CHAPTER - 3

INTRODUCTION TO TAXATION
Meaning of tax
Tax is one of the most important sources of revenue to every government. In the earlier days,
payment of taxes was optional. A choice was given to the people to pay the tax and avail the benefit
of social amenities in the form of education, health and sanitation utilities and recreation facilities.
Naturally, everyone is interested in availing social amenities used to evaluate the benefit derived by
him/her in exchange for the tax to be paid by him/her. But the option in the payment of tax created lot
of problems for the government in fulfilling their obligations to society. Hence, in modern times,
option was withdrawn and tax became a compulsory contribution by every citizen to the government
to enable the government of fulfill its commitments towards society.

A tax, in the modern times, therefore is a compulsory levy and those who are taxed have to pay the
sums irrespective of corresponding return of services of goods by the government. It is not a price
paid by the taxpayer for any definite service rendered or a commodity supplied by the government.
The taxpayers do get many benefits from the government but no taxpayer has a right to any benefit
from the public expenditure on the ground that he is paying a tax. The benefits of public expenditure
may go to anyone irrespective of the taxes paid. Therefore, we may say that taxes are compulsory
payments to government without expectation of direct return or benefit to the taxpayer.
CHARACTERISTICS OF A GOOD TAX SYSTEM
(1) Tax is a compulsory Contribution: A tax is a compulsory payment from the person to the
government without expectation of any direct return. Every person has to pay direct as well as
indirect taxes. As it is a compulsory contribution, so no one can refuse to pay a tax on the
ground, for instance, since, he does not derive any benefit from certain state services or the
has no right to franchise, he is not liable to pay a tax. Therefore, everyone has to pay a tax
upon whom it is levied by the state whether he is an adult or a minor, or a citizen or an alien.
(2) The Assessee will be required to pay tax if it is due from him: No one can be forced by any
authority to pay tax, if it is not due from him. Suppose, if there is a tax on liquor, the state can
force an individual to pay the tax only when he drinks liquor. But, if he does not drink liquor,
he cannot be forced to pay the tax on liquor. Similarly, if an individual’s income is below the
exemption limit, he cannot be forced to pay tax on income.
(3) Taxes are levied by the government: No one has the right to impose taxes. Only the
government has the right to impose taxes and to collect tax proceeds from the people.

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(4) Common Benefits to all: The tax, so collected by the government, is spent for the common
benefit of all the people. In other words, when the government collects a tax, its proceeds are
spent to extend common benefits to all the people. The government incurs expenditure on the
defense of the country, on maintenance of law and order and on the provision against floods
etc. Such benefits are given to all the people whether they are taxpayers or non-taxpayers.
These benefits satisfy social wants. But the government also spends on subsidies to satisfy
merit wants of people.
(5) No Direct Benefit: In the modern times, there is no direct relationship between the payment
of tax and direct benefits. In other words, there is an absence of any benefit for taxes paid to
the governmental authorities. The government compulsorily collects all types of taxes and
does not give any direct benefit to taxpayers for taxes paid. For example, when taxable
income is earned by an individual or a corporation, he/she or it simply pay the tax amount at
the specified rate and cannot demand any benefit against such payment.
(6) Certain Taxes levied for specific Objectives: Though taxes are imposed for collecting
revenue for the government to meet its expenditure on social wants and merit wants, certain
taxes are imposed to achieve specific objectives. For example, heavy taxes are imposed on
luxury goods to reduce their consumption so that resources are diverted to the production of
essential goods, such as cheaper variety of cloth, less costly goods of mass consumption, etc.
Thus, taxes are levied not only to earn revenue but also for diversion of resources or saving
foreign exchange; certain taxes are imposed to reduce inequalities of income and wealth.
(7) Attitude of the Tax-payers: The attitude of the tax-payers is an important variable
determining the contents of good tax system. It may be assumed that each tax-payer would
like to be exempted from taxpaying, while he/she would not mind if other bears that burden.
In any case, he/she would want his/her share to be within the general level of tax burden being
borne by others. In other words, it is essential that a good tax system should appear equitable
to the tax-payers. Similarly, overall burden of the tax system is of equal importance. The
attitudes of the tax-payers in this regard are influenced by factors like the political situation
such as war or peace, natural calamities like floods and droughts, economic situations like
prosperity or depression and so on.
(8) Good Tax system should be in Harmony with National objectives: A good tax system
should run in harmony with important national objectives and if possible should assist the
society in achieving them. It should try to accommodate the attitude and problems of tax-

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 payers and should also take into consideration the goals of social and economic justice. It
should also yield adequate revenue for the treasury and should be flexible enough to move
with the changing requirements of the state and the economy.
(9) Tax system recognizes basic rights of tax payers: A good tax system recognizes the basic
rights of the tax-payers. The tax-payer is expected to pay his/her taxes but not undergo
harassment. In other words, the tax law should be simple in language and the tax liability
should be determined with certainty. The mode and timings of payment should be convenient
to the tax-payer. At the same time, a tax system should be equitable between tax-payers. It
should be progressive and burden of taxation should be equitable on all the tax-payers.

CANONS OF TAXATION
Adam smith has enumerated four canons of taxation, they are:
(1) Canon of Equality: This canon proclaims that a good tax is that which is based on the
principles of equality. In other words, subjects of every state ought to contribute towards the
support of the government, as nearly as possible, in proportion of their respective abilities,
that is, in proportion to the reserve which they respectively enjoy under the protection of the
state. It implies what the income which a person enjoys under the protection of the state,
should be taxed on the proportional rate of taxation. But modern economists do not agree with
Adam Smith. They advocate progressive taxation to observe the canon of equality. In other
words, they advocate progression should be the basis for imposing taxes.
(2) Canon of Certainty: The canon of certainty implies that the tax-payer should be well
informed about the time, amount and the method of tax payment. According to Adam Smith,
“the tax, which each individuals is bound to pay, ought to be certain and not arbitrary. The
time of payment, the manner of payment, the quantity to be paid, ought all to be clear and
plain to the contributor and to every other person.” Adam smith was also of the view that the
government must also be certain of the amount which it derives from a particular tax. Thus,
this canon is equally important both for the individual and the state.
(3) Canon of Convenience: According to Adam smith, “every tax ought to be so levied at the
time or in the manner in which it is most likely to be convenient for the contributor to pay it.”
In other words, taxes should be imposed in such a manner and at the time which is most
convenient for the tax-payer, i.e. the best time for the collection of land revenue is the time of

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 harvest. Similarly, taxes on rent of houses should be collected when it is most convenient for
the contributor to pay.
(4) Canon of Economy: This canon implies that the administrative cost of tax collection should
be minimum, i.e. the difference between the money, which comes out of the pockets of people
and that which is deposited in the public treasury, should be as small as possible.
Administrative cost of tax collection should be minimum because levying a tax may require a
great number of officers, whose salaries may eat up the greater part of the produce of the tax,
and whose pre-requisites may impose another additional tax upon the people. Hence, the
administrative cost should be minimum.

Other canons: In addition to the above four canons given by Adam smith, the following other
canons have been advanced by other economists.

(5) Canon of Productivity: The canon of productivity implies that taxes should be productive.
The productivity of a tax may be observed in two ways. In the first place, a tax should yield a
satisfactory amount for the maintenance of government. In other words, the tax should be
such that it procures a considerable amount of revenue for the expenditure of the government.
Secondly, the taxes should not obstruct and discourage production in the short as well as in
the long run.
(6) Canon of Elasticity: The canon of elasticity that yields of taxes should be increased or
decreased according to the needs of the government. The government may need funds to face
natural calamities and other unforeseen contingencies. It may need funds to finance a war or
for development purposes. The government resources can be raised quickly only when the
system is elastic.
(7) Canon of Diversity: the canon of elasticity implies that the tax system should diverse in
nature. In other words, in a tax system, there should be all types of taxes so that everyone may
be called upon to contribute something towards the revenues of the state. Thus, the
governments should adopt multiple tax system.
(8) Canon of Simplicity: The canon of simplicity implies that a tax should easily be understood
by the tax-payer i.e. its nature, its aims, time of payment, method and basics of estimation
should be easily followed by each tax-payer. In other words, the tax imposed on the tax-

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 payers should be so simple that are able to guess easily the aim of its imposition and they are
not confronted with accounting, administrative or any other difficulties.
(9) Canon of Expediency: This canon implies that the possibilities of imposing a tax should be
taken into account from different angles i.e. its reaction upon the tax-payers. Sometimes, it is
seen that tax may be desirable and may be productive and may have most of the
characteristics of a good tax, yet the government may not find it expedient to impose it, for
example, progressive agricultural income tax, but it has not been imposed. So far in the
manner it should have been imposed.
(10) Canon of Co-ordination: In democratic countries, taxes are imposed by central, state and
local governments. It is, therefore, very much desirable that there must be co-ordination
between different taxes that are imposed by different taxation authorities. In other words,
interest of the tax-payers and the government should be taken into consideration.
CLASSIFICATION AND CHOLCE OF TAXES
(A) DIRECT AND INDIRECT TAXES
DIRECT TAXES
According to Dalton, direct taxes are those taxes which are paid entirely by those persons on whom
they are imposed. In other words, the immediate money burden is upon the man who pays the tax to
the authority. Direct taxes are taxes which cannot be shifted to others. A.R. Prest defines “direct taxes
as those taxes which are based on the receipts of income.” Income-tax, tax on profits, capital gains
tax, property or wealth-tax are direct taxes.
Merits of Direct Taxes:
(1) Equitable: Direct taxes are just and equitable because they are based on the principle of
progression. The larger the income the higher is the rate tax and vice-versa. Direct taxes are
taxed according to the ability to pay of the tax payers. Ability to pay is interpreted as the
money income of the assesses.
(2) Certainty: Direct taxes satisfy the canon of certainty. Direct taxes involve certainty about the
rates of taxes, such as income –tax which are widely publicized. The tax –payer is certain as to
how much he/she is expected to pay and similarly the state is certain how much it has to
receive income from direct taxes.
(3) Reduce Inequalities: As direct taxes are progressive in nature, rich people are subjected to
higher rates of taxation, while poor people are exempted from direct tax obligations. Rates of
taxes increase as the level of income of persons rise. The revenue collected from these taxes

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 can be used to provide amenities to the poor people. Thus, real income of the poor rises and
that of the rich falls.
(4) Elasticity: Elasticity in direct taxes implies that more revenue is collected by the government
by simply raising the rates of taxation.
(5) Civic Consciousness: Since direct taxes are certain, the tax-payers feel the pinch of such
payment and are therefore, alert and take keen interest in the method of public expenditure,
whether the revenue raised is properly utilized or not.
Demerits of Direct Taxes:
(1) Unpopular: Direct taxes are unpopular because they are required to be paid in one lump sum
which is inconvenient to the tax-payer. Direct taxes are generally not shifted; therefore, they
are painful to the tax payer.
(2) Inconvenience: Direct taxes are inconvenient in nature, because tax-payer has to submit the
statement of his/her/its total income along with the source of income from which it is derived.
Moreover, direct taxes are paid in lump sum which causes inconvenience to the tax payers.
(3) Possibility of Evasion: A direct tax is said to be a tax on honesty, but it can be evaded through
fraudulent practices. Since direct taxes are certain and tax-payers know the rate of tax they
have to pay, the awareness of tax liability tempts the tax-payer to evade tax. It is a fact that the
people in the higher income groups do not reveal their full income. They do not hesitate to fill
up false returns, concealing a considerable part of their incomes.
(4) Adverse effects of Direct Taxes on Will to Work and save: If the higher taxes are imposed
on the income of the assess, will of the people to work hard and save may adversely be
affected. This may prove to be injurious to the economy.
INDIRECT TAXES:
Indirect tax is a tax that the burden of which may not necessarily be borne by the assessed.
Indirect taxes can be shifted to other person. Indirect taxes are taxes on commodities. These are
custom duties, sales taxes, excise taxes etc. According to John Stuart Mill, “Indirect taxes are
those which are demanded from one person in the expectation and intention that he/she shall
indemnify himself/herself at the expense of another.” Thus, it is intended that the amount of tax
should be collected from other persons by those on whom it is imposed; such a tax is an
indirect tax.

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Merits of Indirect Taxes:
(1) Convenient: Indirect taxes are convenient to pay. They are paid in small amounts instead of
in one lump sum. They are generally included in the price of a commodity and hence the
burden of these taxes is not felt very much by the tax-payers.
(2) No Evasion: Indirect taxes are generally difficult to be evaded as they are included in the
price of a commodity. A person can evade an indirect tax only if he /She decides not to
purchase the taxed commodity.
(3) Elastic: Indirect taxes can be elastic i.e. the revenue from indirect taxes can be increased.
(4) Wide Coverage: Through indirect taxes, every member of the community can be taxed, so
that everyone may provide something to the government to finance the services of public
utilities.
(5) Can be progressive: Indirect taxes can be made progressive by imposing heavy taxes on
luxuries and exempting articles of common consumption from the tax net. Example Personal
car Vs food consumption. Personal car is taxed heavily than salt.
Demerits of Indirect Taxes:
(1) Regressive: The government in order to increase its revenues imposes heavy taxes on the
articles of common consumption, the demand for which is inelastic. The real burden on
the poor is more, since their incomes are low.
(2) Administrative Cost: The administrative cost of collection of such taxes is generally
heavy as they have to be collected from large number of people in small amounts. It is
necessary to check the records of manufactures and sellers and also to prevent smuggling
of goods.
(3) Discourage Saving: Indirect taxes discourage saving because they are included in the
price of a commodity and people have to spend more on essential commodities. Hence,
they discourage saving.
(4) No Civic Consciousness: Unlike direct taxes, indirect taxes are collected in small
amounts, hence, they are not felt very much by the tax payer and dose not arouse civic
consciousness.
(5) Creation of Inflation: Another major evil of indirect taxes is that these taxes generate
inflation in the economy. Prices of taxed goods keep on rising without any reduction in the
purchasing power in the economy.

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(B) PROPORTIONAL VS PROGRESSIVE TAXATION
PROPORTIONAL TAXATION
A tax is called as proportional if all the tax payers pay the same proportion of their income (property)
as tax.
Arguments in favour of proportional taxation:
(1) Relative position is not affected: According to classical economists, the objective of taxation
should not be to alter the relative position of the tax-payers. Hence, they advocated proportional
taxation, as it does not affect the relative position of the tax-payers as percentage of tax is the
same on all the tax-payers.
(2) Uniform Tax Rates: Tax rates are the same of the rich as well as for the poor. Since the tax rate
is uniform for all the tax payers, taxation is not very much opposed by them.
(3) Certainty: As the tax rates are same for all the tax-payers, the amount of proportional taxes can
be estimated and calculated by the government.
(4) Willingness to work and save not affected: The willingness to work more and save more of the
tax-payers is not adversely affected by the proportional taxation because the rate of taxes remain
constant.
(5) Equitable: Proportional taxes are just and equitable because money burden increases in the same
proportion as the income increases.
PROGRESSIVE TAXATION
A tax is said to be progressive, if larger the tax-payers income (or property), the greater is the
proportion that he/she pays as tax. A sharply progressive tax system tends to reduce inequalities
in the distribution of income and wealth and sharper the progression, the stronger is the tendency
to reduce inequalities.
Arguments in favour of progressive Taxation:
(1) Reduces Inequalities: under the system of progressive taxation inequalities would be reduced
because a higher proportion of the income and wealth of the rich would be taken away by way of
taxes than that of poor. Hence, It reduces inequalities in the distribution of income and wealth.
(2) Economic: Progressive taxes have also been justified on the ground that they are economical
as the cost of collection does not rise with the increase in the rates of taxes.
(3) Elastic: progressive taxes are elastic in nature. Revenue from progressive taxes can be
increased by increasing the rates of taxes.

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 (4) Curbs Inflationary Trends: Progressive taxation may be helpful in curbing the inflationary
trends as it reduces consumption demand and the resources thus mobilized may be directed
towards productive investment which may increase the supply of commodities. Hence,
inflationary trend may be curbed; growth and economic stability may be achieved.
(C) SINGLE Vs MULTIPLE TAXATION
SINGLE TAX SYSTEM
A single tax means only one kind of tax. It does not mean tax on only one person. In other words, a
tax on one thing i.e. on one class of things or one class of people. Such a tax is collected not only
once but regularly every month, or every year, at intervals of shorter or longer durations. A single tax
may be proportional, progressive or regressive, or it may be fixed amount. In the 19 th century, many
people on the continent of Europe advocated a single tax on income. Everybody has income and so
everybody would have to pay this tax. Economists in France advocated a single stamp tax. There
were some who wanted singe tax on capital. Those who have capital must pay the tax and those who
have no capital, need not be taxed. But many modern economists do not consider the proposals of
single tax on the ground that revenue from single tax may be insufficient.
Merits of a single Tax:
(1) Simple: The greatest merit of single tax lies in its simplicity. Since there is only one tax, it
simplifies the work of the government. A multiple tax system complicated the work of the
government. A multiple tax system complicates the work in every respect in collecting revenue
and its effect on production and distribution.
(2) Equitable: single tax like income tax is just and equitable because it is based on the principle of
equity in taxation. Higher taxes are imposed on the income of the rich and lower taxes are
imposed on the income of the poor.
Demerits of a single Tax:
(1) Insufficient Revenue: From the point of view of revenue, the single tax may not be sufficient for
the government. The financial needs of the government are not fixed and sometimes, the needs of
the government suddenly increases which cannot be met by yield of a single tax. The yield of
single tax does not increase as rapidly as the yield from the multiple tax system.
(2) Regressive: Single tax is opposed on the ground that it is regressive in nature as it cannot be
imposed in proportion to the ability to pay of the tax-payer. For instance, if a tax is imposed on
houses, land etc; it is very difficult to make its burden on everybody in proportion to his/her
ability. If the tax is on income it can be made very equitable.

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 MULTIPLE TAX SYSTEM
Modern economists have laid great stress on the diversity of taxation. In other words, there should
be all types of taxes, direct and indirect, so that every class of citizen may be called upon to
contribute something towards the state revenue. Hence, a multiple tax system is preferable to a
single tax system, but too great multiplicity is not desirable, as it may go against the canon of
economy and productivity. If there are large numbers of taxes, each one of them may yield only a
small amount of revenue and the cost of collection would be high. Hence, it is essential to have a
limited number of taxes to maintain the efficiency of the administration.
Merits of Multiple Taxation:
(1) Just and Equitable: Multiple taxes are just and equitable because they are based on the
principle of ability to pay. All the tax-pay taxes according to their money income. Rich pay
taxes at higher rates and poor are exempted from taxation. The burden of taxation is equitably
distributed on all the sections of society.
(2) No evasion: Multiple taxes cannot easily be evaded. If a person evades a tax on one account,
he/she pays the tax on another account because of the multiplicity of taxes. Direct tax like
income tax can be evaded but it is not possible to evade commodity taxation because the tax is
included in the price of a commodity.
(3) Sufficient Revenue: As a number of taxes are imposed in a multiple tax system, therefore all
the people pay, more or less, all the taxes. Hence, the government is able to collect sufficient
revenue to meet the growing needs of the society.
(4) Wide Coverage: through multiple taxes, every member of the community can be taxed, so
that everyone may provide something of public utilities. In other words, through multiple
taxes, every one contributes towards social benefit.
Demerits of Multiple Taxation:
(1) Unpopular: Multiple tax system is unpopular amongst the tax-payers as it is composed of all
types of taxes, direct taxes as well as indirect taxes. Direct taxes are generally not shift able;
therefore, they are painful to the tax-payer. On the other hand, indirect taxes are included in
the price of a commodity; therefore, they cannot be evaded Hence, multiple tax system is
unpopular and opposed to the tax payers.
(2) Inconvenient: Too much multiplicity of taxes may lead to inconvenience to both the taxing
authority and the tax-payer as well as to the general public.

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 (3) Administrative Cost: The administrative cost of collection of such taxes is generally heavy
as they have to be collected from large number of people. It is necessary to check records of
manufactures and sellers. It is also necessary to prevent smuggling of goods. Large numbers
of officers have to be appointed to collect the revenue.
B) OBJECTIVES OF TAXATION
Objectives of tax system in any economy are intimately connected with the overall economic and
non-economic policies of the government, the non-tax components of its fiscal policy and
institutional and other circumstances faced by the economy. Usually, therefore, objectives of a tax
system differ significantly between developed and underdeveloped countries.
OBJECTIVES OF TAXATION IN A DEVELOPED COUNTRY
The problems of developed countries are materially different from those of an underdeveloped one. A
developed country does not have to worry about accelerating its rate of economic growth. It has
adequate capacity to save and invest. Similarly, in spite of the fact that it may not have very wide
inequalities of income and wealth, the problem of distributive justice is not an urgent one. Generally,
the incidence of absolute poverty is very low in a developed country. The main problem facing a
developed market economy is that of instability of income and employment and the tax system is
directed to attack it.
OBJECTIVES OF TAXATION IN UNDERDEVELOPED COUNTRIES
In the case of underdeveloped countries, primary objectives are not related to instability of income
and employment. Instead these countries face a number of problems connected with economic growth
on the one hand and removal of poverty and inequalities on the other.
Besides these, there are some additional problems like chronic unemployment and regional
disparities’. Since, the problem of growth covers numerous aspects; the tax may be designed to help
the economy in more than one ways. The underdeveloped country faces the problem of insufficient
savings and capital accumulation. There is a need to promote specific to fill both the supply and
demand gaps. Social overheads have to be created and maintained and basic industries must be
developed to provide a foundation for the industrialization of the economy removal of regional
disparities necessitates the promotion of agricultural and industrial development in backward areas of
the country. There is also a continuous need to restrict unnecessary imports and promote import
substitution and exports.

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TAX AVOIDANCE AND EVASION
Tax avoidance and evasions constitute a problem in almost all the countries of the world. Tax
avoidance is different from tax evasion, while evasion is against the law; avoidance is within the
ambit of law.
Tax evasion is the general term for efforts by individuals, firms, trusts and other entities to evade the
payment of taxes by breaking the law. Tax evasion usually entails taxpayers deliberately
misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax
liability, and includes, in particular, dishonest tax reporting (such as under declaring income, profits
or gains; or overstating deductions).
By contrast tax avoidance is the legal exploitation of the tax regime to one's own advantage, to
attempt to reduce the amount of tax that is payable by means that are within the law whilst making a
full disclosure of the material information to the tax authorities. Tax avoidance may be considered as
either the amoral dodging of one's duties to society or the right of every citizen to find all the legal
ways to avoid paying too much tax. Tax evasion, on the other hand, is a crime in almost all countries
and subjects the guilty party to fines or even imprisonment.
Tax Avoidance:
Tax avoidance means, “tax-payer may resort to a device within the ambit of law to divert the income
before it accrues or arises to him”.
“Tax Avoidance has to be recognized that the person whether poor or wealthy has the legal right
to dispose of his income so as to attract the least amount of tax”.
The tax avoidance can be defined as “escaping from the tax liability by using the available loop-
holes of the tax laws”.
Thus, tax avoidance means legal minimization of tax burden by the taxpayers.
Examples for Tax Avoidance:
The following are the examples for tax avoidance:
- Suppose a taxpayer’s total income exceeds the maximum tax-free amount, then he has to pay the
tax on such excess amount. But if he invests the excess amount in any of the approved
schemes for which there is a relief in the tax law, he can save on tax altogether.
- An individual sells his let out house property (long-term capital asset) for Birr.2,00,000 making
a capital gain of Birr 60,000. This capital gain would normally be taxed. But, if he invests the
sale proceeds in a particular manner stipulated by law, he need not pay any tax.

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 - Divorcing the wife on paper so that her income is not added together with husband’s income is
also a common device for tax avoidance.
Tax Evasion:
Tax evasion means fraudulent action on the part of the taxpayer with a view to violate civil and
criminal provisions of the tax laws. It can be defined as “tax evasion implies the activities involving
an element of deceit, misrepresentation of facts, and falsification of accounts including downright
fraud”.
Thus, it may be said that the tax evasion is tax avoidance by illegal means i.e. tax evasion is
against the law and is an unsocial act.
There are two forms of tax evasion. They are suppression of income, and inflation of expenditure.
Examples for Tax Evasion:
The following are the examples for tax evasion:
- A trader makes a sale for Birr.20,000 and if he does not account it, in his books under sales; he
is evading tax.
- An individual lends his money of Birr.50,000 to another person at 20% interest per annum and
does not include this income in his total income.
- Under-invoicing of sales and inflation of purchases.
- A manufacturing business employs 30 workers but include 2 more additional namesake workers
(not in actual) in the muster roles. The sum shown as paid to such additional namesake
workers will amount to evasion.
Human intelligence devices new methods of evasion and the Governments are constantly trying to
remove the loopholes in the tax laws.
Effects of Tax Evasion
 It increases the burden of honest tax payers
 It leads to creation of black money / unaccounted and unrecorded money
 It increases inequality and concentration of income and wealth
Causes of Tax Evasion:
The following are the important causes for Tax evasion:
1. High Rates of Taxation: High rates of taxes cause widespread tax evasion, because the greater the
risk undertaken for the purpose of tax evasion, the greater is the reward.
2. Multiplicity of Tax Laws: A number of laws enacted for the recovery of a variety of taxes often
leads to widespread tax evasion.

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3. Complexity of Tax Laws: Complicated tax laws are another reason for tax evasion. The tax laws
contain a number of exemptions, deductions, rebates, relief, surcharges and so on. For example:
the Income Tax Act has 28 chapters and 298 sections including sub-sections. So, such
complication in tax-laws is also a root-cause for the tax evasion.
4. Inadequate Information as to Sources of Tax Revenue: Lack of adequate information as to the
sources of revenue also contributes to tax evasions. In Ethiopia, small businessmen and farmers
rarely maintain any accounts of their income.
5. Ineffective Tax Enforcement: Lack of proper training and efficiency for the authorities enforcing
the tax laws is also a major cause for widespread tax evasion. Shortage of experienced personnel is
another cause for tax evasion. The tax department should have sufficient number of trained and
experienced personnel to cope with assessment and investigation work. To make the department
efficient, procedures and organization of the department should be improved.
6. Absence of deterrent punishment: another reason for tax evasion is that no deterrent punishment
like imprisonment is being meted out to tax evaders when they are caught. It is therefore,
recommended tax evaders to be prosecuted and strictly punished to discourage tax evasion.
7. Luck of publicity: lack of publicity of information of a person’s return or assessment except to
specified authorities relating to the person like state government authorities, central bank, and
courts of law, is yet another reasons for tax evasion. Even if a tax evader is caught and penalized
for concealment, he can keep it as a secret from everyone.
8. Moral and psychological factors: every citizen should realize and be aware of his/her
responsibility towards the government. Unfortunately, all citizens do not realize their duties to the
state and the necessity of paying the correct amount of taxes and paying them in time. In addition,
in this modern competitive world, the deterioration of moral standards, among the people leads to
falsification of accounts, misrepresentation of facts and fraudulent behavior. Only a reformed
moral outlook and development of better civic conscience can improve matters in this respect.
9. Attitudes of income tax departments: biased attitude of the income department is also one of the
important causes of tax evasion. It has been said that even if when the assesses return are correct in
respect of income and produce evidence in support, and the assessing officers do not always accept
them. Because of this attitude of the department, assessees, sometimes, understate their income and
wealth, etc. in returns. This mutual distrust between the assessing officers and the tax payers also,
encourage, to some extent tax evasion. For this purpose the administration has to take the initiative
and trust the assessees and conduct itself with a high sense of justice and fair play.

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10. Officers of the department of taxation authority should be men of integrity: lack of integrity
in some of the officers of the department is also responsible for tax evasion.
11. Corrupt business practices: in spite of number of legislations for the protection of consumers,
we still find the prevalence of black marketing and hoarding in our country. Businessmen indulge
in hoarding and sell their goods in the market at inflated rates. All such corrupt and unfair business
practices lead to the generation of black money.
Methods of Tax Evasion
There are many means and methods to evade the payment of tax. Some of the methods of tax evasion
are as follows:
1. Omission to report taxable income: this is one of the methods of tax evasion in which tax
payers omit their taxable income to the taxation authorities. Under law every person has to furnish
their income-tax returns in time in case his /her total incomes from all sources exceed the
maximum exemption limit. But many people do not supply such information to the government.
They cheat their government by concealing facts with regard to their income and wealth returns.
2. Maintenance of multiple set of books of accounts: many big business houses shows some
baseless transactions of expenditure to lower down their tax burden. In most of the cases tax
evaders maintain double set of books of accounts. One set of book of account is for personal use;
it contains full and accurate particulars of business transactions and another set of book of
accounts for tax purpose; it gives a different picture of the conduct of business.
3. Opening accounts under dummy names: tax evaders open number of accounts under dummy
names, since the bank manager cannot find out the real identity of all depositors particularly those
who come only at the time of the maturity of their fixed deposit receipts. The bank manager
simply compares the signature of the person withdrawing or depositing the money with his/her
earlier signatures. Regular tax dodgers are always alert and they remember when and in what
form they had earlier signed their receipts.
4. Securing contracts under dummy names: many persons secure contracts under fictitious
names. When a person’s income exceeds maximum exemption limit, he establishes, or secures a
contract under the name of his wife and child, which is allowed under law. But regular tax
dodgers carry on their business in the names of such persons who do not exist altogether.
5. Deduction of personal expenses as business expenses: some businesses deduct their personal
expenses from the business by treating personal expenses as business expenses. By doing this
people increase business expenses thus lowering the profit of the enterprise.

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6. Omission to report several incomes from irregular sources: many individuals are in receipt of
different types of income from different irregular sources. For example people receive interest on
deposits in the banks or dividend on shares etc. but they rarely report such income to the taxation
authorities.
7. Understatement of receipts: receipts received from sales/credit sales add to the total income of
the business. This income due to credit sales increases his tax liability. Hence, he takes such steps
as to underestimate his receipts so that he could reduce his tax liability.
8. Overstatement of business expenses: A person, who evades the payment of tax, may
overestimate his business expenses by showing such as more salaries to employees as compared
to actual amount paid. This deflates his taxable income and also his tax liability.
Remedies for Tax Evasion
If steps are not taken to reduce tax evasion, it may cause irreparable harm. The following are the
remedies to prevent or measures to check tax evasion.
1. Thorough Overhauling of Tax Laws: One of the main reasons for tax avoidance and tax evasion
is loose drafting of tax laws which contain several loop-holes and weak points that enable the tax
evaders to carry on the unlawful activities. Hence, it is necessary to re-draft the tax laws
thoroughly without any loopholes and weak points.
2. Reduction in Tax Rates: The prevalence of high rates is the first and foremost reason for tax
evasion. The high rate of taxation affects the capacity and willingness to save and invest of the
people. This shatters the faith of the common man in the dignity of honest labor and virtuous
living. Hence, the rate of tax should be reduced to a reasonable level.
3. Permanent account number: to prevent tax dodgers from evading tax through opening accounts
under fictitious names, permanent account number or tax identification number (TIN) should be
allotted to each tax payer for use in transactions.
4. Tax on Agricultural Income: Agricultural income is exempted from income tax and for this
reason it is used to convert the black money into white. In recent years, agricultural farms and
orchards, and vineyards have come to be acquired by industrialists; film stars etc. because this
enables their owners to whiten their black money. Tax evasions can be avoided by taxing the
agricultural income at normal rates.
5. Maintenance of Proper Accounts: Maintenance of proper accounts should be made compulsory
for persons whose business and professional income exceeds a prescribed limit. In the Income Tax
law, a provision to this effect has been introduced recently.

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6. Change in penal provision: A person, who evades tax, should be punished by the government.
Tightening of tax enforcement may be said to be the crucial remedy if the penalties for violation of
tax laws are strictly enforced, incidence of tax evasion could automatically be reduced.
7. Vigorous prosecution: to make people aware of their duties and responsibilities towards the state
and to instill in them a respect for tax laws, the authority should adopt vigorous prosecution policy.
If a tax payer is found lacking in his duties i.e. if a tax-payer conceals the facts with regard to their
income and wealth and evades the payment of tax, he should be prosecuted.
8. Education to people: to make people pay tax correctly and regularly, they should be educated and
awareness should be given with regard to the payment of tax through public/ mass media like
press, radio and films.

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