Taxation
Taxation is the most important source of revenue for the government. Taxation is the simply the act of levying taxes.
- A tax is a compulsory charge or payment imposed by government on individuals or corporations/businesses.
- The individuals or entities which are taxed have to pay the taxes irrespective of any corresponding return from the goods or services by the government.
- The taxes may be imposed on the income and wealth of persons or corporations/businesses and the rate of taxes may vary.
Tax is defined as the monetary charge imposed by the government on persons, entities, transactions or property to raise public revenue.
Purpose of taxation
There are several objectives for why government taxes.
- Raising Revenue
- Regulation of Consumption and Production
- Encouraging Domestic Industries
- Stimulating Investment
- Reducing Income Inequalities
- Promoting Economic Growth
- Development of Backward Regions
- Ensuring Price Stability
Canons/ principles of taxation
Adam Smith formulated four canons of taxation, which we refer to as the principles of taxation. Later, other economists have added some more principles. Therefore principles which a good tax system should follow are called canons of taxation.
- Canon of Equity/fairness:
- Canon of Certainty:
- Canon of Convenience:
- Canon of Economy:
Canon of Equity/fairness: The canon of equality states that persons should be taxed according to their ability to pay taxes. That is why this principle is also known as the canon of ability. Equity does not mean equal amount of tax, but equality in tax burden.
Canon of Certainty: This can states that the tax which each individual is required to pay should be certain and not arbitrary. The time of payment, the manner of payment and the amount to be paid should be clear to every tax payer.
Canon of Convenience: The mode and timings of tax payment should be convenient to the tax payer. It means that the taxes should be imposed in such a manner and at the time which is most convenient for the tax payer. For example, government of India collects the income tax at the time when they receive their salaries. So this principle is also known as ‘the pay as you earn method’.
Canon of Economy: Every tax has a cost of collection. The canon of economy implies that the cost of tax collection should be kept at minimum.
Characteristics of taxes
Progressive tax: when the rate of taxation increases as the tax payer’s income increases. In this system, the rate of tax goes on increasing with every increase in income. It is most applicable in income taxes. Most income taxes – include PAYE (personal income tax) and CIT (company income tax) – are progress taxes. Illustration: It is a pay as you earn or simply “the more you make the more they take”
Regressive tax: the rate of taxation decreases as the taxpayer’s income increases. Lower income is taxed at a higher rate, whereas higher income is taxed at a lower rate. However absolute tax liability (the actual amount paid to tax body) may increase.
Proportional tax: when the rate of taxation remains constant as the income of the tax payer increases. In this system all incomes are taxed at a single uniform rate, irrespective of whether tax payer’s income is high or low. As a person’s income increases, the percentage of total income paid in taxes remains the same. The tax liability increases in absolute terms, but the proportion of income taxed remains the same.
Classification of taxes
Direct taxes: taxes whose final burden of taxation is borne by the same person or entity on which it is levied. They are imposed on incomes arising from business, property and employment. Individual income tax (e.g. PAYE, property tax, capital gains tax, and rental tax) and corporation tax (CIT) are examples of direct taxes.
Indirect taxes: a tax which is initially paid by one individual, but the burden of which is passed over to some other individual who ultimately bears it. This tax is charged or levied on consumption (the expenditure of) of goods and services usually collected by an agent (the taxpayer – e.g. you pay such a tax when you buy fuel from fuel station). Examples of such taxes include sales tax (e.g. a tax on purchasing airtime), VAT, excise duty, and import duty.
Tax evasion and Tax avoidance
Tax evasion is an illegal act where a legal entity or person intentionally avoids paying their true tax liability. Tax evasion can be described as an illegal manipulation of one’s affairs in order to reduce the tax that they were supposed to pay. It is therefore a manipulation one’s affairs to pay less tax
than was due. Those caught evading taxes are generally subject to criminal charges and substantial penalties.
Tax avoidance: It refers to the use of legal methods to modify and individual’s financial situation in order to lower the amount of income tax owed. This is achieved by claiming the permissible deductions and credits. This is usually done by big corporations which have experts in tax law and financial management. Such companies may present costs incurred and are allowed to offset certain costs by not paying taxes. In developed countries, tax statistics show that the rich profit more from tax discounts and deductions than the poor. For an individual or corporation to legally pay lower taxes, it needs to have either knowledge or advice – and both are costly to acquire. If you are poor, then you have not enough income to use the legal ways of paying less tax.
The causes of tax avoidance and tax evasion
- High tax rates: The higher the rates, the higher the reward from not paying taxes.
- The complexity of the rules and difficulty with compliance makes it easier to deal with by the rich; not the poor.
- The imprecise laws and arbitrary tax rules. There is always the argument that oftentimes the tax rules are one step behind the economy.
- Where there is a lack of control by the revenue body and where there problems with penalties (how to penalize i.e. how to punish tax evasion.
- There is the issue of social penalties for evasion, that is, with regard to how society reacts to the information that someone was evading taxes.
- In situations where there inequality or perceived inequality of the taxsystem, both tax evasion and avoidance become socially acceptable.
How to reduce tax evasion and tax avoidance.
One of the ways is to lower the marginal rate of tax. The government, in and particular the revenue body needs to change the people’s perception of tax payment, the tax system and about tax evasion and avoidance. This can be done by among others educating the society and creating tax awareness
campaigns. There is need to simplify the tax payment procedures. In some rare case, tax abolitions could be necessary.
Challenges facing tax administration in developing countries
- Relatively limited tax administration capabilities: Lack of skilled staff to manage all aspects of tax collection (including calculating actual amounts to be paid by individuals and entities), enforcement of tax laws, and advising Government on formulating tax legislation.
- High dependence on foreign trade taxes: Most developing countries in Africa depend on mainly import trade taxes – and import take away the little foreign exchange form the importing country.
- Temptation to widen tax incentive in the hope to attract more investors: Studies carried have found that what matters more for attracting FDI is not tax incentive but a conducive business environment, peace and security (see section on FDI). Therefore, countries are losing revenue in tax incentives.
- Narrow tax base due largely to a big informal economy: In most poot countries, there is a large amount of economic activity that is done in the informal sector, or perhaps it is illegal activities involved with tax evasion, or simply not declared to government statisticians.
- Lack of modern technology and systems to administer taxes: Sound use of such IT approaches as withholding, information reporting, web-based client focused interfaces with the private sector, and value chain analysis and monitoring — all activities going on all the world in both private and, increasingly public sectors — can be enormously effective in reducing corruption, curbing evasion and improving revenue yields.
- Lack of political will to administer taxes: If the political will exists, the techniques needed for effective tax administration are not secret: have a clear strategy; keep it simple; treat taxpayers as clients; chase down defaulters; keep a tight check on corruption;
- Corruption affects the amount of tax revenue collected.
- Transfer pricing – leads to less tax collected mainly from multinationals.
- Tax evasion and avoidance affects total taxes collected.
