TAXATION

ACC 07319

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TAXATION THEORY

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Learning objectives
At the end of the discussion, a student should
be able to:
Define a term tax
Explain the uses of tax
Explain canons of taxation
Classify taxes
Describe effects of taxation; and
Tax structure in Tanzania.

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 INTRODUCTION

 A term tax is defined as a compulsory levy

charged by a government to her citizen
payable in monetary form for which the
government does not need to offer direct
equivalent compensation on the same.
OR
 A term tax is defined as the compulsory
contribution levied on persons, property or
businesses for the support of government for
economic and social activities

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Why tax?
 Raising government revenue
 Fair distribution of income
 Protection of infant industries
 Social welfare
 Fighting inflation

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Raising government revenue
Tax revenue is the major source of
government revenue,
Therefore governments need revenue to
finance her activities like provision of social
services .i.e. schools, health facilities, clean
water e.t.c and construction of
infrastructures like
roads,railways,bridges,airports e.t.c

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Fair distribution of income
 Every person in any country has an obligation to pay
tax, regardless of the income differences
 Tax is charged differently at all income levels
 High income earners are taxed at a higher rate than
lower income earners( PAY AS YOU EARN)
 Direct taxes are meant for this purpose…..progressive
tax system applies
 However some taxes a paid indirectly ….so if one do
not consume such a product, will not pay tax
 So by charging high taxes on high income earners,
here the government ensures fair distribution to low
income earners
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Protection of infant industries
 In order to protect these industries against
foreign competition, taxation is used as a
major tool for protection
 In so doing the government imposes heavy
taxes on imported goods….though not
all…..while low taxes are charged on locally
manufactured products
 Therefore, home made goods becomes
cheaper than imported ones

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Social welfare
 Some products or goods are considered
harmful to human beings
 Excessive usage of such goods are harmful to
human health e.g. excessive usage of
ciggaretes,alcohol e.t.c
 To discourage consumption of these goods,
the government imposes/charges high taxes
on it

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Fighting inflation
Inflation means an increase in price of
commodities with a consequent fall in value
of money
When money is in excessive supply, also the
prices of commodities goes up
So here the government intervene by
injecting taxes (preferably direct taxes)so to
reduce the money available to public to spend
on few goods and hence reducing inflation

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Principles of an optimal tax system
 An optimal or good tax system may be
defined as the tax system which helps to
achieve maximum possible benefit.
 A good tax system should help to achieve
the following objectives:
 To maintain economic stability
 To equalize distribution of income
 To increase the rate of economic growth

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The main four (4) principles are:-
 Adam smith laid down four principles to guide
taxing authority, these includes

1. Canon of equality
2. Canon of certainty
3. Canon of convenience
4. Canon of economy

Other canons of taxation

 Canon of productivity
 Canon of elasticity
 Canon of simplicity
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 Canon of flexibility 12
Canons of taxations discussed….
1.Canon of equality(equity)
-The principle requires that a person should
pay tax according to ability.
-So inequality in paying taxes should be
minimised by means of progressive tax
system
-Thus equals should be treated equally
(horizontal equity) and the unequal to be
treated unequally

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Canons of taxations discussed….
Note:
-Equality here does not mean all tax-payers
should pay equal taxes
-Equality means equality or justice
-It means that broadest shoulders must bear
the heaviest burden

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Canons of taxations discussed….
2.Canon of certainty

-The tax which each individual has to pay is

ought to be certain and not
arbitrary.‟Adam Smith”.
-The time of payment, the amount to be paid
ought all to be clear and plain to
contributor and every other person.
-Similarly a government should know how
much is going to receive from tax
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 Canons of taxations discussed….
3.Canon of convenience

-Every tax ought to be levied at a time or in a

manner which is most likely to be convenient
to pay it.

-Obviously, it is non sense to fix time and

method of payments which is not suitable

-For example in Tanzania, income taxes

(P.A.Y.E) are paid at the end of each
month(Within seven days after the month
end)
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 Canons of taxations discussed….
4.Canon of economy
-This means that the cost of collection
should be as small as possible.

-If the bulk of the tax is spent on its

collection, it will take much out of the
people’s pockets but bring very little
into the State’s pocket.

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Canons of taxations discussed….
 Canon of Productivity:
-This canon emphasizes that a tax should bring in a
substantial amount of money to the State.

-After all, the main object of the taxing authority is to

secure funds.

-Therefore, a tax which does not yield a fair income is

not of much use.

-It is much better to have a few taxes which yield good

revenue instead of many taxes yielding a little.
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Canons of taxations discussed….
Canon of Elasticity:
-This canon points out that a tax should
automatically bring in more revenue as the
country’s population or income increases.

-There should be an automatic link between the

needs of the State and resources of the people.
-If, in an emergency, an increase in the rate of
the tax brings in increased income, the tax is
elastic.

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Canons of taxations discussed….
Canon of Simplicity:
-It argues that the tax system should be simple;
otherwise may lead to confusion and
corruption.

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Canons of taxations discussed….
Canon of Flexibility:
‘Flexibility’ in taxes is different from ‘elasticity’
mentioned earlier as a canon.
Flexibility connotes the absence of rigidity in the tax
system.
A flexible tax quickly adjusts to the new conditions;
on the other hand, elasticity means that income can
be increased.
Presence of flexibility is a pre-condition for elasticity.
Lack of flexibility in a tax can cause financial
troubles to a State.

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Classification of taxes
Taxes are classified on the basis of:-
1. Impact of tax
2. Base of tax
3. Rates of tax

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Classification of taxes
1. Impact of tax
-It means on whom a tax is imposed and who
has to bear the burden of tax. In this case,
taxes may be:-
i. Direct taxes
ii. Indirect taxes

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Direct and Indirect taxes
direct and indirect taxes are usually defined
on the basis of impact and incidence of the
tax
direct taxes are taxes on which the impact
and incidence of tax is on the same person
e.g income tax
indirect taxes are taxes on which the impact
of tax is on one person and the incidence is
on the other person e.g. excise duty, custom
duty, VAT e.t.c

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Direct and Indirect taxes
NOTE:
By impact of tax we mean to whom a tax is
imposed; and
By incidence of tax we mean to a person who
has to bear the burden of tax

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Advantages of direct taxes
1.Equitable:
 The burden of direct taxes cannot be shifted. Hence equality of
sacrifice can be attained through progression. Of course, the very
low incomes can be exempted.
 This cannot be achieved- by taxes on commodities which fall with
equal force on the rich and the poor.
 The tax raises the price of the commodity, and the price of a
commodity is the same for every person, rich or poor.
2. Economical:
 The cost of collection of direct taxes is low.
 They are mostly collected “at the source”. For instance,-the income
tax is deducted from an officer’s pay every month.
 This saves expense.
 The employer acts as an honorary tax collector. This means great
economy.
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advantages of direct taxes
3.Certain:
In the case of a direct tax, the payers know how much is
due from them and when.
The authorities also know the amount of revenue they can
expect.
There is certainty on both sides. This minimizes corruption
on the part of collecting officials.
4.Elastic:
If the State/country suddenly stands in need of more funds
in an emergency, direct taxes can well serve the purpose.
The yield from income tax can be easily increased by
raising their rate. People cannot stop dying for fear of
paying death duties.
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advantages of direct taxes
5. Productive:
Another virtue of direct taxes is that they are very
productive.
As a community grows in numbers and prosperity, the
return from direct taxes expands automatically.
The direct taxes yield a large revenue to the State.
6. A means of developing civic sense.
In the case of a direct tax, a person knows that he is paying
a tax, he feels conscious of his rights.
He claims the right to know how the Government uses his
money and approves or criticizes it.
Civic sense is thus developed.
He behaves as a responsible citizen.
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disadvantages of direct taxes
1. Inconvenient:
 The great disadvantage of a direct tax is that it pinches the
payer.
 He ‘squeaks’ when a lump sum is taken out of his pocket.
 The direct- taxes are thus very inconvenient to pay.
 Nobody can help feeling the pinch
2. Evadable:
 The assessee can submit a false return of income and thus
evade the tax.
 That is why a direct-tax is “a tax on honesty.” There is a lot
of evasion.
 Many of those who should be paying taxes go scot-free by
concealing their incomes.
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disadvantages of direct taxes
Arbitrary:
If taxes are progressive, the rate of progression has to be
fixed arbitrarily; and if proportional, they fall more heavily
on the poor.
Thus, both are bad. The rate of taxes depends upon the
whim of the Finance Minister. This is arbitrary.
Disincentive:
If the taxes are too heavy, they discourage saving-and
investment.
In that case the country will suffer economically. A high
level of taxation discourages investment and enterprise in
the country.
It inflicts a lot of damage, on business and industry.

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advantages of indirect taxes
1. The Poor Can Contribute:
 They are the only means of reaching the poor.
 It is a sound principle that every, individual should pay something, however
little, to the State.
 The poor are always exempted from paying direct taxes.
 They can be reached only through indirect taxation.
2. Convenient:
 They are convenient to both the tax-prayer and the State.
 The tax-payers do not feel the burden much partly because an indirect tax is
paid in small amounts and partly because it is paid only when making
purchases.
 But the convenience is even greater due to the fact that the tax is “price-
coated”.
 It is wrapped in price. It is like a sugar-coated quinine pill. Thus, a tobacco tax
is not felt when it is included in the price of every cigarette bought.
 It is convenient to the State as well which can collect the tax at the ports or
at the factory.

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advantages of indirect taxes
3. Broad-based:
 Indirect taxes can be spread over a wide range. Very heavy direct
taxation at just one point may produce harmful effects on social
and economic life.
 As indirect taxes can be spread widely, they are more beneficial
and suitable.
4.Easy Collection:
 Collection takes place automatically when goods are bought and
sold.
 A dealer collects the tax when he charges a price. He is an
honorary tax collector.
5.Non-evadable:
 They cannot be evaded, as they are a part of the price.
 They can be evaded only when the taxed article is not consumed,
and this may not always be possible’
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advantages of indirect taxes
6.Elastic:
 They are very elastic in yield, imposed on necessaries of
life which have an inelastic demand. Indirect taxes on
necessaries yield a large revenue, because people must buy
these things.
7.Equitable:
 When imposed on luxury or goods consumed by the rich,
they are equitable.
 In such cases, only the Veil-to-do will pay the tax.
8.Check Harmful Consumption: .
 By being imposed on harmful products, they can check
consumption of harmful commodities.
 That is why tobacco, wine and other intoxicants are taxed.
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disadvantages of indirect taxes
1. Regressive:
 Indirect taxes are not equitable. For instance, tax on necessities fell more
heavily on the poor than on the rich, as it had to be paid at the same rate by
all.
 Whether a rich man buys a commodity or a poor man, the price in the market
is the same for all. The tax is wrapped in the price. Hence, rich and poor pay
the same amount, which is obviously unfair.
 They are thus regressive.

2.Uncertain:
 Unless indirect taxes are imposed on necessaries, we cannot be sure of the
revenue yield.
 In the case of goods, with an elastic demand, the tax might not bring in much
revenue.
 The tax will raise the price and contract the demand.
 When the thing is not purchased, the question of the tax payment does not
arise.
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disadvantages of indirect taxes
3. Raising Prices Unduly:
They cause the price of an article to rise by more
than the tax. A fraction of the money unit cannot
be calculated, so ever middleman tends to charge
more than the tax. This process is cumulative.
4. Uneconomical:
The cost of collection is quite heavy. Every source
of production has to be guarded.
Large administrative staff is required to
administer such taxes.
This turns out to be a costly affair.
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Classification of taxes
2. Base of tax
-The tax base is the object to which a tax is
levied and to which tax rate is applied. So
taxes under this may be:-
i. Income tax: tax base is income
ii. Property tax: the tax base is property
iii. Customs tax: the tax base is the value of
goods imported or exported

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Classification of taxes
3. Rates of tax
-The rate of tax is the percentage of the tax
base to be taken in case of tax. So taxes may
be:-
i. progressive tax
ii. Proportional tax
iii. Regressive tax

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Proportional tax system
Under this system of taxation, the same tax
rate or the same percentage is charged to
whatever size of income.
All tax payers pays tax the same rate, if for
example one percent is to be applied as a tax
rate-all have to pay the same
Assume X earn 10,000 as his monthly income
and Y earn 100,000 as his monthly income.
Under this system X will pay 100 while Y will
pay 1,000 as income tax
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Proportional tax system
Under this system of taxation, the same tax
rate or the same percentage is charged to
whatever size of income.
All tax payers pays tax the same rate, if for
example one percent is to be applied as a tax
rate-all have to pay the same
Assume X earn 10,000 as his monthly income
and Y earn 100,000 as his monthly income.
Under this system X will pay 100 while Y will
pay 1,000 as income tax
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Progressive tax
It is a tax system under which tax rises as the
taxable income increases.
The principle of progressive tax is that “the
higher the income the higher the rate”
When income is divided into groups,the
percentage of taxation increases with increase
in income
Let us say, income brackets 10,001-15,000
pays 2 percent of their income while those with
income 15,001-25,000 pays 3 percent of their
income
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Regressive tax
A tax is said to be regressive when a burden
falls heavily on the poor than the rich.
It is the opposite of progressive tax
Practically it is unwise to lower tax rates
when income increases
But several taxes on commodities whose
burden rests mainly on the poor

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Economic effects of taxation
1. Economic effects of taxation are as listed
below:-
2. Effects on working ability
3. Effects on saving ability
4. Effects on the desire to work
5. Effects on enterprise
6. Effects on inflation
7. Effects on diversion of economic activities

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Economic effects of taxation
1. Effects on working ability
- If heavy taxes are imposed on the necessities of life, the cost of
it will go up hence low income earners will not afford to buy.

- If that is the case, their health will be affected,physical ability

reduced hence they become inefficient at their work places
which will later on affect the whole level of production

2.Effects on saving ability

-Little saving indicates little investments.
- Heavy taxes also reduces the saving ability of individuals but
increasing investment by the government will help in
offsetting this

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Economic effects of taxation
3. Effects on enterprise
-Enterprises depends on profit for their
living….if heavy taxes are charged on them
will discourage them from undertaking risky
investments for which they are not sure of
succeeding.

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 Thanks for your
attention

The end

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