentage of higher incomes and a
smaller percentage of lower incomes. For example, if a person earning
$100,000 a year paid $25,000 for a particular tax, the tax is 25 percent of the
person’s income. If a person earning $1,000 a year paid $100 for that same tax,
the tax is 10 percent of that person’s income. This tax is a progressive tax
because it takes a larger percentage of the richer person’s income and a smaller
percentage of the poorer person’s income”. 6

Regressive tax is a tax that takes a larger percentage from low-income people than
from high-income people. A regressive tax is generally a tax that is applied
uniformly. This means that it hits lower-income individuals harder. Regressive tax

6
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 429
means that the burden of taxes is put more on the poor than the rich. Examples
include sales taxes such as value added tax, excise duty, etc.

“A regressive tax is a tax that takes a larger percentage of lower incomes and
a smaller percentage of higher incomes. Assume that a tax took $10,000 from a
person earning $100,000 per year and $2,500 from a person earning $10,000 a
year. The tax rate is 10 percent for the richer person and 25 percent for the
poorer person. This tax is regressive since the richer person pays a smaller
percentage of income than the poorer person. Regressive taxes go against the
ability-to-pay principle of taxation. They take greater percentages of the
incomes of those who can least afford to pay”. 7

Proportional tax (also called a flat tax) is a tax system that requires the same
percentage of income from all taxpayers, regardless of their earnings. A proportional
tax applies the same tax rate across low-, middle- and high-income taxpayers.
Corporate income tax is often a proportional tax

“Taxes can also be proportional. A proportional tax is a tax that takes the same
percentage of income from all taxpayers. For example, consider a tax that takes
$10,000 from a person earning $100,000 a year and $100 from a person earning
1,000 a year. Both taxpayers must give up 10 percent of their incomes for that
tax. The tax is proportional because it taxes all taxpayers at the same percentage
rate.

Proportional taxes are based less on the ability-to-pay principle than the
progressive taxes. They take proportional amounts of income at all levels. The
proportional amounts taken at lower income levels may have much more value
to the individual than the proportional amounts taken from those with higher

7
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 429
 incomes. So, a proportional tax may take more dollars necessary for survival
from lower income families than it takes from higher income families”. 8

Based on the power to levy, taxes include federal taxes and local taxes.

Federal Taxes

A federal tax is a tax that is levied by the federal government and is paid to the
budget of the federal government. In some countries, federal tax is called state tax
or central tax but the meaning doesn’t change much.

Local Taxes

A local tax is a tax that is paid to the budget of the local authority. The list of local
taxes and the ceiling tax rates are stipulated by the federal government. The local
authority has the right to choose a range of taxes among the list of the local taxes
and to define the rate provided it is not higher than the ceiling rate. Property taxes
such as land tax, house tax, severance tax, etc., are often local taxes.

Federal taxes and local taxes only exist in a country where tax autonomy is given to
the local authority.

1.3.3. STANDARDS OF A MODERN TAX SYSTEM

1.3.3.1. Equity

Equity is the utmost desire of human being. One of the functions of the state is to
help the society to achieve equity. Therefore, the state itself when imposing taxes
has to make tax equitable. The equity in tax is known as horizontal equity and
vertical equity.

The horizontal equity holds that tax treatment between those who are on every
aspect the same must be the same.

8
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 430
The problem with the horizontal equity is that in reality how we can find two persons
who are the same in every aspect. To solve this problem, in practice, persons in a
similar circumstance or basically the same are treated the same in terms of taxation.

The vertical equity insists that those who have more ability have to pay more taxes.

The following difficulties immediately appear:

(i) How much more tax should a person with better ability to pay be taxed than
the less ability person?

(ii) How to measure the ability to pay?

The answer to the first question depends on the political tax views of the government
in power. The ability-to-pay often shown through income earned, property value and
value of goods and services consumed is the answer to the second question.
1.3.3.2. Efficiency

The efficiency of a tax system has two aspects which are efficiency in tax
administration and efficiency in socio-economic impact.

The efficiency in tax administration is shown by two indicators: (i) the low expense
of the tax office in carrying out the responsibility; and (ii) the efficiency in
preventing tax evasion and tax shelter.

The socio-economic efficiency includes three aspects: (i) the impact of tax system
on the economy means that tax system can help best to regulate the economic cycle,
control inflation, lower unemployment, and regulate the development of the
economy to the government’s directions; (ii) the deadweight loss caused by tax is
the least; and (iii) the tax compliance cost is minimized by simple and transparent
tax procedures, by reducing time of and money for declaration and by reducing
corruption in tax officials.
The efficiency doesn’t normally go with the equity standard. A tax cannot often meet
these two criteria at the same time. Sometimes, in order to achieve the standard of
efficiency, the equity must be sacrificed and vice versa. Thus, the efficiency and
equity standards should not be considered as a mutually-exclusive of requirement
to a tax system.
1.3.3.3. Stability

As tax policy is closely related to the business environment, it is required to be stable.

The stability of a tax system is a base to make long-term investments. If the tax
system is frequently and unexpectedly changed, it will put investors at risk because
tax is one of the factors influencing their expenses and turnover which, in turn, affect
their profit.

This standard requires the tax system to be relatively stable for a period of time. In
order to meet this requirement, tax policy must be carefully prepared on the basis of
full and truthful statistics on socio-economic situation of the country. Besides, the
government has to inform the public in advance of any changes in the tax policy.
The government has to make sure that firms have enough time to prepare themselves
for the amendments and supplements of the tax policy.

1.3.3.4. Adaptability

The adaptability requires that a tax system has to be constructed so as to be

automatically adaptable to the changes in socio-economic situation of a country.
This means that there is no need to revise tax laws in case there are considerable
changes in the socio-economic situation due to the good automatic adaptability of
the tax system.

1.3.3.5. Transparency

Transparency is an essential requirement of a modern tax system since this standard

has a strong impact on the business climate and the efficiency of tax system. A
transparent tax system prevents tax avoidance and reduces tax evasion.
Transparency also helps to create a good investment environment because it reduces
corruption in tax officials.

Transparency is shown through three aspects: (i) clarity – meaning only one way to
understand a regulation, (ii) every rule is made publicly, and (iii) no exception exists.

1.4. BASIC ELEMENTS OF A TAX LAW

1.4.1. NAME OF A TAX

Each tax has its own name to distinguish one tax from the others. Names of taxes
often show their contents, purposes or characteristics. For example, value added tax
implies that this tax is charged only on the value added of goods; excise duty implies
that this tax is only levied on certain special commodities.

1.4.2. TAXPAYER

This element states in a certain circumstance stipulated in a tax law who has to pay
that tax. Taxpayer is the one who legally has to declare and pay taxes. In other words,
a taxpayer is any person or organization liable by law to pay a tax or taxes. Taxpayer
can also mean the person on whom tax burden falls.

1.4.3. TAX BASE

Tax base is the amount of income or property or goods, or the amount of value of
property or goods on which a tax is imposed. Thus, this element shows on what a
taxpayer is liable to pay tax.

1.4.4. TAX RATE

Tax rate shows how much a tax is paid on a certain amount of tax base.

In terms of the form, tax rates include specific rate and ad valorem rate.

Specific rate is the one shown in the form of a specific amount (normally of money)
liable to be paid on a physical unit of a tax base. For example, the agricultural land
use tax in Vietnam is charged based on the amount of rice per hectare of land; the
excise duty in Malaysia is charged as RMB per liter of alcohol (However, Malaysia
also uses ad valorem rate to charge excise duty on alcohol).

Ad valorem rate is the rate shown in the form of a percentage on a monetary unit of
a tax base. For instance, the value added tax in Vietnam is charged at three rates (0
percent, 5 percent and 10 percent) on the added value of goods and services.

Considering the ways of taxation, tax rates include single specific rate, proportional
rate and progressive rate.

Single specific rate is a rate that remains unchanged regardless of the amount of tax
base. For example, the poll tax in Vietnam in the 1930s which was charged as
Dongduong dong per capital.

Proportional rate is the one that is charged at a fixed percentage on any variable
amount of a tax base. In the other words, proportional rate is an ad valorem rate that
remains unchanged as the amount of income or value of property or goods increases.
For instance, the corporate income tax in Thailand (2007) is charged at a standard
rate of 30 percent. This rate applies to any amount of the taxable income of a
company.

Progressive rate is the one that is charged at an increasing percentage as the amount
of tax base increases. In order to show this kind of tax rate, a table including brackets
of taxable amount and their respective tax rates is used. It is called progressive tax
table. Example 1.5 below will illustrate clearly this type of tax rate.
 EXAMPLE 1.5: The personal income tax in Vietnam which applies to income
derived from business and employment (Effective from 1 Jan 2009) is charged as in
the following table:
Taxable income per year (million Vietnam Tax rates
dongs) (%)
Up to 60 5
Above 60 to 120 10
Above 120 to 216 15
Above 216 to 384 20
Above 384 to 624 25
Above 624 to 960 30
Above 960 35
Applying the above progressive table, given a resident taxpayer without any
dependants whose assessable income in a tax year is VND308 million, his/her
income tax is calculated as follows:
The first VND108 million is free from tax because it is his/her self deduction.
Therefore, his/her taxable income is VND200 million.
So the income tax he/she has to pay is: 60 x 5% + (120 – 60) x 10% + (200 – 120) x
15% = VND21 million.

1.4.5. INCENTIVES

This is an extra element of a tax. Some taxes may not have this element. Incentives
are used to achieve government’s social or economic targets. Normally, in order to
enjoy an incentive, a taxpayer has to meet one or some conditions stated by the law.
There are some types of incentives as follows:

(1) Exemption: This is one of the common examples of tax incentives. If the
taxpayer is exempt from a tax, he/she is free from having to pay that tax. There is no
time limit to this incentive.
(2) Tax holiday: This type of incentive is similar to the 1st type above but there are
two differences: (i) in some cases, the tax amounts are only reduced partly, normally
50 percent; and/or (ii) the reductions or exemptions are applicable only for a period
of time.

(3) Preferential rates: With this type of incentive, the taxpayer enjoys a lower rate
than the common rate applied to others. The low rate can be applied in a period of
years or in the lifetime of the project.

(4) Tax credit: This incentive is so-called because, in terms of economics, it is

similar to a credit from the government to the taxpayer. In some ways stipulated by
law, the taxpayer does not have to pay a tax amount for the current year but that
amount of tax will be paid in the following years. Accelerated depreciation and tax
refund for reinvested income are two typical examples of this kind of incentive.

(5) Double deduction: With this type of incentive, the taxpayer enjoys a double
deduction for an expense, for example, in some countries research expense is
accepted to deduct twice. As a result, the taxpayer enjoys a reduction in income tax.

1.4.6. PROCEDURE

This element includes some issues such as forms of tax returns, procedures and due
time for declaration and payment, taxpayer’s obligations and rights, and the
obligations and rights of tax office and other relevant persons and organizations.

There are two ways to present this element. In some countries it is stated separately
in each tax law. In other countries, all procedures and tax punishments are included
in a law called act of tax administration or law on tax administration.

1.4.7. PUNISHMENT

In a tax law or in a tax administration law, fines – a sum of money paid as a

punishment – are applied to those who are found guilty of breaking the tax laws
including the following actions: late payments, late declaration, under declaration,
tax evasion, etc.

Where the tax evasion is regarded as criminal, the evader is not punished by the tax
law but by the criminal code.

1.5. THE PRINCIPLES OF TAXATION

(1) Benefit-received principle

The root of this principle is the benefit received by the taxpayer as a result of the
investment of the government. Each citizen benefits differently from the investment
by the government, so in order to achieve equity, the weight of taxes should be
related to the benefit enjoyed by each taxpayer. For instance, the value of a land near
a newly-built road by the government may increase sharply as compared to that of
the time before the investment was made. This principle requires that the more the
taxpayer benefits from the government-supplied goods or services, the more the tax
is paid to finance for them.

However, difficulties in applying this principle at once arise. Those are:

(i) How does the government determine the benefits individual households and
businesses receive from national defense, education, and police and fire
protection? Even in the seemingly tangible case of highway finance we find it
difficult to measure the benefits;

(ii) Government efforts to redistribute income would be self-defeating if financed

on the basis of benefit principle; it would be absurd and self-defeating to ask the
poor to pay taxes needed to finance their welfare payments!

“The benefit principle of taxation is the concept that those whose benefit from
the spending of tax dollars should pay the taxes to provide the benefits. This
means that the people who benefit should pay. The gasoline taxes in America
follow the benefit principle. The amount of gasoline bought is a good measure
 of the amount of highway service used. So, a tax on gasoline makes users of the
highways pay for their use. The money collected from gasoline taxes is used to
repair and improve highways.

But often the benefit principle of taxation does not apply. Most public goods
such as national defense and social welfare programs cannot use this principle.
All people benefit from national defense spending, but all people cannot be
charged directly for the benefit. People who benefit from social welfare
payments cannot afford to pay for those benefits. If they could afford to pay for
them, they would not need them.

The very nature of public goods often makes it hard to apply the benefit
principle of taxation. It is often impossible to separate those who benefit from
those who don’t. Even when this is possible, it is difficult to find ways of
charging only those who benefit. So, two conditions are necessary to use the
benefit principle of taxation: (1) Those that benefit from a particular good must
be easily identified; (2) ways to charge only those who benefit must be found.
However, when these conditions exist, it is usually more efficient to have the
private sector produce that particular good”. 9

(2) Ability-to-pay principle

The ability-to-pay principle contrasts sharply with the benefit principle. The ability-
to-pay taxation rests on the idea that the tax burden should be geared directly to a
taxpayer’s income and wealth. This principle requires that the weight of taxes should
be related to the ability-to-pay of the taxpayer in order to bring about equity of
sacrifice. The ability-to-pay is often regarded as the taxpayer’s income and property
or the value of goods consumed. According to this view point, the more the income
the taxpayer earns, the more the tax is paid; the larger the value of the taxpayer’s

9
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, 428
property is, the more the tax is charged; the higher the value of the goods the taxpayer
consumes, the more the tax is levied.

According to Campbell R. Mc Connell and Stanley L. Brue in the book named

Economics Principles, Problems, and Policies, the root of the ability-to-pay is
explained as follows:

“What is the rationale of ability-to-pay taxation? Proponents argue that each

additional dollar of income received by a household will yield smaller and
smaller increments of satisfaction or marginal utility. Because consumers act
rationally, the first dollars of income received in any period of time will be spent
on high-urgency goods which yield the greatest marginal utility. Successive
dollars of income will go for less urgently needed goods and finally for trivial
goods and services. This means a dollar taken through taxes from a poor person
who has few dollars is a greater utility sacrifice than is a dollar taken by taxes
from the rich who has much money. To balance the sacrifice which taxes levy
on income receivers, taxes should be apportioned according to the amount of
income a taxpayer receives.

This argument sounds reasonable, but problems of application exist here too.
Although we might agree that the household earning $100,000 per year has a
greater ability to pay taxes than a household receiving $10,000, exactly how
much more ability to pay does the first family have compared with the second?
Should the rich person pay the same percentage of his or her larger income –
and hence a larger absolute amount – as taxes? Or should the rich be made to
pay a larger fraction of this income as taxes? And how much larger should that
fraction should be?

The problem is there is no scientific way of measuring someone’s ability to pay

taxes. In practice, the answer hinges on guesswork, the tax views of the political
 party in power; expediency, and how urgently the government needs
revenue”.10

Similar to the above explanation but with better illustration is the viewpoint of J.
Holton Wilson and J. R. Clark in the book named Economics.

“The ability-to-pay principle of taxation is the concept that those who can best
afford to pay taxes should pay most of the taxes. Generally the rich or the
economically better off can best afford to pay. Most economists believe that
every extra dollar earned has value. For a person earning only $1,000 a year,
extra dollars of income mean more food, or badly needed clothing, or medical
care. On the other hand, a person earning $1,000,000 a year does not need the
extra dollars to meet basic needs. This person would hardly notice an extra
dollar of income. Therefore, the extra dollars may not have nearly the value to
that person as to the person earning $1,000 a year. The ability-to-pay principle
of taxation would tax the person earning $100,000 a year more heavily than the
person earning $1,000 a year”. 11

Thus, regarding the question of how the economy’s tax burden should be
apportioned, there are two basic philosophies mentioned above. The following parts
will discuss some other principles concerning certain types of taxes.

(3) Origin principle

This principle only applies to consumption taxation and implies the power of a
country’s authority to impose consumption taxes. According to this principle, a
government has power to levy on goods and services produced in its country despite
where they are sold and consumed. The reason for this principle is that the goods

10
Campbell R. Mc Connell and Stanley L. Brue (1996): Economics Principles, Problems, and Policies, McGraw-
Hill, page 626
11
J. Holton Wilson and J. R. Clark (1993): Economics, South-Western Publishing Co. Ohio, page 429
and services are produced by using the country’s resources and the
producer/taxpayer benefits from the government’s supply of public services.

(4) Destination Principle

Similar to the origin principle, the destination principle concerns the power of a
government to levy taxes on goods and services. Contrary to the origin principle,
this principle states that a government has power to levy on goods and services sold
and consumed in its country despite where they are produced. The rationale of this
principle is that in a market economy, where to produce and by what to produce is
not as important as where to consume. Moreover, the aim of consumption taxes is to
take away part of the consumer’s income and therefore the consumers who benefits
from the public services provided by their governments have to pay taxes to their
governments. In order to practice this principle, the government where the goods
and services are produced has to “concede” the power to tax to the government
where the goods and services are consumed. This process is often done by law to
refund taxes to exported goods and services or to stipulate that exported goods are
free from a certain sales tax.

Both origin and destination principles deal with the power over consumption
taxation but destination principle is often the choice because it is reasonable in the
context of market economy. However, the origin principle, sometimes is chosen,
especially where the government wants to impose export duty.

(5) Source Principle

The source principle and residence principle deal with the power of a government
over income and property taxes. According to the source principle, an income or a
property earned by a person or company is taxed by the government of the country
where it is earned despite the residence state or the nationality of a taxpayer.

(6) Residence Principle

This principle requires that any person or company who is regarded by law to be a
resident of a country is taxed on worldwide incomes including both incomes earned
in the country where the taxpayer is liable to pay and incomes earned overseas. Non-
resident is only charged on incomes earned in the country where the tax payer works
and receives these incomes.

Of course when applying source and residence principles, disputes appear and the
double taxation emerges as an inevitable incident. That is why double taxation
avoidance and tax treaties need to be discussed. This issue will be dealt later in
chapter 10.

1.6. THE VIETNAM’S TAX SYSTEM

Vietnam began to significantly reform its tax system in the late of the 1980s
following the launch of its economic reform in 1986. Since that time, Vietnam’s tax
system has undergone three major reform stages. The general features of current tax
system in Vietnam have been the results of three phases of tax reform, which have
been driven mainly by nature of the transition process.

The first state of the reform took place during early 1990s, which was focused on
the establishment of a foundation for a tax system in line with the process of
transition from a Soviet-state tax system to a tax system that could be facilitate for
the functioning of a multi-sectoral economy. In this stage, tax reform in Vietnam
could be characterized by the formalization of tax laws. A number of tax laws were
enacted to replace the old taxes, which were based on administrative decrees under
the centrally planned economy. The second stage was carried out in the late 1990s
and early 2000s. More significant reform took place during this phase, including the
promulgation of the Law on value added tax (VAT), the Law on Corporate Income
Tax (CIT) as well as the amendment of the Law excise duty (In other words, it is
special consumption tax - SCT) and the Law on export and import duty. The third
stage of tax reform has been carried out since the mid of the 2000s, focusing on
reform of compressively all tax instruments and a modernization of tax procedure.
Vietnam's tax system has continued to change in various aspects. In particular,
Vietnam has undertaken a tax overhaul to meet the requirements of acceding into
the World Trade Organization (WTO). Currently, Vietnam is undertaking its 4 th
phase of tax reform in line with the objectives and direction set in the Tax reform
Strategy for the 2011-2020, which has been recently approved by the Prime Minister.

To various extents, Vietnam's tax reform has been carried out in line with
international accepted guidance and principles, such as broadening the tax bases,
reducing tax rates and simplifying methods of tax calculation and declaration and
payments. Vietnam's achievements in tax reform have been quite impressive. The
country has recorded itself as one of strong performers in tax reform (IMF, 2011).
By the end of the 2018, Vietnam’s tax system has had the presence of major types
of taxes, which are considered as necessary for the performance of a market-oriented
economy, such as CIT, PIT, CIT and excise duty.

The Vietnam’s tax system now includes:

- Value added tax;

- Excise duty;

- Customs duty;

- Environmental protection tax;

- Corporate income tax;

- Personal income tax;

- Agricultural land use tax;

- Non-agricultural land use tax;

- Severance tax.
CHAPTER REVIEW

SUMMARY

1) Tax is a part of income which is legally stipulated and compulsorily paid by

citizens to the government in order to finance the public expenditures. Its
prominent characteristics are compulsory and indirectly compensational.

2) Tax plays three important roles: (i) Crucial state budget revenue; (ii) Help to
regulate the economic activities, the economic cycle, control inflation, and
protect domestic production, etc., and (iii) Help to reduce inequity in economic
distribution by applying progressive tax rate and charging high excise duty on
luxury goods and services.

3) There are many ways to classify taxes. Depending on each criterion, taxes can
be classified differently. The most frequently used taxes are: direct and indirect
taxes, income, property and consumption taxes, progressive, regressive and
proportional taxes, and federal and local taxes.

4) There are five main standards of a modern tax system. They are equity,
efficiency, stability, adaptability and transparency. It is ideal for a tax system to
achieve all these standards but normally in order to meet a certain standard; one
of the rest has to be sacrificed.

5) Normally, there are seven elements to constitute a tax law including name,
taxpayer, tax base, tax rate, incentives, procedures and punishment of which tax
rate is the most important one. To decide on the tax rate is a difficult issue of any
government because high rate are not always accompanied with high revenue
from taxes and tax rate is also a key tool to redistribute income as well as to
regulate economic activities. In tax laws of countries all over the world, we can
see many kinds of tax rates such as specific rate, ad valorem rate, proportional
rate and progressive rate.
6) Some principles are used to impose taxes among which two principles (the
ability-to-pay and benefit principles) are used to construct almost all taxes and
the others are used to levy certain types of taxes (e.g. the origin and destination
principles are used for consumption taxes while the source and residence
principles are used for property and income taxes).

7) Vietnam’s tax system has undergone three major reform stages. The general
features of current tax system in Vietnam have been the results of three phases
of tax reform, which have been driven mainly by nature of the transition process.
By the end of the 2018, Vietnam’s tax system has had the presence of 9 taxes,
among which some taxes are considered as necessary for the performance of a
market-oriented economy, such as CIT, PIT, CIT and excise duty.

KEY TERMS

Supply definitions for the following terms:

Ability-to-pay Fee Specific rate

Accelerated depreciation Levy Stability
Adaptability Local tax Tax base
Ad- valorem rate Indirect tax Tax credit
Agricultural land use tax Income tax Tax evasion
Benefit Personal income tax Tax incentive
Compliance cost Procedure Taxpayer
Consumption tax Property tax Tax exemption
Corporate income tax Progressive rate/tax Tax holiday
Declare Proportional rate/tax Tax punishment
Destination Public goods Tax reduction
Direct tax Regressive rate/tax Tax refund
Efficiency Residence Value added tax
Equity Sales tax
Excise duty Severance tax
Federal tax Source
ECONOMIC CONCEPTS

1. What is tax?

2. What is the protection role of tax?

3. List the 5 standards that a modern tax system should follow.

4. How can taxes be classified?

5. List the principles of taxation.

DISCUSSION QUESTIONS

1. Point out the similarities and differences between tax and fee.

2. Why do we have taxes?

3. In countries such as Gulf countries where natural resources are abundant, does
tax act as the most important source of the state budget?

4. Why, in the context of integration, the role of tax as a tool to protect domestic
production become lessened?

5. Give examples of tax types. Discuss the significance of tax classification.

6. What are the standards of a modern tax system? Why sometimes in order to
achieve the equity we have to sacrifice the efficiency?

7. What is the most important element of a tax law?

8. Give examples of each type of tax rate.

9. State the types of tax incentives and discuss the advantages and disadvantages
of each type.

10. Discuss the taxation principles and give examples.

EXERCISE

Given a country’s personal income tax table as follows:

Taxable income per year (USD) Tax rates (%)

Up to 100,000 10

Above 100,000 to 200,000 20

Above 200,000 to 400,000 30

Above 400.000 40

Suppose Mr. John’s taxable income is USD 500,000 in the tax year.

Required: Define the amount of income tax paid by John for that tax year in case the
above tax table is a progressive rate.