 Equity (continued)

 Horizontal and vertical equity

 Taxation according to ability to pay calls for

people with equal capacity to pay the same,

and for people with greater ability to pay
more.
 The former is referred to as horizontal

equity and the latter as vertical equity.

 Vertical equity concerns people in unequal

economic circumstances.
 Horizontal equity states that people who
are “similarly situated” should be taxed
alike.

 It leaves open the essential question of

what is meant by “similarly situated”.
 If income is used as index of ability to pay,
then HE says people with the same income
should, all else equal, pay the same tax.

 Again, we are left with essential questions:

what do we mean by “income” .
 2. Certainty
 The tax which each individual is bound to

pay ought to be certain and not arbitrary.

 The time of payment, the manner of

payment, the quantity to be paid should all
be clear to the taxpayer and to every other
person.
 Certainty pertains to objectivity.
 3. Convenience

 The mode and timing of tax payments should

be convenient to taxpayers.

 This canon recommends that unnecessary

trouble to the taxpayer should be avoided,
otherwise various ill-effects may result.
 4. Economy
 “every tax should be so designed as both to

take out and to keep out of the pockets of

the people as little as possible over and
above what it brings into the public treasury
of the state” (Smith 1776, (1952 ed), p 362).
 taxes should not cause an unnecessary

burden upon the society in the form of

costs over and above the tax liability.
 In addition to the actual payment of taxes,
taxes induce other costs:
◦ Compliance and administrative costs (tax operating
costs)
◦ Efficiency costs

 Tax compliance costs – costs incurred by

taxpayers and third parts in the process of
complying with the requirements of a tax
legislation and administration procedures;
 Tax administrative costs can be broadly
viewed as resources sacrificed by the public
sector in connection with a tax system.

 Public sector costs of taxation conceptually

constitute those costs which would not have
been incurred if the tax had never been
introduced (Sandford et al. (1989)).

 Excessive public spending on tax administration can be

wasteful, but spending too little can also be economically
wasteful;
 Convenience and certainty canons deal with
tax compliance costs while the economy
canon is concerned with both the
administrative and compliance costs;

 The economy canon deals with efficiency

costs as well
• 5. Economic Efficiency
• Economic efficiency can be thought of as the
effectiveness with which an economy utilizes its
resources to satisfy people’s preferences.

• When resources are directed to their highest valued

uses, the economy is said to be efficient (effectively
utilized).

• Taxes change prices (wage rates, goods prices, etc.) in

the economy which results in changes in PATTERNS of
consumption, savings, work effort, investment etc.

• By changing the relative attractiveness of highly taxed

and lightly taxed activities taxes can distort resource
allocation decisions (divert resources);
•Tax structures should be designed to collect a given tax
revenue with a minimum excess burden or economic
efficiency cost.

•High efficiency costs may be related to high tax rates and

to large differentials in tax rates.

•Largetax rate differentials (differential treatment )

between similar economic activities cause efficiency costs.

• This principle leads to reforms of tax structures towards

LOWER and MORE UNIFORM TAX RATES charged on
BROAD TAX BASES.
 The total cost of taxes from a taxpayer’s
point of view:
=tax liability + efficiency costs + compliance costs

 Costs of taxation to an economy =

 = efficiency costs + compliance and

administrative costs;
• 5. Productivity and stability of revenues –
• Productivity also called canon of fiscal adequacy.
• the tax system should be able to yield enough
revenue for the government;

• The overall tax structure should produce stable

revenue flows so that fiscal deficits are predictable
and manageable;

• 6. Elasticity /buoyancy
• the tax revenue should have an inherent tendency
to increase along with an increase in national
income, even if the rates and coverage of taxes are
not revised.
 7. Flexibility –
 it should be possible for authorities without

undue delay to revise the tax structure both

with respect to its coverage and rates, to suit
the changing requirements of the economy
and of the Treasury.

 8. Simplicity
 The tax system should not be too

complicated.
 Complex tax system is difficult to understand

and administer and breeds problems of

interpretation and legal disputes.

 A tax system – a set of all the taxes that a
nation imposes;
 A tax system covers both tax policy and

administration; may be stretched to cover

compliance;
 Tax systems/ taxes can be classified in

different ways
◦ Single and Multiple tax system
◦ Direct and indirect
◦ Ad Valorem and unit
• Single and Multiple tax systems
• Single tax system is where there is only one
tax in place;

• It is claimed that taxpayers are more certain

of their liabilities in a single tax and this can
help in reducing costs of collection.

• Against this claim note the following

problems:
– identification and choice of an appropriate single
tax,
– the adequacy and growth of revenue,
• One simple form of a single tax is the poll tax, or the
head tax;
• Poll / lump sum tax is imposed on a person simply
because he/she is there in the society and not
because he/she has an income, or wealth, or is
following any particular trade or profession etc.

 pure lump-sum taxes, are attractive from an

efficiency perspective, but are of limited usefulness
because they do not vary with indicators of ability to
pay, such as income or consumption,

• Poll tax is against the principle of equity assessed in

terms of either the benefit principle or the ability to
pay principle.

• It does not enable governments to raise sufficient

amount of revenue;
• Multiple tax system

• A multiple tax system is with several tax

structures being used in the system.
• Any worthwhile tax system in a modern
economy will be a multiple tax system.  
• (1) a modern economy is not one-objective
economy. It tries to forge ahead
simultaneously along the paths of growth,
equitable distribution of income and wealth,
economic stabilization and so on.
• Since no single tax can be expected to help
the economy on all fronts, a choice for a
multiple tax system becomes inevitable.
 (2) Income of a modern economy originates
from many sources.
 It would be highly unjust to tax income

originating from any one source and leave

out others.
 Equity would demand that a government

should tax all the important sources of

income in an equitable manner.
 Single (multiple) tax systems are different
from single (multiple) stage taxes;

 Multiple/single stage Value Added Tax – this

relates to stages VAT is imposed;

 VAT at wholesale level only is a single stage

VAT;

 VAT at each stage in the production and

distribution process is a multiple stage VAT;
 Direct vs Indirect taxation
 One way of distinguishing between direct and

indirect taxes has been in terms of the

incidence of taxation;

 Tax incidence and impact

 concerned with the issue of who bears the

burden of taxes;
 tax impact – initial burden – is borne by those
who make the payment of taxes to the
government (eg. VAT- businesses bear initial
impact);
 tax impact concerns where the tax first hits;
 tax incidence – ultimate burden – is borne by

those whose real incomes are reduced as a

result of taxes;
 tax incidence concerns its ultimate resting

point;
 Tax impact - legal incidence (statutory
incidence);

 Tax incidence - economic incidence;

 The initial and final burdens of a tax may be

quite different;
 When the incidence and impact are not at the
same point, the tax is said to have been
shifted.

 Shifting tax burden through changes in

prices, wages and returns on investments;
 Businesses as such do not bear the incidence
of any tax. Taxes imposed (i.e, with impact)
on business always result in burdens
(incidence) on people;

 The burden of corporation income tax is

shifted to other groups of people through
lower income (to employees and investors) or
higher prices (to consumers);