CHAPTER ONE

INTRODUCTION TO TAXATION
 Definition: -Taxation, Tax
• Taxation is a compulsory collection of
money by government;
 It is a payment extracted by the
government from people and organizations
to fund public expenditures
• transfers resources from private to public
consumption.
• taxes are involuntary levies without a quid
pro quo;
 Cont…
“Taxes,” said rich dad. “You’re taxed when you earn. You’re
taxed when you spend. You’re taxed when you save. You’re
taxed when you die.”
“Why do people let the government do that to them?”
“The rich don’t,” said rich dad with a smile. “The poor and
the middle class do. I’ll bet you that I earn more than your
dad,
yet he pays more in taxes.”
 Cont…
• Throughout history, people have debated
– the amount and kinds of taxes that a government should
impose, as well as
– how it should distribute the burden of those taxes
across society.
 Cont…
• Unpopular taxes have caused public protests,
riots, and even revolutions.
• In political campaigns, candidates’ views on
taxation may partly determine their
popularity with voters.
• Countries differ considerably in the amount
of taxes they collect; however, the most
important source of revenue for modern
government is tax.
 Cont…
• governments compel the payment of taxes:
– to fund services which are mainly public and which
cannot be provided through the market system;
people otherwise would not be willing to pay for
these services;
– to accomplish some redistribution role;
Today, tax has become a part and parcel of all economic
activities of human beings.
Every man, willingly or unwillingly, pays an amount of
money in the form of tax on the products he uses
basically.
Besides, he pays tax on his income, wealth, etc.
 Taxation and Public Finance
• Taxation is defined as a system of collecting money
– tax revenue – to finance government operations.
• All governments require money to undertake
different functions. The required money – taxes – is
collected from the citizens. Without taxes to fund its
activities, government could not exist.
• Initially, the government imposed taxes for three
basic purposes: to cover the cost of administration,
maintaining law and order in the country and for
defense.
 Cont…
• Taxation is the most important system of collecting
public revenue (tax revenue) in modern economic
system.
• It is the powerful instrument in the hands of the
government for transferring purchasing power from
individuals to government.
• Governments may raise or lower taxes to achieve
social and economic objectives, or to achieve
political popularity with certain groups.
• It is interrelated with public Finance due to these
factors
 Public Finance Issues
• Public finance deals with the income and
expenditure pattern of the Government
• The subject matter of the public finance is
classified under five broad categories. These are:
– Public Expenditure
– Public revenue
– Public debt
– Financial administration
– Economic stabilization
Public Finance and Private Finance
• The Private finance deals with the wants and
the satisfaction of households and firms. But
the public finance deals with the collective
wants and their satisfaction.
• The objective of both private and public
finance is similar. Public finance aims at
maximizing social welfare or social benefit by
efficient use of public goods.
• Distinction between private and public goods
is important in the study of public finance.
 Public and Private Goods
• Private goods refer to all those goods and
services, which are consumed by people to
satisfy their personal and private wants or
needs.
• They relate to articles of food, clothing, shelter,
recreation, transportation, communication etc.
• These goods are priced in the market on the
basis of their cost of production on the one
side and the nature of demand on the other.
 Cont…
• All those who want them and are willing to pay
the market price will buy them.
• Those who do not want them or who are not in
a position to pay for them will be excluded
from the consumption of these goods.
• In other words there is no compulsion that
every one will have to buy them.
• Thus distribution of these goods is based on
effective demand and market price.
 Cont…
• Thus, private goods are divisible in the sense that
price mechanism divides people in to two groups
– those who want to consume them and
– those do not; and
• private goods are subject to the principle of
exclusion; in the sense that price mechanism
excludes the group of people who are not willing
to consume a particular good.
 Cont…
• But price mechanism or market mechanism
may fail when ever private goods are
associated with the concept of externalities.
• Externalities refer to favorable and
unfavorable effects which are associated
with the production of those goods.
 Public Goods
• Collective wants are those which are
demanded by all members of the community
in equal or more or less equal measures.
• Defense, education, public health,
infrastructure facilities like power,
transportation and communication, etc., are
examples of collective wants.
• Goods and services produced to satisfy
collective wants are known as public goods.
 Cont…
• These goods are produced and supplied by
the society to meet its collective wants for
increasing social welfare.
• These goods are supplied by the country to
all its citizens.
• But the degree of benefit a person derives
will depend upon the use he can put it to.
– For example medical and educational facilities
are made available for all the people of Ethiopia.
 Taxation and Other Disciplines
• Economics & Taxation
– Taxation is used as one of the tools of fiscal policy or other
economic measures and taxation uses different economic models
• Public Finance and Taxation
– Taxation is used as a system of collecting public money (public
revenue)
• Tax Law and Taxation
– Tax Laws provide the rules & regulations that are used to guide
taxation so that the system will be streamlined.
• Politics and Taxation
– Political decisions on tax related issues directly or indirectly affect
the environment of taxation.
 Cont…
• Government revenue might not be just tax
revenue:
• Government may charge fees for certain services
such as registration of legal documents and supply
of other commodities for which the government
may enjoy a monopoly (eg. supply of electricity);
• If the charges exceed the costs of such services the
excess may be considered as a tax; otherwise they
are not taxes;
 Cont…
• Fines for a certain offences (like for example,
polluting the waterway);
• Fines are compulsory payments without any quid
pro quo;
• But, fines are not taxes; they are used to curb certain
offences not to raise revenue for the government;
• Import and export duties maybe imposed with
different intentions in mind.
• If the intension is to get some revenue for the public
treasury, they are taxes.
 Characteristics of taxes
1. Tax is compulsory contribution
 The people on whom the tax is levied can’t refuse
to pay the tax.
 Any refusal in these regard leads to punishments.
2. Benefit is not the Basic Condition
 For the payment of tax, there is no direct return
or quid pro quo to the taxpayers.
 That is, people cannot expect any return in
benefit for the amount of tax paid by them.
 Cont…
3. Personal Obligation
 Tax imposes a personal obligation on the
taxpayers.
 When a person becomes liable to pay the
tax, it is the duty of him to pay it and in
no way he can escape from it.
 Cont…
4. Tax is for common benefit
 Tax collected by government is spent for common
benefit of all peoples.
 Taxes are said to be the sharing of common burden
by the people.
5. Tax is levied only by the government
One has a legal right to impose tax except the
government (federal or state).
But there are withholding agents who are required
by law to collect taxes on behalf of the governments.
 Cont…
6. Tax is legal collection
Tax is collected from legal activities based on
tax rules and regulations.
Government doesn’t collect tax from illegal
activities
7. Element of Sacrifice
 Since the tax is paid without any return in
benefit, it can be said that there is the
prevalence of sacrifice in the payment of tax.
 Cont…
8. Regular and Periodical Payment
The payment of tax is regular and
periodical in nature.
It is levied for a fixed period usually a
year.
Thus, almost all the taxes are annual taxes.
The payment of taxes should be regular
also.
 Cont…
9 Tax doesn’t discriminate
Tax is levied on all persons who are eligible for tax
payments on the basis of the prescribed tax criteria,
 without any discrimination of castle (social class),
creed (religious belief), and ethnicity (race).
10 Tax system recognizes the basic rights of tax payers
Tax payers shall pay their tax liability no undergo
harassment. In a good tax system, tax law should be
simple, understandable and flexible.
 Why do governments bother to tax?
• Alternatively, government could:
– Finance its expenditures by printing money;
– Compulsorily seize the goods or services it
needs, or
– Borrow money.
 Cont…
Problems with the above alternatives:
• Printing money merely debases the
currency and causes inflation; eg. Zimbabwe
• Compulsory acquisition is a crude and not
very fairly distributed form of impost and in
any event under our constitution requires
just compensation and
• Borrowed money must be repaid or interest
bill met
 Objectives and principles of taxation
• objectives of taxation -what is sought to be
achieved through taxation;

• principles of taxation -rules to be observed

in formulating tax structure;

• features of a tax system -broad description

of a tax system devised in conformity with
principles;
 Objectives of taxation
Tax measures influence economic activities –
taxation affects various decisions;
• savings, investment and labor supply
• Objectives of taxation may differ between
developed and developing countries.
• A tax system by itself cannot be expected to
achieve all the goals fully. It has to fit in the
overall framework of policies and measures
of the government.
 Cont…
• Generally government levies and collects
taxes for various objectives (specific or
general).
 Cont…
1.Raising revenue
Government raises its revenue to support expenditure of its
activities by imposing various kinds of taxes.
2. Removals of inequalities in income and wealth
To remove the inequalities government adopt progressive taxation
system.
Higher income groups pay more amount of tax, middle income
groups pay lower amount of tax and the lower income groups are
exempted from tax.
 Cont…
3. Ensuring economic stability
Government use taxation to control inflation and defilation.

During inflation - government may increase the existing tax rates or impose additional

taxes to reduce the excess demand.

during defilation period, government may reduce the existing rates or remove certain

taxes to increase demand.

4. Reduction in regional imbalances

Government may give tax exemption or concession to those investors who
want to invest in relatively underdeveloped regions.
 Cont…
5. Capital accumulation
Tax concession is given for saving or investment in provident
funds, life insurance, bonds and shares that can lead to large
amount of capital formation.
6. Creation of employment
By giving tax concession or exemption to the labor
intensive industries, government may create additional
employment opportunities
 Cont…
7. Preventing harmful consumptions
By imposing high/heavy taxes on harmful products that worsen people’s
health such as tobacco and alcoholic products, government can reduce
the consumption of such products.
8. Utilizing scarce resources for the production of
more essential goods.
By imposing heavy tax on non essential and luxury goods the
government diverts the attention of the producers to production
of only essential goods.
 Cont…
9. Encouragements of exports
Government may enhance exports by providing certain tax exemption
or by arranging tax free zones.
10. To minimize Unemployment
Giving tax exemption to labor intensive industries.
Giving tax exemption to small entrepreneurs.
11. Enhancement of standard of living

Government also increases the living standard of people by

giving tax concession to certain essential goods.
 Cont…
12. Certain taxes have specific objectives
the primary objective of taxation is to raise
revenue by the government, but some taxes
are imposed to achieve specific objectives such
as:
– To discourage harmful consumption
– To stabilize an economy
– To utilize scarce resources for production of essential
goods
– To minimize income and wealth inequalities
 Canons/principles/ of Taxation
Imposing tax on income, property and
commodities etc. raises tax revenues.
According to Adam Smith, "a tax is a contribution
from citizens for the support of the Government".
Government, while collecting tax, has to
consider principles like equality, simplicity,
convenience etc.
These principles are called as "Canons of
Taxation".
 Cont…
The following are important canons of taxation. Canons Advocated by
Adam Smith
A.Canon of Equality.
B.Canon of Certainty.
C.Canon of Convenience.
D.Canon of Economy.
Canons Advocated by Others
A.Canon of Productivity.
B. Canon of Elasticity.
C. Canon of Diversity.
D. Canon of Simplicity.
E. Canon of Expediency.
F. Canon of Co-ordination.
G.Canon of Neutrality.
1 Canons Advocated by Adam Smith

A. Canon of Equality
A good tax system should be based on the ability to pay
of the people.
Tax burden should be more on the rich than on the
poor.
Ability to pay may be determined either on the basis of
income and wealth or on the basis of consumption i.e.
luxury or necessity.
A good tax should distribute the burden of supporting
government more or less equally among all those who
benefit from government.
 Cont…
B. Canon of Certainty
 The tax which each individual is bound to pay ought to be
certain and not arbitrary.
The time of payment, the manner of payment, the quantity to
be paid, should be clear and plain to the contributor and
every other person.
It means the time, amount and method of payment
should all be clear and certain to the taxpayer.
This principle removes all uncertainties in the payment
of tax and ensures smooth functioning of the tax
department.
 Cont…
C. Canon of Convenience
Every tax ought to be levied at the time or in the manner in which it
is most likely to be convenient for the tax payer/contributor/ to pay
it".
That is, the tax should be levied and collected in such a way
that is convenient to taxpayer.
D. Canon of Economy
This principle states that the minimum possible amount should
be spent on tax collection.
Taxation should be inexpensive in collection.
 It has a close connection with the canon of productivity.
 Canons Advocated by Others
A. Canon of Productivity
 Tax system should be productive enough i.e.
 It should ensure sufficient revenue to the
Government and
It should encourage productive activity by
encouraging the people to work, save and invest.
B. Canon of Elasticity
The taxes should be flexible.
It should be levied in such a way to increase or
decrease the tax revenue depending upon the need.
 Cont…
C. Canon of Diversity
 There should be diversity in the tax system of the country.
 The burden of the tax should be distributed widely on the
entire people of the country.
 The burden-every one should pay according to his ability.
 Government should impose both direct and indirect taxes
of various types.
D. Canon of Simplicity
The tax system should be simple, easy and understandable
to the common man.
 Cont…
E. Canon of Expediency
 A tax should be levied after considering all
favorable and unfavorable factors from different
angles such as economical, political and social.
F. Canon of Co-ordination
In a federal set up like Ethiopia, Federal and State
Governments levy taxes.
So, there should be a proper co-ordination between
different taxes imposed by various authorities.
 Cont…
G. Canon of Neutrality
 The tax system should not have any
adverse effect.
 That is, it shouldn’t create any
deflationary or inflationary effects in the
economy.
 ……………..

• THE END