Chapter THREE

ETHIOPIA BUDGET SYSTEM

Budget in Ethiopia
The word now means, “Plans of government finances submitted for the approval of the
legislature”. The budget reflects what the government intends to do. The budget has become the
powerful instrument for fulfilling the basic objectives of government. The budget covers all the
transactions of the central government.
Budget is a time bound financial program systematically worked out and ready for execution
in the ensuing fiscal year. It is a comprehensive plan of action, which brings together in one
consolidated statement all financial requirements of the government. The budget goes into
operation only after it is approved by the parliament. A rational decision regarding allocation of
resources to satisfy different social wants requires considerable thinking and planning. Thus
budget is an annual statement of receipts and payments of a government.

Functions of Budget
The functions of budget include the following:

- proper allocation of resources: - to relate expenditure decisions to specified policy

objectives and to existing and future resources;

- to relate all major decisions to the state of the national economy;

- long term economic growth:- to ensure efficiency and effectiveness in the implementation
of government programs;

- to facilitate legislative control over the various phases of the budgetary process.

- equitable distribution of income and wealth and

- Securing economic stability and full employment.

It implies that the objective of budget policy is to take corrective measures or to adopt regulatory
policies to remove imperfection or inefficiencies of market mechanism. Besides, the objective of
the budget policy is to make provision of social goods or the process by which total resources are

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divided between private and social goods. It means that the objective of budget policy is to
ensure equitable distribution of income and wealth. This may be termed as distribution function.
Third objective of budget policy is to maintain a high level of employment, reasonable degree of
price stability and an appropriate rate of economic growth.
To implement its economic functions government raises revenues through taxation. Fees and
charges, and spend them on different programs and activities. This process of rising revenues and
spending by government is performed through budgeting. Budget thus stands for the yearly
plans/forecasts of government revenues and expenditures. The budgeting process starts from the
initial stage of preparing the annual revenues and expenditures forecast and end at the stages of
approval by the higher government body followed by its implementation.

The Concept of Budgeting in Ethiopia

The government budget represents a plan/forecast by government of its expenditures and
revenues for a specified period. Commonly government budget is prepared for a year, known as
a financial year or fiscal year. In Ethiopia the fiscal year is from July 7 of this year to July 6 of
the coming year (Hamle 1-Sene 30 in Ethiopian calendar). Budgeting involves different tasks on
the expenditures and revenues sides of government finance. On the side of expenditure, it deals
with the determination of the total deals with the determination of the total size of the budget (i.e
total amount of money for the year), size of outlays on different functions, and the magnitude of
outlays on various activities; on the revenue side, it involves the determination of the size of the
overall revenue and foreign aid.
Furthermore, budgeting also address the issue of the budget deficit (i.e. the excess of outlays
over domestic revenues), and it’s financing. Budgeting is not solely a matter of finance in the
narrow sense. Rather it is an important part of government’s general economic policy. Budget is
not solely a description of fiscal policies and financial plans, rather it is a strong instrument in
engineering and dynamiting the economy and its main objectives are to devise tangible directives
and implement the long term, medium term, and annual administrative and development
programs”.

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 Budget Structures in Ethiopia
Budget structures are the formats that organize budget data. Budget data could be classified in
different ways and for different purposes. In the early days, for instance, budget classification
basically focused on providing a better understanding of the intentions and purposes of
government for which funds were planned and to be spent. Later on, the budget structures started
to be influenced largely by the issue of accountability. That is in addition to providing
information on what the government proposed to do, the budget structures indicate the full
responsibility of the spending agency. To this end the budget heads or nomenclatures the full
responsibility of the spending agency. To this end the budget head or nomenclature of the budget
are mostly mapped to each spending agency. This should not, however, imply unnecessarily
extended and detailed structure (or mapping). Perhaps, due consideration must be taken to make
the structure manageable and appropriate. The first classification of the budget is between
revenue and expenditure.

Revenue Budget
It represents the annual forecast of revenues to be raised by government through taxation and
other discretionary measures, the amount of revenues raised this way differ from country to
country both in magnitude and structure, mainly due to the level of economic development and
the type of the economy.

In Ethiopia, the revenue budget is usually structured into three major headings: ordinary
revenue, external assistance, and capital revenue. Hence, the funds expected from these three
sources are proclaimed as the annual revenue budget for the country. The revenue budget is
prepared by the Ministry of Finance (MoF) for the federal government and by Finance Bureaus
for regional governments.

Ordinary revenues include both tax and not tax revenues. the tax revenues being direct taxes
(personal income tax, rental income tax, business income tax, agricultural income tax, tax on
dividend and chance wining, land use fee and lease); indirect taxes (excise tax on locally

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manufactured goods, sales tax on locally manufactured goods, service sales tax, stamps and
duty); and taxes on foreign trade (customs duty on imported goods, duty and tax on coffee
export). Non tax revenues include charges and fees; investment revenue; miscellaneous revenue
(e.g. gins); and pension contribution. The second major item in revenue budget is external
assistance. It includes: cash grants, these are grants from multilateral and bilateral donors for
different structural adjustment programs; and technical assistance in cash and material form. The
third item is capital revenue. This could be from domestic (sales of movable properties and
collection of loans), external loan from multilateral and bilateral creditors mostly for capital
projects, and grants in the form of counterpart fund.

Categories of Revenues to Government

 Revenue on the basis of Nature
The revenues on the basis nature can be classified as in the following table. Of these two types of
classifications of revenues the classification of revenues based on the nature is considered as the
ideal classification.

A. Tax Revenue
The revenue from tax includes the following.
I. Tax on Income
The Government imposes two types of taxes on income.
They are tax on:
a) personal income, and
b) Corporation profits.
The personal income tax is levied on the net income of individuals, firms and other association
of persons. The tax on the net profits of the joint stock companies is known as corporation tax.
II. Taxes on Property:
It is the tax revenue from properties including rental income tax land use tax etc.

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 On the basis of Nature of
Revenue

TaxTax Revenue
Revenue Non –Tax Revenue

Commercial
Administrative Revenues
Tax Tax
on on Tax on
TaxTax
on on Commodities Revenue Prices on Others
Income
Income Property
Property goods and
1. Fees services
2. Licensee Issue of
3. Form currency
4. Forfeits
5. Escheats
6. Special
Assessment
Corporate Tax
Personal
Personal
Income
Income tax tax

Excise Tax Turnover Tax

Borrowings Gifts and Grants
Customs
Tax 1. With in the
1. From general
Public (Issuing of Country
Bonds etc 2. From other
2. From other Countries
Value Added Tax Countries
3. From other
Institution (IMF.
World Bank, etc)
III. Taxes on Commodities
The important taxes levied by the Government on commodities are:

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 a) Customs Duty,
b) Excise Duty,
c) Value Added Tax
d) Turnover Tax
 Customs Duty includes both import and export duties. These duties are le
vied when the goods cross the boundaries of the country.
 Excise duties are levied on the commodities produced in the country. Excise
duties now constitute the single largest source of revenue to the Union
Government.
 Value Added Tax is levied by the Government on the commodities sold at
specified percentage on the value of sales.
 Turnover Tax is levied by the Government on the sales which are not
covered under Vat.

B. Non-Tax Revenues
The following categories of revenue are included under non-tax revenue.
 Administrative Revenue
It includes the following:
I. Fees
It is the compulsory payment made by the individuals who obtain a definite service in return.
Fees are charged by the Government to bear the cost of administrative services rendered by it.
These services are rendered for the benefit of general public. It includes court fee, registration
fee, etc.
II. Licenses
A license fee is collected not for any service rendered, but for giving permission or a privilege to
those who want to do a special or specified work. It is charged on the grounds of control of
certain activities.
III.Fines and Penalties
Fines and penalties are imposed as a form of punishment for the mistakes committed such as
violation of the provisions of law, etc. The basic aim behind them is to prevent the people from

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making mistakes. A fine is also compulsory like a tax, but it is imposed more as a deterent as a
source of revenue.
IV. Forfeitures
Forfeiture means the penalty imposed by the courts on the persons who have not complied with
the notice served by it or for the breach of contract or has failed to pay the dues in time, etc.
V. Escheats
The property of a person having no legal heirs and dying intestate, will be taken possession of by
the Government that is, the Government can take over the property cannot be considered as a
main source of revenue to the Government.
VI. Special Assessment
According to Prof. Seligman, special assessment means “a compulsory contribution levied in
proportion to the special benefit derived to defray the cost of the specific improvement to
property undertaken in the public interest “. Thus, it is a compulsory payment or contribution. It
is levied in proportion to the special benefits derived to bear the cost of specific improvement to
property. Whenever the Government has made certain improvements, somebody will bet
benefited. For example, irrigation facility, road and drainage facility, etc.

Budget Deficit
A budget is considered as surplus or deficit according to the position of the revenue accounts of
the government. Thus a surplus budget is one in which revenue receipts exceed expenditure
charged to revenue account regardless of the gap in capital accounts; while a deficit budget is
one in which expenditure is greater than current revenue receipts.

Budget deficit is the excess of total expenditure over total revenue of the government.
The deficit financing denotes the direct addition to gross national expenditure through budget
deficits whether the deficits are on revenue or capital accounts”. It implies that the expenditure of
the government over and above the aggregate receipt of revenue account and capital account is
treated as budget deficit of the government.

The meaning of deficit financing is different in different countries. In western countries, the
budget gap, that is covered by loans is called deficit financing because, if the government
borrows from the banks rather than from individuals the idle funds will be activated and there

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will be an increase in the total public expenditure and thus there will automatically be an deficit
financing has been used in a different sense,. Here it is used to denote the direct addition to
gross national expenditure as a result of budget deficit.
Thus deficit financing can be defined as “the financing of a deliberately created gap between
public revenue and public expenditure”. The government of Ethiopia has used deficit financing
for acquiring funds to finance economic development. When the government cannot raise
enough financial resources through taxation, it finances its developmental expenditure through
borrowing from the market or from other sources.

Methods of Financing Deficit

There are four important techniques through which the Government may finance its budgetary
deficits. They are as follows:
A. borrowing from central bank
B. The running down of accumulated cash balances
C. The government may issue new currency
D. Borrowing from market or from external sources.
Under the first method, government borrows from central bank as per budgetary policy. In the
second source, government spends from available cash balance. In the third measure,
government issues new currency for financing deficit. The last method is that government
borrows from internal and external sources to finance its deficit.
Objectives of Deficit Financing
1. Deficit financing has generally been used as a method of meeting the financial needs of the
government in times of war, when it is considered difficult to mobilize adequate resources.
2. Keynes advocated deficit financing as an instrument of economic policy to overcome
conditions of depression and to raise the level of output and employment.
3. The use of deficit financing has also been considered essential for financing economic
development especially in under developed countries.
4. Deficit financing is also advocated for the mobilization of surplus idle and unutilized
resources in the economy.
Pattern of Revenue Sharing

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Ethiopia has chosen the federal structure in which a clear distinction is made between the union
and state functions and sources of revenue, but residual powers, belong to the center, although
the states have been assigned certain taxes, which are levied and collected by them, they also
share in the revenue of certain federal taxes. In addition, the states receive grants-in-aid of their
revenue from the federal government, which further increase the amount of transfers between the
two levels of government. The transfer of resources from the central government to the states is
an essential feature of the present financial system.
Distribution of Revenues between Central and States
The present federal fiscal system in Ethiopia is of a recent origin. The distribution of revenues
between the centre and states is followed on the basis of "constitution of Ethiopia” and
proclamation no.33/1992-proclamation “to define sharing of revenue between the central
government and the national/regional self governments”. The articles 96, 97, 98, 99 and 100 of
the constitution of Ethiopia make a clear demarcation of areas where the central alone or state
alone have authority to impose taxes. It contains a detailed list of the functions and financial
resources of the center and states.
Basis for Revenue Sharing
The sharing of revenue between the central government and the National/ Regional governments
shall take in to consideration the following Principles:
1. Ownership of source of revenue;
2. The national or regional character of the sources of revenue;
3. Convenience of levying and collection of the tax or duty;
4. Population, distribution of wealth and standard of development of each region;
5. Other factors that are basis for integrated and balanced economy.
Categorization of Revenue
According to "Constitution of Ethiopia” and Proclamation No.33/1992-Proclamation, revenues
shall be categorized as Central, Regional and Joint. That is there are three lists given in the
Articles. They are as follows:
A. Central List,
B. Regional List, and
C. Joint/Concurrent List

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The important sources of revenue under "Constitution of Ethiopia” and The Proclamation
No.33/1992-Proclamation “To Define sharing of Revenue between the Central Government and
the National/Regional Self Governments” are explained below:
A. Central List
The sources of revenue are given under Federal/Central List are as follows:
I). Duties, tax and other charges levied on the importation and exportation of goods;
II). Personal income tax collected from the employees of the central Government and the
International Organizations;
III). Profit tax, Personal income tax and sales tax collected from enterprises owned by the
Central Government. (Now sales tax is replaced with VAT and Turnover taxes).
IV) Taxes collected from National Lotteries and other chance winning prizes;
V). Taxes collected on income from air, train and marine transport activities;
VI). Taxes collected from rent of houses and properties owned by the central Government;
VII) Charges and fees on licenses and services issued or rented by the central Government;
B. Regional List
The following shall be Revenues for the Regions:
I). Personal income tax collected from the employees of the Regional Government and
Employees other than those covered under the sources of central government.
II) Rural land use fee.
III) Agricultural income tax collected from farmers not incorporated in an organization.
IV) Profit and sales tax collected individual traders.
V) Tax on income from inland water transportation.
VI) Taxes collected from rent of houses and properties owned by the Regional Governments;
VII) Profit tax, personal income tax and sales tax collected from enterprises owned by the
Regional Government:
VIII) With prejudice to joint revenue sources, income tax, royalty and rent of land collected
from mining activities.
IX). Charges and fees on licenses and services issued or rented by the Regional Government;
C. Joint/Concurrent List
The following shall be Joint revenues of the Central Government and Regional Governments.

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 I. Profit tax, personal income tax and sales tax collected from enterprises jointly
owned by the central Government and Regional Governments;
II. Profit tax, dividend tax and sales tax collected from Organizations;
III. Profit tax, royalty and rent of land collected from large scale mining, any petroleum
and gas operations;
IV. Forest royalty.

CHAPTER FOUR
MEANING AND CHARACTERISTICS OF TAXATION
Public Revenue
Sources of public revenues
Government has played an important role in the socio economic development of society. Social
development may be in the form of raising the level of living and social welfare in the form of
providing social amenities to the people. Social amenities are in the form of education, health
and sanitation, utilities like electric supply, water supply etc., and recreation facilities.
The process of socio-economic development requiring huge expenditure cannot be carried unless
the government has the perennial source of income. Every government has two important
sources of revenue. These are:
(a) Tax sources, and
(b) Non-tax sources.
What is a 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 to avail the
benefit of social amenities in the form of education, health and sanitation, utilities and recreation
facilities. Naturally, everyone interested in availing social amenities used to evaluate the benefit
derived by him in exchange for the tax to be paid by him. 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 to fulfill its commitments towards society.
Every Government imposes two kinds of taxes:
(1) Direct taxes, and
(2) Indirect taxes
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 or goods by the government. It is not a
price paid by the tax-payer for any definite service rendered or a commodity supplied by the
government. The tax-payers do get many benefits from the government but no tax-payer 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 tax-payer.

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Objectives of Taxation
Initially, governments impose taxes for three basic purposes: to cover the cost of administration,
maintaining law and order in the country and for defense. But now government’s expenditure
pattern changed and gives service to the public more than these three basic purpose and it
restore social justice in the society by providing social services such as public health,
employment, pension, housing, sanitation and other public services. Therefore, governments
need much amount of revenue than before. To generate more revenue a government imposes
taxes on various types. In general objective of taxations are:
1. Raising revenue: to render various economic and social activities, a government needs large
amount of revenue and to meet this government imposes various types of taxes.
2. Removal of inequalities in income and wealth: government adopts progressive tax system
and stressed on canon of equality to remove inequalities in income and wealth of the people.
3. Ensuring economic stability: taxation affects the general level of consumption and
production. Hence, it can be used as effective tool for achieving economic stability.
Governments use taxation to control inflation and deflation
4. Reduction in regional imbalances: If there is regional imbalance with in the country,
governments can use taxation to remove such imbalance by tax exemptions and tax concessions
to investors who made investment in under developed regions.
5. Capital accumulation
Tax concession or tax rebates given for savings or investment in provident funds, life insurance,
investment in shares and debentures lead to large amount of capital accumulation, which is
essential for the promotion of industrial development.
6. Creation of employment opportunities
Governments might minimize unemployment in the country by giving tax concession or
exemptions to small entrepreneurs and labor intensive industries.
7. Preventing harmful consumptions
Government can reduce harmful things on the society by levying heavy excise tax on cigarettes,
alcohols and other products, which worsen people’s health.
8. Beneficial diversion of resources
Governments impose heavy tax on non- essential and luxury goods to discourage producers of
such goods and give tax rate reduction or exemption on most essential goods. This diverts
produce’s attention and enables the country utilize to utilize the limited resources for production
of essential goods only.
9. Encouragement of exports
Governments enhance foreign exchange requirement through export-oriented strategy. These
provide a certain tax exemption for those exporters and encourage them with arranging a free
trade zones and by making a bilateral and multilateral agreement
10. Enhancement of standard of living
The government also increases the living standard of people by giving tax concessions to certain
essential goods.
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, no one can refuse to pay a tax on the ground that he or she does not get any benefit
from certain public services the government provides.

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(2) The Assesses will be required to pay Tax if 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. For
example individuals earning monthly salary below birr 150 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.
(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, provision of social services such as education, health etc. Such
benefits are given to all the people- whether they are tax-payers or non-taxpayers. These benefits
satisfy social wants. But the Government also spends on subsidies to satisfy merit wants of poor
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 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 tax-payers for taxes paid. For example, when taxable income is earned by an
individual or a corporation, he or it simply pays the tax amount at the specified rate 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 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 directed 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 a good tax
system. It may be assumed that each tax-payer would like to be exempted from taxpaying, while
he would not mind if other bears that burden. In any case, he would want his 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 a host of
other 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 payers and should also take into consideration the goals of social and economic

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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 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.

Principles of taxation
A tax system (that is, the set of all taxes) for achieving certain objectives chooses and adheres to
certain principles which are termed its characteristics. A good tax system therefore, is one of
which designed on the basis of an appropriate set of principles, such as equality and certainty.
Mostly, however, objectives of taxation conflict with each other and a compromise is needed.
Therefore, usually economists select some important objectives and work out the corresponding
principles which the tax system should adhere to. The first set of such principles was enunciated
by Adam smith (which he called Cannons of Taxation)
Canons of Taxation
The four canons of taxation as prescribed by Adam Smith are the following:
(1) Canon of Equality
This canon proclaims that a good tax is that which is based on the principle 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
This canon is meant to protect the tax payers from unnecessary harassment by the ‘tax officials’.
It 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 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, 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
The third canon of Adam Smith is that 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

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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 harvest. Similarly, taxes on rent of houses should be collected when it is
most convenient for the contributor to pay.

(4) Canon of Economy

The fourth canon is the 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 of 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.
In addition to the above four canons given by Adam smith, the following other canons have
been advanced by Basable and other economists
(5) Canon of Productivity
The canon of productivity advocated by Bastable 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 a 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
Bastable also laid stress on the principle of elasticity. The canon of elasticity implies 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 diversity put forward by Bastable implies that the tax system should be 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 basis of estimation should be easily followed by
each tax-payer. In other words, the tax imposed on the tax-payers should be so simple that they
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

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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.
EFFECTS OF TAXATION
Taxation these days is not used as means of raising revenues only, but it is an important
instrument for achieving socio-economic objectives, such as, regulation of consumption and
production, controlling booms and depression, promoting economic growth and removing
inequalities of income. The economic effects of taxation may be good as well as bad. Therefore,
the government should not keep only the revenue considerations in mind, but the economic
effects of taxation should also be considered. To put it in the words of Dalton, “The best system
of taxation from the economic point of view is that which has the best, or the least bad economic
effects.” Effects of taxation can be analyzed in terms of production, distribution and stabilization.
Thus, in this we will discuss the economic effects under the following three heads:
 Effects of taxation on production
 Effects of taxation on distribution
 Effects of taxation on stabilization

I) Effects of Taxation on capacity to Work, Save and Invest

a) Capacity to Work
Capacity to work depends on the health and efficiency possessed by the people. Health is related
to the level of consumption which is determined by the money income of the assesse. Imposition
of higher tax reduces the purchasing power of the tax payer and his ability to obtain the
necessaries, comforts and luxuries of life. This effect is most strongly felt by the poorer people.
When the tax burden falls upon the poor, it curbs the consumption of necessaries and comforts
which lowers the standard of living and thus efficiency and ability to work of poor people is
adversely affected by taxation. For the rich, however, the ability to work is not so much affected
by taxation because taxation on rich may only curb his luxurious consumption and this may not
affect his efficiency and ability to work. Therefore, heavy taxation on the poorer section of the
community has been strongly objected by most of the economists. Therefore, to maintain the
health efficiency and ability to work of the people, system of progressive taxation should be duly
implemented by the government. In other words, taxes on low incomes and on those articles
which are largely consumed by less well to do sections of the community should be avoided in
the interest of production. This will keep the health and efficiency intact without additional work
load on them.

b) Capacity to Save
Capacity of the people to save depends on the tax policy followed by the government. Ability to
save is adversely affected by taxation as taxes fall on income and savings depend on income.
When income is reduced by taxation, savings automatically decline. Ability to save is affected
adversely in the case of those who have a higher marginal propensity to save. It is the rich who
possesses a high marginal propensity to save since their incomes exceed their expenditure. Taxes
falling on the poor have no effect on their ability to save as they have no margin to save out of
their low incomes. Since the rich are accustomed to a very high level of living, they maintain
their expenditure and pay taxes out of their savings. Hence their ability to save is greatly
reduced. This affects investment and capital formation in the economy. Therefore, to maintain

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the capacity of the people to save the government should provide tax incentives to the rich and
spend the tax income on the poor to enhance their ability to save.
c) Capacity to Invest
Capacity to invest depends on the resources available for investment that is savings. It is clear
from the above discussion that savings are reduced by taxation. When ability to save is adversely
affected by high taxes, ability to invest of those who take investment decisions is automatically
reduced. These are the people having a high entrepreneurial ability. Such people are generally
the people in the higher income group. The government has to pay a major role in exploiting the
capacity to invest of the tax payer by adopting an appropriate tax policy. The government should
exempt earnings from investment to encourage savings and capital formation.
II) Effects of Taxation on the will to Work, Save, and Invest
a) Effects on the Will to Work
Will of the people to work depends on the nature of taxes. Each individual tax has its specific
effects. However, some taxes by their very nature have the least or no bad effect on the
willingness to work e.g., estate duty excess profit tax etc. Likewise, reasonable rates of income
tax, sales tax, etc., have no bad effects on the desire of the people to work hard. Conversely,
unduly high rates of income tax, wealth tax and commodity taxes adversely affect the desire of
the people to work hard.

b) Effects on the Will to Save

Will of the people to save depends on the volume of income, volume of tax and the tax policy
pursued by the government. If a tax payee has limited income and is hardly sufficient to meet
his/her day to day requirements it will be difficult for him to save anything. Some people save
for their old age and many times they save to improve their social prestige. So in order to
enhance the will of the people to save, the government should provide tax incentives to the
people.
c) Effects on the Will to Invest
Will of the people to invest depends on savings. If savings are taxed, nothing will be left with the
people for investment purposes. To enhance the will of the people to invest, the government
should devise such a tax policy which provides tax incentives to those who divert their savings
towards investment. Investment also depends on the treatment of income from investment-under
tax laws. If earnings are exempted from tax net, people will divert most of their savings towards
investment. People will also save and invest if they have full knowledge about the avenues
available for investment and the tax incentives associated with each of these channels of
investment.
III) Effects of Taxation on the Composition and Pattern of Production
The effects of taxation on the consumption and pattern of production depend upon allocation of
resources. When higher taxes are imposed on some industries, resources will shift from the high
taxed industries to low taxed industries. Likewise, when a tax rebate is offered, it will encourage
allocation of resources in favour of developing industries. Similarly, there will be reallocation of
resources from high taxed regions to the low taxed regions. High rate of tax on goods of harmful
consumption has a beneficial impact as the production of these goods will be diverted to low-
taxed essential goods. Taxes may thus change the pattern of production in an economy. A high
tax on the production of luxuries may improve the production of necessaries. Some taxes,
however, have no effect on diversion of resources; example, taxes on windfall gains, high land

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values, monopoly profits and non-differential taxes such as income-tax, etc. have no effect on
consumption or pattern of production.
Effects of Taxation on Distribution
There are two aspects of an economy:
1. Income Generation
2. Income Distribution

Income generated in society if not distributed properly will create inequality in the distribution of
income and wealth. It will give rise to the creation of two classes that is the class of the rich and
the class of the poor. The gap between rich and poor will lead to class conflict which may prove
disastrous to the society. Every government in the world tries to bridge this gap by imposing
higher taxes on the richer section of the society and the proceeds realized from such taxes are
distributed among the poorer section of the society by way of providing social amenities to them.
The effects of taxation on the distribution of income and wealth among different sections of the
society, however, depend upon two factors: nature of taxes and tax rates and kinds of taxes.
1) Nature of Taxes and Tax Rates
By nature, taxation may be proportional, progressive or regressive. The nature of taxation also
implies as how the burden of taxation is distributed among different section of the community.
A tax is called as proportional, if all the tax payers pay the same proportion of their income as
tax. A tax is said to be progressive, if larger is the tax payers income, the greater is the proportion
that he pays as tax. A tax is regressive, if larger is the tax payee’s income, the smaller is the
proportion, which he pays as tax.
a) Effects of Regressive Taxation on Distribution
If regressive taxation is followed, the inequalities may increase in the distribution of income and
wealth, as the burden of taxation will fall more heavily on the poor than on the rich. A toll-tax is
regressive as the amount of the tax is the same for the rich and the poor, while the utility of
money, which is paid in tax, is greater for the poor than the rich. A regressive tax thus tends to
widen the gap of inequality.
b) Effects of Proportional Taxation on Distribution
Under proportional taxation, inequalities would continue as before, if the income remains the
same. However, if the income changes in unequal proportions, the inequalities in income will
increase. For instance if A’s income is $500 and B’s income is $1,000 and both are taxed at the
rate of 10% the net income of A and B, after tax payment, would be $450 and $900 respectively.
The burden of taxation falls heavily on A than on B. Hence, the burden of taxation is higher on
the poor than on the rich.
c) Effects of Progressive Taxation on Distribution
Under the progressive system of taxation, inequalities would be reduced, because a higher
proportion of the income and wealth of the rich would be taken away by taxes than that of poor.
Hence, a sharply progressive tax system tends to reduce inequalities in the distribution of income
and wealth. Sharper the progression, greater is the tendency to reduce inequalities. Obviously,
progressive system is desirable in order to bring about a more equitable distribution wealth.
However, the tax system should be based on the principle of ability to pay. The higher the
income of a person, the greater would be his ability to pay taxes and vice-versa. People who get
unearned income should be taxed at higher rate than poor because of their greater capacity to pay
taxes. The progressive tax system may be designed in such a way that it may not have adverse
effects on production.

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In other words, tax system should be progressive to the highest income group, the middle income
groups should be subjected to lower tax rates and the low income groups should be exempted
from taxation.
1) Tax Rates
While fixing the rates of taxes, progression should be kept in mind. Higher taxes should be
imposed on the richer section of society and revenue realized from the rich should be utilized for
the benefit of the poorer section of the society by way of providing social amenities to them. In
other words taxes should be progressive because sharper the progression, greater is the tendency
to reduce inequalities.
2) Kinds of Taxes
Whether the effect of taxation is progressive, proportional or regressive in nature depends upon
the kinds of taxes.
There are two kinds of taxes: direct tax and indirect taxes.
a) Indirect Taxes and Distribution
The burden of indirect taxes, like taxes on commodities is regressive in nature. The commodities
on which indirect taxes are imposed are widely consumed by the poor and they have to spend
larger proportion of their income on such goods than rich. That is, propensity to consume is
higher for the poor than that of rich. Hence, the burden of indirect taxes, like the tax on foodstuff,
raw tobacco, cheap alcohol, etc., falls more heavily upon the poor than upon the rich. However,
the indirect taxes may be made progressive if the necessities are exempted from taxation and
luxuries are subjected to higher rates of taxation so that the tax rates would be higher for the high
priced goods. But it should be noted that purchase of luxury goods is optional. Hence, the rich
can avoid the payment of these taxes by not purchasing such goods or by contracting their
demand to some extent. Therefore, indirect or commodity taxes in general are and regressive
nature. Thus, inequalities of income and wealth cannot reduced by these taxes.
b) Direct Taxes and Distribution
To bring about equitable distribution of income and wealth, all taxes which fall heavily or
exclusively upon the richer section of society can have favorable distribution effects. All direct
taxes which are based on the principle of progression and ability to pay may have desire
distributional effects.
Effects of Taxation on Stabilization
Economic stability may be judged by the behavior of prices. This does not mean that prices
should remain static. Conversely there should be a normal rise in price because a normal rise in
price is a sign of healthy economy. Problem, however, arises whenever there are price
fluctuations. These price fluctuations may be known as abnormal economic situations prevailing
in the country. Economic stability also implies stability in the economic activity, output and
employment. It also refers to the avoidance of inflationary and deflationary conditions. Every
government tries to overcome these problems through fiscal measures which is the safest and the
durable course adopted by any government to control such situations.
There may be two abnormal economic situations:
 Inflation
 Deflation

Classification and choice of Taxes

Direct and Indirect Taxes:

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 Taxes are sometimes referred to as direct or indirect. The meaning of these terms can vary in
different contexts, which can sometimes lead to confusion. In economics, direct taxes refer to
those taxes that are paid by the person who earns the income. By contrast, the cost of indirect
taxes is borne by someone other than the person responsible for paying them. For example,
taxes on goods are often included in the price of the items, so even though the seller sends the
payments to the government, the buyer is the real payer. Indirect taxes are sometimes
described as hidden taxes because the purchaser of goods or services may not be aware that a
proportion of the price is going to the government.
I. Direct Taxes:
A direct tax is paid by a person on whom it is levied. In direct taxes, the impact and
Incidence fall on the same person. If the impact and incident of a tax fall on the same person, it
is called as direct tax. It is borne by the person on whom it is levied and cannot be passed on to
others. For example, when a person is assessed to income tax or wealth tax, he has to pay it
and he cannot shift the tax burden to anybody else. In Ethiopia, Government levies the direct
taxes such as income tax, tax on agricultural income, professional tax, land revenues, taxes on
stamps and registrations etc. From the above discussion, it can be understood that the direct
taxes levied in Ethiopia take the form of taxes on income and property.
II. Indirect Taxes
Under indirect taxes, the impact and incidence fall on different persons. It is not borne by the
person on whom it is levied and can be passed on to others. For example, when the excise duty is
levied on the manufacturer of cement, he shifts the burden of tax to the consumers by raising the
selling price. Here the impact of excise duty falls on the manufacturer and the incidence on the
ultimate consumers. The person who is required to pay the tax does not bear its burden. Thus,
indirect taxes can be shifted.
. Differences between Direct and Indirect Taxes:
Direct and Indirect taxes differ among themselves on the following grounds:
1. Shift ability of the Burden of Tax: In the direct taxes, the impact and incidence fall on the
same person. It is borne by the person on whom it is levied and is not passed on to others. For
example, when a person is assessed to income tax, he cannot shift the tax burden to anybody
else, and he himself has to bear it. On the other hand, in the case of indirect taxes, the impact

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and incidence fall on different persons. It is not borne by the person on whom it is levied. The
burden of the tax can be shifted. For example, when the manufacturer of cement pays excise
duty, he can shift the tax burden to the buyers by including the tax in the price of the cement.
2. Principle of Ability to Pay: Direct taxes conform to the principle of ability to pay. For
example, now people having income above Birr.150 pm, only is liable to pay income tax.
But, indirect taxes are borne and paid by the weaker sections of the society also. As such, these
taxes do not conform to the principle of ability to pay.
3. Measurement of Taxable Capacity: In the case of direct taxes, tax-paying capacity is
directly measured. For example, the taxable capacity for income tax is measured on basis of the
income of the individual. On the other hand, in the case of indirect taxes, taxable capacity is
measured indirectly. The luxurious articles are levied at the higher rate of taxes on the
assumption that they are purchased by the rich people. However, low rate is charged on the
articles of common consumption.
4. Principle of Certainty: Direct taxes ensure the principle of certainty. Both the Government
and the taxpayer know what amount is to be paid and the procedures to be followed. But in the
case of indirect taxes, it is not possible. The taxpayer does not know the amount of tax to be paid
and the Government cannot predict the quantum of revenue generated from the indirect taxes.
5. Convenience: Direct taxes cause much inconvenience to the taxpayers since they are to be
paid in lump sum. But the indirect taxes are paid by the consumers in small amounts as and when
they purchase the commodities. Moreover, the taxpayers need not follow any legal formalities in
the payment of tax. Thus, indirect taxes are more convenient to them.
6. Civic Consciousness: People felt the burden of direct taxes directly. The taxpayer is conscious
of his contribution to the Government and interested in knowing whether the tax paid by him is
properly used or not. In this way, it creates civic consciousness among the taxpayers. But
indirect taxes do not raise such consciousness among the taxpayers, because they pay the taxes
indirectly.
7. Nature of Taxation: Direct taxes are progressive in nature. The rates of taxes go up with the
increase in the tax base i.e. income of a tax payer. But rich and poor irrespective of their income
equally pay indirect taxes. Thus, they are regressive in nature.

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8. Removal of Disparity in Income and Wealth: Since the direct taxes are progressive in nature,
they reduce the disparities of income and wealth among the people to a considerable extent.
But indirect taxes have a negative effect. Actually they are widening the gap between the rich
and poor when they are levied on the goods of common consumption.
9. Examples: The examples for direct taxes are income tax, wealth tax, gift tax, estate duty etc.
The examples for indirect taxes are customs duty, excise duty, sales tax, and service tax
Etc.
2.4 Single Vs Multiple Tax System
 On the basis of volume (Single and Multiple tax)

Single tax: - It refers to the system in which the taxes are levied only on the ‘item’ or ‘head of
tax’. There is only one kind of tax, which constitutes the source of public revenue.
Multiple taxes: - It refers to the system in which the taxes are levied on various items.
 On the basis of method

Proportional taxes: - A system that taxes everyone at the same rate, regardless of his or her
income brackets. It is amount increase with the increase in income and decreases with the
decrease in income.
Progressive taxes: - It is the tax which varies with the change in income of the different
individuals. The rate of tax is gradually higher for the increasing incomes and lower for the
decreasing incomes.
Regressive tax: - Under it, the larger the income of tax-payer, the smaller is the proportion that
he contributes. A schedule of regressive tax rate is one in which the rate of taxation decreases as
the base increases.
SHIFTING AND INCIDENCE OF TAXES
Meaning of Impact
The impact of a tax is on the person who pays the money in the first instance. In other words, the
man who pays the tax to the government in the first instance bears its impact. The impact of a tax
is, therefore, the immediate result of the imposition of a tax on the person who pays in the first
instance. It corresponds to what is often, but erroneously called the “original incidence” or the
“primary incidence” of a tax. The impact of tax as such, denotes the act of imposing.
Impact of a tax, therefore, refers to the immediate burden of the tax and not to the ultimate
burden of the tax.
Meaning of Shifting
Shifting of a tax refers to the process by which the money burden of a tax is transferred from one
person to another. Whenever there is shifting of taxation, the tax may be shifted forward or
backward.

Meaning of Incidence
Incidence of a tax refers to the money burden of a tax on the person who ultimately bears it. In
other words, when the money burden of a tax finally settles or comes to rest on the ultimate

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taxpayer, is called the incidence of a tax. The incidence of tax remains upon that person who
cannot shift its burden to any other person, i.e., who ultimately bears it.
Thus, there are three distinct conceptions- the impact, the shifting and the incidence of a tax,
which correspond respectively to the imposition, the transfer, and the settling or coming to rest
of the tax. The impact is the initial phenomena, the shifting is the intermediate process, and the
incidence is the result.
Distinction between Impact and Incidence
The impact refers to the initial burden of tax while incidence refers to the ultimate burden of the
tax. Impact is felt by the tax payer at the point of imposition of the tax, while the incidence is felt
by the tax payer at the point of settlement or rest of the tax.
The impact of the tax is felt by the person from whom the tax is collected, while the incidence is
felt by the person who actually bears the burden of the tax.
Impact of a tax can be shifted, but the incidence of a tax cannot be shifted.
Thus, impact of the tax is always on the person who is responsible by law to pay the tax amount
to the Government treasury, in the first instance. Incidence may fall on somebody from whom
the manufacturer ultimately recovers the amount, provided he shifts the tax.
Tax Shifting
Shifting of a tax refers to the process by which the money burden of a tax is transferred from one
person to another. Shifting can occur only in connection with the price transaction. Price is the
only vehicle through which a tax can be shifted. Thus, shifting is common in commodity
taxation. If a tax is shifted, the price of the taxed commodity increases. Whenever, there is
shifting of taxation, the tax may be shifted forward or backward.
Types of Tax Shifting
Tax shifting may be of two types: forward shifting and backward shifting.
Forward Shifting
A tax is said to have shifted forward if price of the commodity which constitutes the medium for
shifting the money burden of tax is increased. Under complete shifting; the price will be higher
by the full amount of tax. In forward shifting of commodity taxation, the money burden of a tax
is transferred from the producer or seller to the consumer or buyer when the tax is initially
imposed on the producer. Thus, forward shifting is possible with regard to all indirect taxes
which are generally passed partly or shortly to the buyer of goods.
Backward Shifting
Backward shifting refers to the process by which the money burden of commodity tax is shifted
from the consumer or buyer to the producer or seller, if the tax is initially imposed on the
consumer. In other words, it is a typical situation in which the tax burden is shifted backward,
that is, from the buyer of good to the seller of goods under the following conditions:
Backward shifting is applicable in the case of property tax only. Backward shifting is effected
when the buyer of property shifts the entire tax burden to the seller of property. The shifting is
done by buyer of property by way of capitalizing the value of tax by the life of the property and
deducting it out of the total value of the property.
Factors Influencing Shifting and Incidence
From the foregoing analysis, we find that their area number of factors which influence tax
shifting and incidence. These factors are mentioned below.
(i) Elasticity of Demand. The elasticity of demand for commodity taxed exercises a very
important influence in determining incidence. If the demand for the product taxed is perfectly
elastic, i.e., if the demand curve is a horizontal straight line, price cannot be raised at all, because

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the slightest rise in price will largely reduce the demand for the product. Hence, the incidence
will be wholly on the seller. On the contrary, when the demand is perfectly inelastic, the
incidence will be wholly on the buyer. In between these two extremes, the incidence of tax will
be shared between the buyer and the seller. Thus, with given supply, the larger the elasticity of
demand, the smaller will be the incidence on buyer and larger on seller; while, the lesser the
elasticity of demand, the larger will be the incidence on buyer and small on the seller.
(ii) Elasticity of Supply. Because price is determined by the interaction of both demand and
supply, it follows from the similar reasoning that the incidence of tax on a commodity will be
wholly on the buyer when supply is completely elastic and will be wholly on the seller when
supply is completely inelastic. With varying degrees of supply elasticity, the incidence will be
shared between the buyer and the seller. With given demand schedule, the incidence will be
larger on buyer and smaller on seller the greater the elasticity of supply of the product taxed,
while the-reverse will be the order of incidence when the elasticity of supply is lesser and lesser.
(iii) Market Conditions. Shifting of tax is also influenced by the conditions of market for the
product taxed. If the product is sold in the perfect market which is characterized by many sellers
and perfectly elastic demand curve, the price cannot be changed by the seller and, hence, tax
cannot be shifted. On the other and, when the product is sold under monopolistic conditions, he
can manipulate the price by withholding supply of the product and, hence, can shift the tax at
least to some extent.
(iv) Magnitude of Tax. Shifting depends on the magnitude of tax levied. If the amount of tax is
very small, it is generally not shifted but absorbed by the seller, because it does not much reduce
his profit. The seller, moreover, may absorb it in the hope that he will be able to attract more
customers in the event of other sellers trying to raise the price in their trial of shifting the tax.
However, if the magnitude of tax is considerably large, absorption of tax is more likely to reduce
the profit of the seller and, hence, he will try to shift it either backward or forward. He may also
shift the tax forward by lowering the quality of product without raising the price of it.
(v) Coverage of Tax. Another important factor that influences shifting and incidence is the
extent of coverage of the tax. If the tax is more general in natural, falling on wide range of
commodities, it may be easily shifted. For example, if a tax levied on bathing soap is general in
nature, covering all its kinds and brands, it will be readily shifted. But if the tax is imposed on
only one brand of soap with the exclusion of others, the tax may not be possibly shifted. Hence,
shifting of tax is easier for more general taxes than non-general taxes.
(vi) Substitutability of Product. It follows from the above argument that taxes imposed on a
commodity which has no substitutes or has only poor substitutes can be easily shifted to the
buyer, because the buyer will not find an alternative product to satisfy his demand and, hence, he
will be ready to purchase the same even when the price is increased by the amount of the tax. But
if the product taxed has good substitutes, the raising of price is not possible for the fear of losing
customers and, hence, the seller will himself bear the burden of tax instead of trying to shift it.
(vii) Public Policy and Tax Laws. If the Govt. wants that the business enterprise should not
raise the price of the product in the event of shifting the tax burden forward, the seller /producer/
business enterprise should bear the burden himself or itself. Tax laws, may legally prohibit
shifting of tax through controls, restriction on prices and etc.
Tax Evasion and Tax Avoidance
Tax Evasion
Tax evasion is the general term for efforts by individuals, firms, and other entities to evade the
payment of taxes by breaking the law.

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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, mis-representation 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 as follows:
1. Suppression of income, and
2. Inflation of expenditure.
Examples for Tax Evasion: The following are the examples for tax evasion:
1. A trader makes a sale for Birr.20, 000 and does not account it, in his books under sales. He is
evading tax.
2. 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.
3. Under-invoicing of sales and inflation of purchases.
4. 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.

Causes of tax evasion

 High rates of taxation; - Prevalence of high tax rates is the first and foremost reason.
 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.
So, such complication in tax-laws is also a root-cause for the tax evasion.
 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.
 Lack of publicity;-Lack of publicity of information of a person’s return or assessment, is
yet another reasons for tax evasion.
 Moral and Psychological factors; - moral and psychological factors have also been
pointed out as responsible for tax evasion.
 Every person should realize his responsibility towards the govt.
 Unfortunately, all citizens do not realize their duties to the govt. and the necessity
of paying the correct amount of taxes and paying them in time.
 officers of the department should be men of integrity;- Lack of integrity in some of the
officers of the department is also responsible for tax evasion
Methods/Sources of Tax Evasion
Omission to report taxable income.

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  One of the methods of tax evasion is the omission of the tax-payer to report
taxable income to taxation authorities.
 Under law, every individual, sole proprietorship, partnership firms and
corporations have to furnish their income tax returns in time in case his or her
total income from all sources exceeds the maximum exemption limit.
 But many people do not supply any such information to the govt.
 They cheat their govt. by concealing facts with regard to their income and wealth
returns.
Maintenance of multiple set of books of accounts.
 Many big business houses have been showing some baseless transactions of
expenditure to lower down their tax burden.
 Most of the business people are maintaining double set of books of accounts by
tax evaders.
 One set of books of accounts is for personal use and another for tax purpose.
Opening accounts under dummy names.
 Tax evaders have been opening number of bank accounts under dummy names.
Deduction of personal expenses as business expense.
 Some employees of big business houses regularly deduct their personal expenses
from office.
 For example, an officer using official transportation for personal purposes.
 By treating personal expenses as business expenses, people increase business
expenses thus lowering the profit of the enterprise.

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.
 But they rarely report such income to the taxation authorities.
Understatement of receipts.
 Receipts received from credit sales add to the total income of the business man.
 This addition to the 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.
Over-estimation of business expenses.
 A person who evades the payment of tax, overestimated his business expenses by
showing more salaries to employees as compared to actual amount paid.
Tax avoidance – An Overview
 Tax avoidance is method of reducing ones tax liability by making use of
loopholes in tax law.
 Therefore, tax avoidance is not illegal.

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  But whatever be the method an assesse adopts whether it is avoidance or evasion,
the consequences of his action is the same.
 i.e., loss of revenue to the state and increase in the burden of the tax on other tax-
payers.
 Thus, tax avoidance is the art of escaping taxes without breaking the law.
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.
2. 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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