Taxation Theory

Introduction
Introduction and Overview
• Welcome
• Housekeeping rules
• Evaluation Matrix
• Discussion questions - 3 X 5% = 15%
• Attendance - 5%
• Assignment - 20%
• MME - 20%
• EOSA - 40%
Taxation Theory
• Jamaican Taxation
• Taxation of Emoluments
• Capital Allowances
• Individual Income/Other sources
• Income from Trade and Profession
Course Evaluation
Presentation Outline

Define Define the term taxation

Explain Explain the attributes of a good tax system

Outline Outline the main tax structures

Explain Explain the economic effects of taxation

 1.1 What is taxation?
• It is the inherent power by which the sovereign state
imposes financial burden upon persons and property as a
means of raising revenues in order to defray the necessary
expenses of the government (Tax Digest, 2002).

• Taxation is the practice of collecting money from citizens

based on their earnings and property. The money raised from
taxation supports the government and allows it to fund police
and courts, have a military, build and maintain roads, along with
many other services. (Tax Law and Jurisprudence by Justice
Vitug, 2000)
1.1 Coercive vs. Contractual Taxation?
Coercive:
• Uncertainty in assessing tax liabilities.
• Intimidation and force in the collection process.
• Absence of any representation for taxpayers in policy decision.
• Taxes are not exchange for anything much.

Contractual:
 Open exchange of tax revenues for services.
 Standardized methods of assessing and collecting revenue.
 A voice for taxpayers in setting tax policy.
 Semi-voluntary compliance of taxpayers.
The distinguishing
features of a tax are:
• It is Compulsory

• It is imposed on all citizen

• It is imposed by the exercise of the state’s

sovereign power

• It is levied by the ordinary legislative process

• It is imposed for a public purpose.

Attributes/Principles/Canons
of a ‘Good Tax System’:
 Attributes/Principles/Canons of a
‘Good Tax System’:
1. Canon of Equity

The principle aims at providing economic and social justice to the people.
According to this principle, every person should pay to the government
depending upon his ability to pay. The rich class people should pay higher taxes
to the government, because without the protection of the government
authorities (Police, Defence, etc.) they could not have earned and enjoyed their
income. Adam Smith argued that the taxes should be proportional to income,
i.e., citizens should pay the taxes in proportion to the revenue which they
respectively enjoy under the protection of the state.

2. Canon of Certainty

According to Adam Smith, the tax which an individual must pay should be
certain, not arbitrary. The tax payer should know in advance how much tax he
must pay, at what time he must pay the tax, and in what form the tax is to be
paid to the government. In other words, every tax should satisfy the canon of
certainty. At the same time a good tax system also ensures that the government
is also certain about the amount that will be collected by way of tax.
 Attributes/Principles/Canons of a ‘Good Tax System’:

3. Canon of Convenience

The mode and timing of tax payment should be as far as possible, convenient to the
tax payers. For example, land revenue is collected at time of harvest income tax is
deducted at source. Convenient tax system will encourage people to pay tax and will
increase tax revenue.

4. Canon of Economy

This principle states that there should be economy in tax administration. The cost of
tax collection should be lower than the amount of tax collected. It may not serve any
purpose, if the taxes imposed are widespread but are difficult to administer. Therefore,
it would make no sense to impose certain taxes, if it is difficult to administer.

5. Canon of Productivity

It is also known as the canon of fiscal adequacy. According to this principle, the tax
system should be able to yield enough revenue for the treasury and the government
should have no need to resort to deficit financing. This is a good principle to follow in a
developing economy.
Attributes/Principles/Canons of a ‘Good Tax System’:

6. Canon of Elasticity

According to this canon, every tax imposed by the government should

be elastic in nature. In other words, the income from tax should be
capable of increasing or decreasing according to the requirement of the
country. For example, if the government needs more income at time of
crisis, the tax should be capable of yielding more income through
increase in its rate.

7. Canon of Flexibility

It should be easily possible for the authorities to revise the tax

structure both with respect to its coverage and rates, to suit the
changing requirements of the economy. With changing time and
conditions, the tax system needs to be changed without much difficulty.
The tax system must be flexible and not rigid.
Attributes/Principles/Canons of a ‘Good Tax System’:

8. Canon of Simplicity

The tax system should not be complicated. That makes it difficult to

understand and administer and results in problems of interpretation
and disputes. In India, the efforts of the government in recent years
have been to make the system simple.

9. Canon of Diversity

This principle states that the government should collect taxes from
different sources rather than concentrating on a single source of tax. It
is not advisable for the government to depend upon a single source of
tax, it may result in inequity to the certain section of the society;
uncertainty for the government to raise funds. If the tax revenue
comes from diversified source, then any reduction in tax revenue
because of any one cause is bound to be small.
Tax Structure
 Structure of Taxation
Direct Taxes:
A tax that is paid directly by an individual or organization to the
imposing entity. A taxpayer pays a direct tax to a government for
different purposes, including personal property tax, income tax
or taxes on assets.

Indirect Taxes:
A tax that increases the price of a good so that consumers are
actual paying the tax by paying more for the products. An
indirect tax is most often thought of as a tax that is shifted from
one taxpayer to another, by way of increase in the price of the
good. An example is the General Consumption Tax (GCT)
 Structure of Taxation
Advantages of Direct Taxes:
1. Equitable. The burden of direct taxes cannot be shifted. Hence,
equality of sacrifice can be attained through progression. The tax
raises the price of the commodity and the price of a commodity is
the same for every person, rich or poor.

2. Economical. Their cost of collection is low. They are mostly

collected "at the source". For instance, the income tax is deducted
from an officer's pay every month. This saves expense. The employer
acts as an honorary tax collector.

3. Certain. In the case of a direct tax, the payers know how much is
due from them and when. The authorities also know the amount of
revenue they can expect. There is certainty on both sides. Certainty
minimizes corruption on the part of the collecting officials.
 Structure of Taxation
Advantages of Direct Taxes:
4. Elastic. If the State suddenly stands in need of more funds in an
emergency, direct taxes can well serve the purpose. The yield from
income tax can be easily increased by raising their rate.

5. Productive. Another virtue of direct taxes is that they are very

produc­tive. As a community grows in numbers and prosperity, the
return from direct taxes expands automatically. The direct taxes yield
large revenue to the State.

6. A Means of Developing Civic Sense. In the case of a direct tax, a

person knows that he is paying a tax; he feels conscious of his rights.
He claims the right to know how the Government uses his money and
approves or criticizes it. Civic sense is thus developed. He behaves as
a responsible citizen.
 Structure of Taxation
Disadvantages of Direct Taxes:
1 .Inconvenient. The great disadvantage of a direct
tax is that it pinches the payer. He 'squeaks' when a
lump sum is taken out of his pocket. The direct
taxes are thus very inconvenient to pay. Nobody can
help feeling the pinch.
2. Evadable. The person being assessed can submit
a false return of income and thus evade the tax.
That is why a direct tax is "a tax on honesty". There
is a lot of evasion. Many of those who should be
paying taxes go scot-free by concealing their
incomes.
3. Arbitrary. If taxes are progressive, the rate of
progression has to be fixed arbitrarily; and if
proportional, they fall more heavily on the poor.
Thus, both are bad. The rate of taxes depends upon
the whim of the Finance Minister.
4. If the taxes are too heavy, they discourage saving
and investment. In that, case the country will suffer
economically
Tax classification based on income:
Regressive Tax
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.
Tax classification based on income:
Regressive Tax
Merits of Regressive Tax
• Regressive tax helps to reduce the demand for goods like tobacco and
alcohol products.

• People get the freedom to choose the products they need and the tax can
be paid only on the goods they need. Only the people who need the product
shall pay for the goods.

Demerits of Regressive Tax

 Regressive Tax paid by the poor will be more and the income left for their
living will be less as a major part of the earning will be paid as tax.
 Unemployment level increases as the poor might not be willing to work as
the major part of the earning should be paid as tax.
 Revenue might decrease if the consumption of goods is reduced by low-
income people.
 Wealthier will continue to earn more and low-income group will continue to
earn less.
Tax classification based on income:
Progressive Tax
A tax that takes a larger percentage from the income of high-income
earners than it does from low-income individuals. Taxpayers are broken
down into categories based on taxable income; the more one earns, the
more taxes they will have to pay once they cross the benchmark cut-off
points between the different tax bracket levels.
Tax classification based on income:
Progressive Tax
Merits of Progressive Tax
 As rich people pay more than the poor, so the progressive taxes are
equitable.
 It helps to reduce unequal distribution of income and wealth.
 It yields more revenue, so it is productive.
 It is economical because the cost of the collection tends to be lower.
 It is elastic in nature.
Demerits of Progressive Tax
 There is the chance of tax evasion.
 It discourages the saving and investment.
 The rate of tax may be changed every year according to the news of the
government, so it is unstable.
Tax classification based on income:
Proportional Tax
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.
 Tax classification based on income:
Proportional Tax
Merits of Proportional Tax
 It is simple and easy to understand as the rate of the tax is same.
 It encourages the saving and investment due to uniform rate.
 It is simple to calculate as the rate is same for every level of income.

Demerits of Proportional Tax

 It doesn’t follow the principle of equitability as the rate of tax is same for
both poor and rich people.
 It is inelastic nature.
 As the burden of a tax is more in poor than rich so it brings social justice.
Tax Policy
 Tax Policies
•
What is a tax policy?

• Refers to what taxes government

choose to levy, in what amounts, and
on whom.

• Types:

1. Contractionary
2. Expansionary
 Tax Policies
• Types:

1. Contractionary

• As a result of inflation the

government increases taxes in order
to reduce spending.

• Why? This will allow the growth rate

of inflation to slow down. How?
 Tax Policies
• Types:

• Contractionary – What
happens?

• Disposable income reduces

• Government spending reduces
How?
 Tax Policies
• Types:

• 2. Expansionary

• As a result of recession the

government lower taxes in order to
increase spending.

• What are the effects of this policy?

• How?
 Tax Policies
• Types:

• Expansionary – What happens?

• Disposable income increases

• Government spending
increases
•?
 Questions
1. What are some of the disadvantages of a
Progressive tax system?

2. Do you think the recent change in the

income tax is progressive or proportional?

3. You implement a contractionary policy in

order to increase consumer spending? T/F

4. Expansionary policies will be used when

there is inflation? T/F
Questions & Answers

THE END