FIN702Sem

Public Finance
Week: 9 Lecture Notes
Topic : Taxation and Tax Analysis
Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 1
 Lecture Outline :
1. Analyze the theories of taxation.
2. Evaluate the rates of Taxation in Fiji
3. Analyze the Principles/Characteristics of Taxation Systems.
4. Evaluate Merits and Demerits of Direct and Indirect Taxes.
5. Validate Tax Incidence.
6. Evaluate the link between Taxation and Efficiency.
7. Compare partial and General Equilibrium Models.
Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 2
LO:1 What are the Theories of Taxation ?
A government needs funds to provide goods and services. The methods of
financing public expenditure have changed over time but there is no
escape from the fact that in the end somebody has to foot the bill.
The economists have put forward many theories or principles of taxation
at different times to guide the state as to how justice or equity in taxation
can be achieved. The main theories or principles in brief, are:

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 3

 Benefit Theory
According to this theory, the government should levy taxes on individuals
according to the benefit passed on them.
The more benefits a person derives from the activities of the state, the more he
should pay to the government.
Critics of Benefit theory :
1. Most of the expenditure incurred by the slate is for the general benefit of its
citizens, It is not possible to estimate the benefit enjoyed by a particular
individual every year.
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 Cont.…
2. if we apply this principle in practice, then the poor will have to pay the
heaviest taxes, because they benefit more from the services of the state. If
we get more from the poor by way of taxes, it is against the principle of
justice.
You can read more about “Benefit Theory” if you read the following
paper.
Cooper, G. S. (1994). The benefit theory of taxation. Austl. Tax F., 11, 397.

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 Cost of Service Theory
The cost of service principle can no doubt be applied to some extent in those cases
where the services are rendered out of prices and are a bit easy to determine, e.g.,
postal, supply of electricity, etc.
Critics of Cost of Service Theory
1. Most of the expenditure incurred by the state cannot be fixed for each individual
because it cannot be exactly determined. For instance, how can we measure the cost
of service of the police, armed forces, judiciary, etc., to different individuals
Kaplow, L. (2010). The theory of taxation and public economics. Princeton University
Press.
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 Ability to Pay Theory
The most popular and commonly accepted principle of equity or justice in taxation is that
citizens of a country should pay taxes to the government in accordance with their ability
to pay. It appears very reasonable and just that taxes should be levied on the basis of the
taxable capacity of an individual. For instance, if the taxable capacity of a person A is
greater than the person B, the former should be asked to pay more taxes than the latter.
Critics of Ability to Pay theory
Which measure of ability are we going to look ?- Ownership of property or what?
Kendrick, M. S. (1939). The ability-to-pay theory of taxation. The American Economic
Review, 92-101.

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 7

 LO:2 Evaluate the Rates of Taxation in
Fiji
Resident individuals are liable to tax on taxable income accruing in or derived from Fiji
or elsewhere.

Non-residents are liable to tax only on taxable income accruing in or derived from Fiji.
Pensions received by non-resident pensioners from a Fiji source will not be taxed.

When a non-Fiji citizen is in Fiji mainly for employment purposes under a contract of
employment of not more than three years, income other than employment income is not
subject to tax in Fiji if it is not derived from or does not accrue in Fiji.
Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 8
 Cont…
• Resident individuals

• Chargeable income (FJD) Income tax payable SRT payable ECAL payable

• From To

• 0 30,000 0 0 0

• 30,000 50,000 18% assessed on amounts over FJD 30,000 0 0

• 50,000 270,000 FJD 3,600 plus 20% assessed on amounts over FJD 50,000 0 0

• 270,000 300,000 FJD 47,600 plus 20% assessed on amounts over FJD 270,000 13% assessed on amounts over FJD 270,000 10% assessed on amounts over FJD 270,000

• 300,000 350,000 FJD 53,600 plus 20% assessed on amounts over FJD 300,000 FJD 3,900 plus 14% assessed on amounts over FJD 300,000 10% assessed on amounts over FJD 270,000

• 350,000 400,000 FJD 63,600 plus 20% assessed on amounts over FJD 350,000 FJD 10,900 plus 15% assessed on amounts over FJD 350,000 10% assessed on amounts over FJD 270,000

• 400,000 450,000 FJD 73,600 plus 20% assessed on amounts over FJD 400,000 FJD 18,400 plus 16% assessed on amounts over FJD 400,000 10% assessed on amounts over FJD 270,000

• 450,000 500,000 FJD 83,600 plus 20% assessed on amounts over FJD 450,000 FJD 26,400 plus 17% assessed on amounts over FJD 450,000 10% assessed on amounts over FJD 270,000

• 500,000 1,000,000 FJD 93,600 plus 20% assessed on amounts over FJD 500,000 FJD 34,900 plus 18% assessed on amounts over FJD 500,000 10% assessed on amounts over FJD 270,000

• 1,000,000 and above FJD 193,600 plus 20% assessed on amounts over FJD 1,000,000 FJD 124,900 plus 19% assessed on amounts over FJD 1,000,000 10% assessed on amounts over FJD 270,000

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 9

 Readings on Taxation Rates in Fiji
• https://taxsummaries.pwc.com/fiji/individual/taxes-on-personal-income

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 LO : 3 Analyze the Principles/Characteristics of Taxation Systems.

Tax Base – the item or activity that is to be taxed

A general tax is one that taxes all of the components of the economic base,
with no exclusions, exemptions, or deductions from the tax base.
A selective tax is one that taxes only certain portions of the tax base, or it
might allow exemptions and deductions from the general tax base.
Tax Rate Structure-the relationship between the amount that is to be paid
in tax and the tax base for a given accounting period

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 Tax basics (cont..)

 Total Taxes Paid

MTR 
Value of theTax Base
Average Tax Rate- the total amount of tax divided by the total amount of
the tax base.
The range of the tax base in which the marginal rate is constant

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 Cont…
A Progressive Tax has a structure where the marginal tax rate is
increasing and greater than the average tax rate.
A Proportional Tax has a structure where the marginal tax rate is constant
and equal to the average tax rate. (Sometimes called a Flat Tax)
A Regressive Tax has a structure where the marginal tax rate is decreasing
and less than the average tax rate.

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 14

 Tax Rate Structure

Proportional Tax • Example

Regressive Tax Progressive Tax
Amount Percent Amount Percent Amount Percent
Income of Tax of Income of Tax of Income of Tax of Income
$50,000 $12,500 25% $15,000 30% $10,000 20%
100,000 25,000 25% 25,000 25% 25,000 25%
200,000 50,000 25% 40,000 20% 60,000 30%
LO: 4 Evaluate Merits and Demerits of Direct and Indirect Taxes.

Merits of Direct Taxation (Which is disadvantage of Indirect Taxation)

1. Equity
There is social justice in the allocation of tax burden in case of direct taxes
as they are based on the principle of ability to pay.
Persons in a similar economic situation are taxed at the same rate. Persons
with different economic standing are taxed at a different rate- there is both
horizontal and vertical equity under direct taxation.

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 16

 5.4 Merits of Direct Taxes

• 1. Equity
 There is social justice in the allocation of tax burden in case of direct
taxes as they are based on the principle of ability to pay.
 Persons in a similar economic situation are taxed at the same rate. Persons
with different economic standing are taxed at a different rate- there is both
horizontal and vertical equity under direct taxation.
 Cont…

2. Certainty -As far as direct taxes are concerned, the tax payer is certain as
to how much he is expected to pay, as the tax rates are decided in advance
3. Relatively Elastic-The direct taxes are relatively elastic. With an increase
in income and wealth of individuals and companies, the yield from direct
taxes will also increase. Elasticity also implies that the government's revenue
can be increased by raising the rates of taxation. An increase in tax rates
would increase the tax revenue.
 Cont..
4. Creates Public Consciousness-They have educative value. In the case of
direct taxes, the taxpayers are made to feel directly the burden of taxes and
hence take keen interest in how public funds are spent
5. Economical - Direct taxes are generally economical to collect. For
instances, in the case of personal income tax, the tax can be deducted at
source from the income or salaries of the individuals
 Disadvantages of Direct Tax (Advantages of Indirect Taxation)

1. Tax Evasion - In India, there is good amount of tax evasion. The tax evasion is due
to High tax rates, Documentation and formalities, Poor and corrupt tax administration.
It is easier for the businessmen to evade direct taxes
2.Arbitrary Rates -The direct taxes tend to be arbitrary. Critics point out that there
cannot be any objective basis for determining tax rates of direct taxes. Also, the
exemption limits in the case of personal income tax, wealth tax, etc., are determined in
an arbitrary manner.
3. Inconvenient -Direct taxes are inconvenient in the sense that they involve several
procedures and formalities in filing of returns.
 LO :5 Validate the Tax Incidence

Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 21

 Cont..

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 Watch the video given the link below to understand
the incidence of Taxation on Buyers and sellers
• https://www.youtube.com/watch?v=3Zlvg-xRJpU

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 LO : 6 Evaluate the link between Taxation and Efficiency.

 Excess burden is the loss in individual’s utility due to imposing a tax.

 One way of measuring the loss in utility is by using the equivalent variation:
 The amount of income we would have to take away from the consumer (before
imposing the tax) to induce it to move from the high to the low indifference
curve.
 The EV measures the loss caused by the tax as the size of the reduction in
income that would cause the same decrease in utility as the tax.
 The EV is the amount by which we need to shift the original budget constraint.
Fiji National University - Semester 1, 2020 (Notes complied by : Shasnil Chand) 24
 Con…
Consider a lump sum tax (an amount paid regardless taxpayer’s behavior) that shifts the
budget line inward parallel to the original line (because it does not change relative prices).

 In addition, because the consumer attains the same utility level as in the case of the
commodity tax, the budget line must be tangent to the new indifference curve.

 Because tax  revenue collected from a lump sum tax equals its EV, it has no excess
burden.

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 Cont…
• Generally:
1. A tax that changes relative prices generates an excess burden.
2. A tax that changes relative prices is inefficient since it lowers individual
utility more than is necessary to raise a given amount of revenue.

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 LO : 7Compare partial and General Equilibrium Models.

Partial equilibrium tax incidence misses out on a lot of important aspects

of economic activity. Among those aspects : markets are interrelated, so
that prices of all goods are determined simultaneously, not one market at a
time ; behind the suppliers of goods and services are the owners of the
factors used in producing the goods and services, who may be affected by
a tax ; people are simultaneously buying goods and services, and also
selling factors they own, such as the labour they supply.

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 Cont….
General equilibrium models can help deal with all these aspects. A general
equilibrium model is a comprehensive model of the whole economy. But
there is a price to pay for making models so general : in order to analyze
these models theoretically, they have to be made very simple. We can, and
do, construct more realistic models. But these realistic models are
complicated. It is very difficult, in particular, often, to understand how the
models work, or what particular assumption may be responsible for the
results.
http://www.yorku.ca/bucovets/4070/incidence/incidence_c.pdf
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 Readings.
• Please read the additional materials which are referenced in the lecture
notes.

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 Thanks!
• You are now ready to answer tutorial 6.

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