Professional Documents
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Single and Multiple tax systems One simple form of a single tax is the poll tax, or
the head tax;
Single tax system is where there is only one tax
in place. Poll tax is imposed on a person simply because
he/she is there in the society and not because
It is claimed that taxpayers are more certain of
he/she has an income, or wealth, or is following
their liabilities in a single tax and this can help in
any particular trade or profession etc.
reducing costs of collection.
Poll tax is against the principle of equity assessed
Against this claim note the following problems:
in terms of either the benefit principle or the
identification and choice of an appropriate ability to pay principle.
single tax,
It does not enable governments to raise sufficient
the adequacy and growth of revenue, amount of revenue;
Taxation 1
Direct vs Indirect taxation Tax incidence ultimate burden tax is borne
by those whose real incomes are reduced as a
One way of distinguishing between direct and result of taxes;
indirect taxes has been in terms of the incidence tax incidence concerns its ultimate resting
and impact of taxation. point;
Tax incidence and impact - concerned with the Tax incidence -economic incidence
issue of who bears the burden of taxes; Tax impact -legal incidence (statutory
Tax impact initial burden tax is borne by incidence);
those who make the payment of taxes to the The initial and final burdens of a tax may be
government; quite different
tax impact concerns where the tax first hits; When a tax is imposed on some person, it is
possible to transfer to a second person
Taxation 2
Businesses as such do not bear the incidence of any tax. The distinction between direct and indirect taxes
Taxes imposed (i.e, with impact) on business always is ambiguous;
result in burdens (incidence) on people in one of three Most writers define direct taxes as those, which
capacities; are imposed initially on the individual or
1.Consumers-to the extent a tax is forward shifted, household that is meant to bear the burden.
consumers pay higher prices than they otherwise would Indirect taxes-taxes imposed at some point in the
to pay and thus have their real incomes reduced.
system but are meant to be shifted to the final
2. Workers and other resource suppliers to the extent a bearer of the burden.
tax is backward shifted, workers and other factors of
Corporations do not actually bear the ultimate
production receive lower payments, and thus their real
incomes reduced; burden of the corporate income tax; instead,
other groups of people bear the burden of the
3. Business owners To the extent a tax can be neither
corporate income tax
forward-shifted nor backward shifted, the owners of the
taxed business suffer reduced real incomes;
Taxation 3
Demerits of Indirect Taxes Role of Indirect Taxes in Underdeveloped
Regressive- fall more on low income group than Economies
high income ones Diversion of Resources
Administrative cost- generally heavy From consumption to production goods. Eg.
Discourage savings- more spending on basic Automobile vs building
commodities From imported to domestically produced goods
Uncertainty- cant be accurately estimated Revenue effect generate much revenue
No civic consciousness Checking and correcting price behavior effect
Adverse effect on efficiency- reduce Inflationmoney supply exceed resources;
consumption and productivity taxes reduce money supply
Cause inflation- prices of taxed goods keep on
Deflationlack of money supply; reducing
rising
taxes stimulates the economy
Taxation 4
Proportional, Progressive and
Arguments for unit taxes Regressive
Classification is on the basis of the degree of
Less chance of tax evasiontax is imposed
progression of a tax the nature of the tax rate
based on units of measurement which are easily
Make use of both tax base and tax rates;
ascertainable;
Tax base and tax rates
Easy to administer and collectonce the item
the base of a tax is the legal description of the
is identified it is easier to administer;
object to which the tax applies;
Arguments against unit tax For example the base of an excise duty is the
Static revenue yield it wont generate large production or packing or processing of a
specific good or importation of a specific good;
amount of revenue during periods of price
increases; the base of an income tax is the income of the
assessee defined in terms of certain rules ;
Taxation 5
Progressive structure Arguments for progressive tax
The tax liability as a percentage of income
(average tax rate) increases as income increases;
structure
Reduce the inequality of income and wealth
If the rate rises as the tax base increases, we have
;reduces income disparity
progressive tax;
Revenue productivity
Average tax rate increases when tax base
increases. Stabilizing the economy
If the tax rate structure is progressive, then the Arguments against progressive tax
marginal rate would be rising as the tax base structure
increases;
Ideal progression is impossible
Further the marginal tax rate would lie above the
Disincentive to work, save and invest
average rate of tax. Eg. Employment IT in Ethio
Regressive tax structure In regressive tax schedules both the average and
The tax liability is a smaller percentage of a the marginal tax rates fall as the tax base
taxpayers income as income increases; i.e increases;
average tax rate decreases as tax base increases
Marginal tax rate lies below the average tax rate;
It takes a larger percentage of income from
Notes:
people whose income is low; the poor are taxed
at a higher rate the concept of progressiveness is with
reference to only the money (or money
Example
equivalent) burden of a tax.
Income (Br) tax rate (%) tax payable (Br)
4000 20 800 It is not being translated into real burden or
6000 15 900 the sacrifice which the taxpayers undergo.
10000 12 1200
20000 10 2000
Taxation 6
Items Included in S-H-S Income Income in kind
Items ordinarily thought of as income includes: From the S-H-S point of view, it makes no
wages and salaries, difference whether benefits are received in monetary
form, or in the form of goods and services.
rents,
dividends and
A number of difficulties arise in using the S-H-S
criterion as a basis for constructing a tax system;
interest etc.
Capital gains and losses: may be very difficult to
Employer contributions to pensions and other
retirement plans. measure, particularly when they are unrealized.
Employer contributions for employees insurance. Imputed income from durables also presents
Transfer payments;
measurement difficulties. Eg. Renting ones
residence to others and renting others residence to
Capital gains-both realized or unrealized;
oneself
Taxation 7
Global income basis and scheduler income Corporation income tax
basis of individual income taxation; is the levy on the taxable income of corporations
Global income basis -income from all sources are computed in accordance with the GAAP subject to
added together to get the overall tax base; the legal tax regulations pertinent to the matter.
The basic principle is that the taxpayers income
from all sources be combined into a single or global Tax Accounting Methods
measure of income (global method). The accounting method for computation of the
Scheduler income basis instead of aggregating the corporate income tax base could be;
various sources of income together it adjusts each cash basis
source of income for any deduction and exemption
and apply the tax rate appropriate for each source of accrual accounting basis; or
income. modified cash basis
For example, dividends are governed by dividend tax Accrual basis appears to have wider application;
law, interest by interest tax law, etc.
Taxation 8
Corporation tax rates If the investment tax credit was K and the
Rates may be bracket rate where there are a acquisition price was q , the effective price of the
number of rates in a sliding scale or graduated rate asset would be (1-k)q.
where there is only one rate applicable for all or The value of an ITC to the firm does not depend on
almost all of the corporations subject to the corporate income tax rate;
corporation income tax. Because the ITC is subtracted from tax liability
Further considerations (depending on the tax law rather than taxable income.
in question) ITC was used in the USA before 1986s tax reform;
Investment tax credit For example, in the early 1980s, equipment with a
Allows taxpayers to deduct a certain percentage tax life of three years was eligible for a 6% credit,
of the costs of assets acquired in the year of and all equipment with a longer life was entitled to
purchase from total tax liability; a credit of 10%
Taxation 9
As a result, the French government first allowed a Some countries look to a VAT not only to replace
credit for the tax content of purchases of raw existing sales taxes but also to increase revenue;
materials against the sales tax liability and second
a credit for the tax content of capital purchases; The other reason for the spread of VAT has been
Other causes of dissatisfaction include: caused by the European Economic Community
complexity of administration, and (now called EU) requiring the adoption of
the complex and multiple relationship between VAT(GST) as a condition of entry to the common
traders and government when many taxes are market environment of continental Europe
used. embracing the UK as well.
For example take the case of Korea; The main reason for requiring the adoption of
A reduction of other taxation or to simply VAT was EU countries contribute from their
increase revenue revenue raised from their VATs to fund the
activities of EU.
Defining the aggregate base of VAT Production type: investment expenditures are
not deductible from the base of the VAT (P-VAT);
At macroeconomic level the total sum of all value
added in an economy (GDP) can be determined in Income type: investment expenditures are first
capitalized and then depreciated as under an
reference to National Accounts;
income tax (I-VAT);
GDP -total sum of all value added in an economy; Consumption type: investment outlays are
In practice, we define VAT base according to how treated in the same way as purchases of raw
we treat different types of expenditures for VAT materials and intermediate products (C-VAT);
purposes; Investment expenditures are directly deducted in
There are three approaches in defining the base the computation of the VAT base; Considered as
for VAT; input
The base of the typical VAT in most countries is
Production VAT; income VAT and consumption
determined under C-VAT (consumption type
VAT VAT);
Taxation 10
Cont Methods of calculating VAT
For a particular business, value added =wages +
This is done by allowing the VAT paid on the profit or output input;
purchase of investment goods to be claimed by Four methods Tait (1988);
businesses as a credit against their VAT
liabilities on outputs immediately; 1.Additive direct or accounts method
The C-VAT is the narrowest of the three VAT=T (wages + profit);
potential tax bases; 2.Additive indirectthe value added is not
By making different provisions with respect to calculated; instead the tax rate is applied to the
the treatment of investment goods, a VAT can be components of value added separately;
transformed into three distinct taxes, each of VAT=T (wages) + T (profit);
which has different efficiency effects; 3.Subtractive directsometimes called business
transfer tax; VAT=T (Output Input);
The built-in audit trail may sometimes fail: Origin and destination principle
1.On the final consumption transaction since there Deal with the imposition of VAT on transaction that
is no financial incentive for the final consumer cross the border;
to collect invoices; Possibility of evasion since Origin principle allows the taxation of the
commodity in the country of origin (production);
sales are made without invoices
Allows commodities crossing the border to be taxed
2.It fails in connection with exempt or input taxed in the country of the exporter;
goods since there is no credit on these goods Under this principle exports are VAT taxable but not
businesses do not have the incentive to collect imports;
invoices; Destination principle -commodities cross the border
3.It also fails in connection with businesses that VAT free (in the country of export) and subject to
VAT in the country of consumption (destination);
are outside the VAT legislation framework
Many countries use this principle in that exports are
(including small businesses);
zero rated (VAT free) but imports are taxed;
Taxation 11
Single and Multiple stage VAT VAT rates
Single stage VAT-imposes VAT on one level of The rate or rates at which VAT is levied is an
important consideration in the operations of VAT;
the chain in the production process giving credit
for taxes paid on inputs; Single and Multiple Rates
Multiple stage VAT -levies VAT at several stages Single rate -VAT system uses only one rate
(ignoring zero rate on exports) while the multiple
in the chain of the production process giving
rates is to a system having many positive VAT rates;
credit for VAT paid on inputs;
A substantial number of countries operate VAT with
However, there are countries that do not tax the a single positive rate while there are a few countries
retail stage; tax only manufacturers or that use up to four rates.
wholesalers stage and leave the retail stage out of In some countries there are different rates for
the VAT net; different regions or parts of the country;
Tax administrators prefer to use a single rate of VAT
but politicians may opt multiple rates
Taxation 12
VATs in developing countries; Other mechanisms include prohibiting VAT
unregistered businesses from participating in
VATs in developing countries appear to have
government auctions;
features that are quite different from VATs in
developed countries; 2. VAT rates
1. Registration for VAT Some developing countries have multiple rates
against the usual advice for a single positive
Registration requirements based on turnover;
rate;
Sector selected registration requirements;
For example Kenya, Lesotho, Mali have more
Voluntary registration is nonexistent or than one positive rate (multiple rates);
restrictive;
Some developing countries zero rate domestic
transactions apart from exports;
Taxation 13
Wealth taxes Wealth taxes are imposed on assets one has
income and consumption are associated with a time accumulated;
dimension; Wealth (Property) can be divided into real
the concept of income would be meaningful when property and personal properties;
it is put in the context of some time interval;
Real properties- land and anything attached to
income and consumption are known as flow the land;
variables;
Personal properties - anything moveable.
amount of tax applies to some time interval
Personal property taxes are collected on
A stock variable is a quantity at a point in time, not
an amount at some time interval.
registered vehicles including motor vehicles,
trailers, planes, and boats;
Wealth is a stock variable because it refers to the
value of the assets an individual has accumulated at
a point in time;
Taxation 14
In these countries most taxpayers lack the Presumptive taxation uses a variety of
financial transparency (proper books) that allows alternative means of determining the tax base
for effective taxation by the government; and assessing the tax liability;
In developing countries most taxpayers 1. Estimate of income using factors like type of
especially small ones do not have the resources profession (sector), number of employees,
needed to maintain proper books of accounts; resources used etc;
In these situations, presumptive taxation may be 2. Using assets:- Commercial property, business
the most appropriate method of tax vehicles;
administration. 3. Using turnover or gross receipts, purchases
and wages;
4. External indicators of income: personal
wealth;
Taxation 15