Law of Taxation

Chapter One
Public Finance and State’s Economic
Role
Meaning and scope of public finance
Meaning
The study of the principles underlying the spending
and raising of funds by public authorities”.
• Public finance, therefore, deals with the financial
operations or finances of the government. States, all
over the world have a number of public projects, such
as social security, protection and other services of
public utilities like electricity, water supply, railways,
heavy electrical and atomic energy, etc. and to
provide social services in the form of education,
health and sanitation facilities and public utilities.
• The government raises revenue from various tax and
non-tax sources and borrowing from individuals,
corporations and friendly foreign countries to incur
huge expenditures in order to materialize the
aforementioned functions and utilities.
Scope of public finance.
Accordingly, the whole spectrum of public finance is
branched in to five categories of financial activities
of the government:
(1) Public Revenue,
(2) Public Expenditure,
(3) Public Debt,
(4) Financial Administration and Control; and
(5) Economic Stability and Growth.
Sources of Public Revenue
different sources or forms of government revenue
following
(1) Taxes
(2) Commercial Revenues
(3) Administrative Revenues
(4) Gifts and Grants
Definition and Classification of Taxes
• tax can be defined as a contribution from individuals out of
their private property for the maintenance and defense of
government, so that it may perform its functions and the
ends of the state be realized.
• In simpler terms, “tax is a financial charge or other levy
imposed on an individual or a legal entity by government”.
• Taxes are a portion of private wealth, exacted from
individuals by the State for the purpose of meeting the
expenditure essential to carrying out the functions of
government
• Taxes are defined to be burdens, or charges, imposed by
"the legislative power of a state upon persons or property,"
to "raise money for public purposes
Characteristics of tax
(1) Compulsory Contribution—
Tax is a contribution given to state by people living
within the premises of country due to residence and
property etc. or by citizens and this contribution is
given for general use only. Though it is a compulsory
contribution, therefore, no individual can deny from
the payment of tax. Therefore, tax must be paid by
each individual which is imposed by state, whether he
is adult or minor and citizen or foreigner. If a person
denies to pay tax, he must be prosecuted.
2. Personal Obligation —
Tax casts personal obligation on taxpayer. Its meaning
is that if tax has been imposed on some person then it
is his duty or obligation to pay it and don’t try to
avoid it in any condition. For example, tax is imposed
on incomes of persons then there can be many
sources of income of persons, therefore it is possible
that government may not be aware of all sources of
income of people. In that condition, it is the duty of
taxpayer that he must declare all his income and pay
tax according to it.
3. Tax is Imposed for the General and Common Benefit
• The contribution that is received from taxpayers in the form of
taxes, it can be possible that it cannot be spent for their profit
only, but it must be spent in favor of common people. It can be
possible that a person is not capable to fulfill all his needs
specially to fulfill those needs where huge amount is spent there
such as construction of hospital. In that condition the state
arranges for such services for the benefit of all people.
Therefore, for bearing this general burden, the tax is imposed on
all those people who are capable to pay it.
Elements of Tax
On the basis of above mentioned analysis, it can be said that
the main elements of tax are as follow-
1. Compulsory Contribution-
Tax is a compulsory contribution, if the directions instructed by
law are imposed at the time of paying tax.
2. Taxes are Imposed by a Government—
Taxes are imposed by government only. If the management of
any temple or any other organization makes compulsory to
give a special amount for one year for each family, then it
cannot be said tax in any condition.
3. Involvement of Sacrifice—
The emotion of sacrifice lies within the payment of tax because
taxpayer pays in the general favor of society.
4. Social Welfare—Tax is imposed for the objective of
welfare of whole community, i.e. revenue received
from tax, at one hand, it is spent for the welfare of
whole society but for special category of society and,
on the other hand, the inequalities of revenue remove
from this expenditure.
5. The Benefit is not the Condition for the Payment —To
receive benefit is not a compulsory condition for the
payment of tax. Taxes are not paid merely because
taxpayer receives benefit from government
expenditure, but they are paid because they are
compulsory. If the taxpayer receives any benefit then it
is not necessary that it must be in ratio of tax paid.
6. No Relation with the Cost of Service —
The benefit which is provided to individuals by government
service tax is not imposed to utilize the cost of that benefit, i.e.
tax has no relation with the cost of that service which is
provided by the Government to individuals. For example, it is
possible that poor person gets benefit from government
expenditure but he gets very less effect of taxation
7. Payment from Income—Taxes can be imposed on income
and on capital also. But, they are paid from high income only.
8. Individual Payment—Taxes can be imposed on individual’s
property or any commodity, but they are paid only by
individuals.
9. Legal Collection —Tax is a legal collection
Classification of taxes
A commonly applied classification of taxes is into direct and
indirect taxes. The classification of taxes into direct and
indirect owes to the relationship between the nature of the
taxes and the reason for payment of the taxes.
A direct tax is one for which the formal and economic
incidence are essentially the same, i.e. the taxpayer is not
able to pass the burden to someone else. Accordingly, direct
taxes are paid entirely by those persons on whom they are
imposed.
On the other hand, an indirect tax is a tax whereby the
taxpayer’s burden to pay the tax can easily be passed on to
another person. Generally, the tax incidence of an indirect
tax is on the ultimate consumer; however, sometimes,
sellers might absorb such indirect taxes so as to be
competitive in the market in which they are operating.
The major types of direct taxes in Ethiopia are
 personal income tax,
 rental tax,
 business profit tax,
 withholding tax and
 Taxes from games of chance, dividends or property
taxes
The major types of indirect taxes in Ethiopia are
• value added tax,
• custom duties,
• stamp duties,
• excise tax and
• Turn over tax.
General Theories and Principles of Taxation
1) Equity
2) Efficiency
3) Neutrality
4) Simplicity
5) Certainty
Equity_ means fairness, justice, equality
ability to pay
Equity has two main elements; horizontal equity
and vertical equity. Horizontal equity suggests
that taxpayers in similar circumstances should
bear a similar tax burden [equal treatment of
equals]. Vertical equity suggests that taxpayers in
better circumstances should bear a larger part of
the tax burden as a proportion of their
income[unequal treatment of unequals]
Efficiency:
• Compliance costs to business and administration
costs for governments should be minimized as far as
possible.
• Efficiency in broad terms relates to the costs of
taxation. When an adjective “administrative” is added,
it is often employed in order to emphasize the direct
costs of taxation – namely, the cost of taxation to tax
administration (administrative cost), and
• the cost of taxation to taxpayers (compliance cost).
Neutrality:
Taxation should seek to be neutral and equitable between
forms of business activities. A neutral tax will contribute to
efficiency by ensuring that optimal allocation of the means
of production is achieved. A distortion, and the
corresponding deadweight loss, will occur when changes in
price trigger different changes in supply and demand than
would occur in the absence of tax.

In this sense, neutrality also entails that the tax system raises
revenue while minimizing discrimination in favor of, or
against, any particular economic choice. This implies that
the same principles of taxation should apply to all forms
of business, while addressing specific features that may
otherwise undermine an equal and neutral application of
those principles.
• Tax rules interfere with the way taxpayers do their
business or go about their affairs, and the goal of
taxation should be to minimize the level of interference
in taxpayers’ decision-making.
• There are, however, times when taxes are deliberately
designed to interfere and when this is considered as good
policy. For example, excise taxes on tobacco and alcohol
are consciously designed to influence the consumption
of these products by making these products more
expensive. Since the consumption of these products is
generally regarded undesirable, the use of taxation to
reduce the consumption of these products is generally
accepted. Overall, however, the norm of “neutrality”
remains one of the major principles of taxation today.
Certainty and simplicity:
Tax rules should be clear and simple to understand,
so that taxpayers know where they stand. A simple
tax system makes it easier for individuals and
businesses to understand their obligations and
entitlements. As a result, businesses are more likely to
make optimal decisions and respond to intended
policy choices. Complexity also favors aggressive tax
planning, which may trigger deadweight losses for
the economy.
Flexibility:
Taxation systems should be flexible and dynamic
enough to ensure they keep pace with technological
and commercial developments. It is important that a
tax system is dynamic and flexible enough to meet the
current revenue needs of governments while adapting
to changing needs on an ongoing basis. This means
that the structural features of the system should be
durable in a changing policy context, yet flexible and
dynamic enough to allow governments to respond as
required to keep pace with technological and
commercial developments, taking into account that
future developments will often be difficult to predict
Principle of legality
• Legality principle of taxation at its minimum
protection is attached to the slogan “no taxation
without legislation” and at its maximum or extreme
linked to “no delegation of taxation powers
whatsoever”. Therefore, the legality principle of
taxation is not only confined to the maxim no taxation
without legislation but also about delegation of power
of tax law making.
Functions/objectives/ of taxation
Three objectives of taxation
1) Allocation function
2) Distribution function
3) Stabilization function
Allocation function deals with provision of public goods
• The “allocation function” determines the proportion of
government involvement in the provision of “social
goods” or what are more commonly known as “public
goods.” Taxation, as a major source of government
revenue, of course plays a pivotal role in this regard.
Without taxation, few governments would be able to
meet their responsibilities in providing even basic
public services.
Distribution
• The “distribution function” of budgetary policy (of
which, once again, taxation is an important
instrument), determines the distribution of income
and wealth in accordance with “what society
considers fair or just,” which is not usually obtained
through the operation of market forces alone.
Taxation is one recognized fiscal instrument for
redistribution of income and wealth.
Stabilization_ economic fluctuations
• The last, perhaps not the least, goal of taxation
may be to play its part in the stabilization of the
economy. It has been known for a long time that
economies do not stabilize by themselves and
need “policy guidance.” Without the steady hand
of “policy guidance,” economies may suffer from
frequent fluctuations, with symptoms of high
unemployment, inflation and low economic
growth afflicting economies from time to time.
Governments have two major instruments at their
disposal to ensure economic stability – monetary
and fiscal policies.
• Monetary policies utilize the supply and
regulation of supply of money and credit
facilities to stabilize economies while
• fiscal policies use taxes and government
expenditures to regulate the level of
employment, prices and the rate of economic
growth.
• In all of the three functions of budgetary
policy, taxation plays an important (albeit
controversial) role.
 Fiscal Federalism and Division of Revenues under the
Ethiopian Constitution
FF deals basically with the division of revenue raising
power and expenditure responsibilities to multiple layers
of governments formed by federalism.
In other words, it is the study of how competencies
(expenditure side) and fiscal instruments (revenue side)
are allocated across different (vertical) layers of the
administration.
• Accordingly, fiscal federalism encompasses principles of
fiscal relations between federal and state governments,
which are the command over resources by various level
of governments and the direction and size of
intergovernmental fiscal flows.
• This includes the division of tax power and the means
through which resources are adjusted to match
expenditure responsibilities for the federal and state
governments.
The major issues of fiscal federalism are summarized as:
I. allocation of expenditure responsibilities, which deals
with the issue of which item of power of spending
should be carried by which level of government;
II. allocation of revenue raising power; which deals with
the issue of which types of taxes should be levied and
non tax revenues should be assumed in which
jurisdiction by which level of governments;
III. the fiscal imbalance between the tires of government
and disparities between them in executing their
respective responsibilities; vertical and horizontal
imbalances; and
IV. the intergovernmental financial transfer; which
deals with the issue of financial flows between the
federal and the states and among the states; vertical
transfer and horizontal transfer in order to adjust the
imbalance and keep a viable federal system.
Factors to be considered while allocating
• What kind of taxes should be assigned to the federal
government and which should be assigned to the local
governments? The theory and practice in the
assignment of taxation power identifies the following
main criteria in assignment process: taxes on mobile
tax bases, redistributive taxes, taxes that could easily
be exported to other jurisdictions, taxes on unevenly
distributed tax bases, taxes that have large cyclical
fluctuations, and taxes that involve considerable
economies of scale in tax administration should be
assigned to the national or federal government. There
are efficiency and equity considerations behind such
principle of tax assignment.
• The assignment of taxing power between the federal
and the regional governments and the provision for
concurrent power to share establishes the basic link in
which the behavior of one of the parties would
influence the decision making power of the other and
its effective tax base.
• There is a possibility for vertical tax externality that
might require additional policy instruments to correct
their effect on other levels of government. When there
are clear cases in which vertical tax externalities are
prevalent, the tension between the federal and the
state governments would arise. This in turn would
require mechanisms for the assignment of taxing
power and revenue based on the nature and
characteristics of the tax base.
• First, despite the legislative assignment of taxes, the actual
potency of the tax network depends on the nature and
development of the national economy, the relative
distribution of economic activities across jurisdictions, and
the administrative efficiency of the taxation system.
• Second, the practice of fiscal federalism, especially when
citizens across regions with diverse economic and
demographic situations are treated unequally, gives rise to
the violation of one of the core principles of horizontal
fiscal equity. Moreover, fiscal decentralization might also
potentially breach the principle of vertical fiscal equity by
not treating taxpayers with different capacity to pay
differently.
• Third, despite the monopoly of taxing power resides at the
disposal of the government, the reach of the taxation
network depends on the economic circumstances of the
potential taxpayers.
• By taking into consideration principles such as
ownership of revenue, regional character of
revenues sources, convenience for
administration, population, and wealth
distribution
• In sharing of revenues, taxes are grouped into
three: central (that of the Federal Government),
regional and joint. As far as collection of the
revenues goes, the regional governments collect
their own revenues whereas the Federal
Government collects not only its own revenues
but also the joint revenues, of course with a
possibility of delegation whenever deemed
necessary.
The Structure of Taxation Power in Ethiopia
• The division of taxation power is a principal
aspect of the Constitution that provides the legal
framework of the Ethiopian federation.
• The FDRE Constitution divides the taxation
power into four categories, namely
a. ‘the federal power of taxation’, 96
b. ‘the state power taxation’ and, 97
c. ‘the concurrent power of taxation’ 98
d. Undesignated power of taxation. 99
Federal Power of Taxation
• The FDRE Constitution under Article 96 enumerates the
exclusive revenue sources of the federal government. Among
them, revenue sources such as :-
A. Customs duties
• Import /export tax and
• other duties exclusively reserved to the federal government.
B. Income tax
• income of employees of the federal government,
• Income of the public enterprises owned by the federal gov’t,
• Income of international organizations,
• income arising from rail, air and see transport
• Income from chance winning from national lotteries and
• Income obtained from leasing its own property and houses are
subject to federal taxation
C. Sales and excise taxes
• The area of sale and excise tax so far as they pertain to the
sale and production or services of public enterprises
owned by the federal government are exclusive power of
the federal government (Art.96 (3)).
• In addition, the introduction of VAT broadens the federal
taxation to the sale and production or services of
individual traders.
• The other areas of federal revenue assigned by the
Constitution are fees and charges. The Ethiopian
Constitution provides the federal government the power
to determine and collect fees and charges relating to
licenses issued by organs of the federal government
(Art.96 (7)).
• It also empowers the federal government to levy and
collect stamp duties provided that the organs of the
federal government render the service (Art.96 (9)).
• As the World Bank report (World Bank, ‘Ethiopia:
Review of Public Finances’ 200), the income of the
federal government from taxes of its agent and
enterprises accounts the third largest source of
revenue. This consists of income from the National
Bank, rent from government property, and residual
surpluses from various public enterprises that the
government monopolizes. The latter source includes
enterprises such as banks, insurance companies,
Telecommunication Corporation, the Electric Power
Corporation, the Post Office, the Petroleum
Corporation, sugar industries, and government farms.
 State Power of Taxation
•

• Unlike the federal government, the states have no

exclusive tax bases assigned to them by the FDRE
Constitution. The lists under Article 97 entitled ‘state
power of taxation’ enumerates those tax bases shared
from the federal tax competence based on different
category of taxpayers or particular things. Therefore,
except custom duties, all tax bases are also the source
of state revenue. Hence, the states income taxes, sale
and excise taxes, property taxes and fees and charges
are discussed hereunder.
• Accordingly, with respect to personal income from employment,
income from employees of the states and from employees of private
enterprises are subject to the exclusive authority of the states (Art.97
(1)).
• The exclusive tax power of the states on income extends to other
sources than employment (payroll tax). The income or profits of the
public enterprises owned by the states are taxed by the states (Art.97
(7)).
• Profit or income from small business activities and sole
proprietorships (the nature of the business activities determined by
the Commercial Code and other relevant laws) is left to the states
(Art.97 (4)).
• Income from individual farmers or cooperative association, income
from water transport service provided within the boundary of the
state and rental income from properties owned by the state are
exclusively taxed by the state (Art.97 (3), (5) and (6)).
There are sales and excise taxes reserved to the states.
• The states can levy and collect excise and sale taxes
against public enterprises owned by them (Art.97 (7)).
In addition, the states can levy and collect these taxes
from individual traders within their jurisdiction (Art.97
(4)). However, the exclusive power of the states is
restricted in some cases since some individual traders
are subject to federally administered VAT law.
• The states are also empowered to levy and collect
taxes and royalties on small-scale mining activities
(Art.97 (8)). One of the most important property tax
of the states could be revenue from land lease
payment from investors, for the Constitution provides
that land is publicly owned.
• Similar to the federal list, the taxation powers listed
for the state also have provisions authorizing the
collection of fees and charges on license issued and
services rendered by different organs of the state.
Hence, the states are empowered to determine and
collect fees and other charges for the service rendered
by the state organs (Art.97 (9)).
Concurrent power of taxation
The FDRE Constitution provides the source of
concurrent taxes under Article 98. These sources are:
• Profit, sales, excise and personal income taxes on
enterprises they jointly establish,
• taxes on profits of companies and on dividends due to
shareholders, and
• taxes on incomes derived from large-scale mining and
all petroleum and gas operations and royalties on
such operations.
Undesignated Power of Taxation
• The House of Federation and the House of peoples’
Representatives shall, in a joint session, determine by a
two-thirds majority vote on the exercise of powers of
taxation which have not been specifically provided for in
the constitution.
• it implies that states necessarily have a residual power
concerning matters other than taxation. With regard to
exercising residual tax, either level of government can
only acquire the power of taxation after a decision is
reached by the joint meeting of the two Houses of the
Federation.
• Therefore the power over residual taxes is an exception to
residual powers of the Constitution.
• The exercise of the taxing powers of both the Federal
and Regional governments has to take certain
considerations into account. For one, both
governments are required to ensure that any tax is
related to the source of the revenue taxed and that it
was determined per the proper procedures. Secondly,
both governments are required to ensure that the
relationship amongst themselves is not adversely
affected by the tax and that the rate and amount of
taxes are commensurate with the services that the
taxes help deliver. Finally, both governments are
prohibited from levying and collecting taxes on each
other’s properties unless it is a profit-making
enterprise.