SS2 ECONOMICS TTLNWK2

MEANING OF TAXATION:

Taxation is the imposition of compulsory levies on individuals or entities by governments. Taxes

are levied in almost every country of the world, primarily to raise revenue for government
expenditures, although they serve other purposes as well.

economies taxes are the most important source of governmental revenue. Taxes differ from
other sources of revenue in that they are compulsory levies and are unrequited—i.e., they are
generally not paid in exchange for some specific thing, such as a particular public service, the
sale of public property, or the issuance of public debt. While taxes are presumably collected for
the welfare of taxpayers as a whole, the individual taxpayer’s liability is independent of any
specific benefit received.

CLASSES OF TAX:

There are basically two classes of tax namely; Direct tax and Indirect tax.

DIRECT TAX:

A direct tax is a tax that a person or organization pays directly to the entity that imposed it.
Examples include income tax, real property tax, personal property tax, and taxes on assets, all of
which are paid by an individual taxpayer directly to the government.

Direct taxation - this is taxation on income. This covers taxes like income tax profits tax and
wealth taxes on inheritance.

Indirect taxation - this is taxation on expenditure. This covers taxes like VAT, excise duties (tax
on cigarettes, alcohol etc.).

Progressive, regressive and proportional taxes

Taxes differ according to their impact on different income groups. Some taxes will redistribute
from better-off groups to less well-off and these are called progressive taxes. However, others
will have the opposite effect and these are called regressive taxes.

TYPES OF DIRECT TAX:

• Progressive tax - a tax that takes a greater proportion of a person's income as their income
rises.

• Regressive tax - a tax that takes a smaller proportion of a person's income as their income
rises.

• Proportional tax - a tax where the percentage of income paid in taxation always stays the same.
The balance of these taxes can have a significant effect on income distribution in an economy.
If a government chooses to switch the balance of taxation from progressive to regressive taxes
then the less well-off in society will be hardest hit. In general, direct taxes tend to be progressive
and indirect taxes regressive.

Governments with differing objectives will often aim to change the balance of direct and indirect
taxes. Right wing governments may choose to shift the balance of taxation from direct to
indirect. They will argue that this is more efficient as it allows people to keep more of what they
earn - giving them more incentive to work hard. Taxing people on expenditure is seen as more
economically efficient. However, a switch from progressive direct taxes to regressive indirect
taxes will have an adverse impact on the distribution of income.

INDIRECT TAX:

Indirect taxation - this is taxation on expenditure. This covers taxes like VAT, excise duties (tax
levied on goods and services.). The producers or sellers bear the initial burden of tax before
shifting them to the final consumer in the form of higher prices

Often, indirect taxes are built into the price charged to consumers. This means that when a new
indirect tax is imposed, consumer prices of the affected goods and services generally increase
as a result.

Note

In states that have a sales tax, consumers pay indirect taxes to retailers, which are responsible
for collecting sales taxes and remitting them to the state government. Retailers generally
charge higher prices to customers, then collect sales taxes from them at the point of sale.

TYPES OF INDIRECT TAX:

What many people are not aware of is that practically everyone pays taxes, especially indirect
taxes. This is because taxes are imposed on almost all the products that we consume. Here are
some of the types of indirect taxes.

• Sales tax

Whenever people go to the malls or department stores to shop, they are already about to pay
indirect taxes. Goods such as household items, clothing, and other basic commodities are
subject to such types of taxes.

• Excise tax

Excise tax is also very common. When a manufacturer buys the raw materials for the company’s
products, for example, tobacco for cigarette companies, they already need to pay indirect taxes
on the items. Through a part of the normal course of business, the manufacturer can pass on
the burden to the consumers by selling the cigarettes at a higher price.
• Customs tax

Ever wonder why imported products are expensive? It is because of customs tax. When a
container filled with bananas from another country enters the US, the importer pays a tax
(customs tax), which is then passed on to consumers.

• Value Added Services

This is the type of tax imposed on goods and services at each stage of production. The burden
of the taxation is finally borne by the final consumer.

PRINCIPLES OF A GOOD TAX SYSTEM:

They are the principles of convenience, simplicity, economy, equity, certainty, flexibility and
stability.

1. Convenience: A good tax system must be based on the ability to pay.

2. Simplicity: A good tax system should not be difficult to administer and understand. It should
not cause problems of differences in interpretation.

3. Economy: A good tax system should economically small compared to the revenue derived
from the tax.

4. Equity or Ability to pay: This means that the tax should be levied according to the person's
ability to pay.

5. Flexibility: The tax system should be easy to change to adapt to changing circumstances in
the economy such as inflation, deflation etc.

EFFECTS OF TAXATION:

(a) Effect on Employment: If resources collected via taxes are utilized for development projects,
it will increase employment in the economy. If taxes affect the volume of savings and
investment badly then recession and unemployment problem will be aggravated.

(b) Effects on inflation: An increase in indirect taxes and decrease in direct tax by government
can lead to increase in the volume of money in circulation thereeby leading to inflation.

(c) Effects on savings: High level of taxation on individuals or corporate bodies can lead to
reduction in savings.

(d) Effects on the price level: A decrease in taxation would lead to an increase disposable
income which would increase the level of demand of consumers. This would generate inflation
if the level of demand is not met with an increase in productivity.

(e) Effects on investment: Imposition of high level of excise duty, company tax, etc on investors
by government will discourage investors from investing in businesses.

(f) Effects on prices of goods and services: When government imposes high excise duty this will
make cost of production to be very high which could lead to high prices of goods produced.

INCIDENCE OF TAXATION:

Tax incidence" (or incidence of tax) is an economic term for understanding the division of a tax
burden between stakeholders, such as buyers and sellers or producers and consumers. Tax
incidence can also be related to the price elasticity of supply and demand. When supply is more
elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply,
producers will bear the cost of the tax.

• A tax incidence describes a case when buyers and sellers divide a tax burden.

• A tax incidence will also lay out who bears the burden of a new tax, for instance among
producers and consumers, or among various class segments of a population.

• The elasticity of demand of a good can help understand the tax incidence among parties.

TYPES OF INCIDENCE OF TAXATION:

1. Effective incidence: A person or entity who actually bears the burden of tax is known as the
effective incidence of tax. With reference to direct taxes, the payer bears the full (initial and final)
burden of taxation.

2. Formal incidence: A person or entity which is obliged to pay the tax is known as a formal
incidence of tax. It shows where the initial burden of tax lies. In the case of direct tax, the initial
burden of tax is borne on the payer while in the case of indirect taxes, the producers or
manufacturers bear the initial burden of tax.

STRUCTURE OF EFFECTS OF PUBLIC EXPENDITURES ON GOVERNMENT BUDGET:

• If the country is operating at full employment, increased government expenditures will

generate inflation because the increase in demand will not be met by an increase in output since
all factors of production are fully utilised. There will therefore be an excess of demand over
supply leading to high prices.

• An increase in government expenditures affects the growth rate of an economy. Aggregate

demand can be increased by increasing government expenditures during periods of slow
economic growth such as deflation, recession etc. At full employment, economic growth can
also be increased by increasing government expenditures on capital investments.

• If the country is operating at less than full employment, an increased government expenditures
would have the following effects;

a. An increase in the volume of output in the economy: If workers are paid higher wages by
government, their demand for goods and services will increase and this will encourage the
producers to increase their level of output to meet the increased demand.

b. An increase in employment: In order to increase the level of output producers would have to
increase their demand for factors of production. The factors of production working below full
capacity, will be fully utilised and there will be an increase rate of employment.

ASSIGNMENT

With the aid of diagram explain the following;

1. Progressive tax

2. Regressive tax

3 Proportional tax