Incidence of Taxation

Q: What are the reasons for taxation?

a) To finance the provision of merit and public goods such as education

health law and order and national defence.

b) To influence the level of consumer spending in order to control the level

of inflation.

c) To reduce the inequality in the distribution of income the rich pay more
in taxes which helps finance free education and health for the poor.

d) Taxes on imports (tariff) can be used to protect domestic industries from

foreign competition.

e) The government can use taxes to discourage the consumption of

demerit goods such as cigarettes and alcohol.
How many types of taxation?
Direct tax: are those types of taxes which cannot shift to other person
or impose only on income and assets. Ex Income tax, corporation
tax, in heritage tax etc.

Indirect tax: are those types of tax which imposes only on

goods. Example. Tax on computer, car etc.
 Cont.

Income tax- Tax on income

Corporation profit tax: Tax on profit of a company
In heritage tax: Tax on properties
 10+6 = 16 taka
t S1
Mobile, BMW

2= consumer
10-6 =4 Who paid it. ? Producer
12
10

4 5
6 *4= 24 taka Income for the government
 40* 9 = 360

80
50
40

9 10
 Types of Indirect tax

VAT – Value added tax.

Custom duty: Tax on imported goods
Excise duty: tax on domestically produced goods
Car tax: Special tax.
 Explain the structure/Nature/Ch
of taxation
Progressive tax: A tax is progressive when people with
higher incomes pay a greater percentage of their income in
tax. Example, income tax.
Regressive tax: When the income rises but the rate of tax
decline. This is known as regressive tax. Eg. Export
oriented goods.
Proportional tax: When the income rises but the rate of tax is remaining
same. Ex. Corporation profit tax.
What are the arguments in favor of lowering direct and raising indirect taxes?

Incentive for hard work: Lower income taxes will increase people’s disposable income.
This will motive them to work harder as they know they will be left with more
money as a result of raise or a promotion, if income taxes are reduced. On the
other hand levels of income tax could act as a disincentive for hard work, as most
of the extra income could go to the government.
More choice for taxpayers: Consumer have more choices regarding indirect taxes, as
they can simply reduce or even avoid consuming the product. A direct tax is a tax
on income and therefore cannot be avoided.
More revenue for the government: An increase in indirect taxes, particularly on goods
with inelastic demand (for example necessities such as petrol and habit forming
goods such as cigarettes and alcohol) could increase the revenue earned by the
government. This revenue can be used to finance the provision of merit and public
goods.
Government can influence the pattern of demand: Raising the indirect taxes on
certain products for example, demerits goods such as cigarettes and alcohol could
reduce consumption of these items. Indirect taxes can help the government to
influence consumer behavior.
Reduction in unemployment: Lower direct taxes will lead to an increase in people’s
disposable income and as a result the aggregate demand will rise. This will lead to
the creation of jobs as firms will increase output levels to match the rise in
demand.
Q: Write down the arguments against reducing direct tax and
increasing indirect taxes.
Inflationary effect: Reducing direct taxes would increase people’s disposable
income. As a result consumer spending should increase leading to a rise
in aggregate demand and demand pull inflation. Increasing indirect taxes
will also lead to higher prices.
Imperfect distribution of income and wealth: Income taxes are progressive
and as a result lead to a more equitable distribution of income as the rich
pay a higher proportion of their income. Reducing income tax could make
it more difficult to achieve this goal. Indirect taxes are by nature
regressive as the burden is higher on the poor. This could widen the gap
between the rich and the poor.
Government revenue could fall: Income taxes are an important source of
government revenue and lowering direct taxes could lead to a significant
reduction in government income.
Balance of payments problems: Rising indirect taxes and lowering direct
taxes will have an inflationary effect. A rise in the price of domestically
produced goods will encourage people to buy more foreign products. The
country’s exports will also become less competitive. A fall in exports and
rise in imports will lead to balance of payments difficult.
 Incidence of taxation
Tax Burden:
Cont.