Definition of taxation

The Latin word taxare is related the word Tax which means to charge.
Tax is one kind of contribution exacted by the government of the
country. It is non-penal but compulsory transfer of recourses from
the private sector to the public sector, charged on the basis of
predetermined criteria. Taxes are the most important sources of
government revenue of all the modern governments. According to
P.E. Taylor “ Taxes are the compulsory payment to the government
without expectation of direct return in benefit to the tax payer”.
Sometimes people call it - a burdensome charge, obligation,
duty, or demand. Considering the above tax can be defined as - A
sum of money demanded by a government for its support or
for specific facilities or services, levied upon incomes,
property, sales, etc.
 Characteristics of tax
• Tax is a payment to the government by the citizens of the country.
• enforced contribution.
• Payment of taxation is non-penal and compulsory.
• Refusal to pay tax is a punishable offence.
• In the payment of tax there must be an element of sacrifice.
• The objective of tax collection is to finance the government expenditure
• Tax is not the costs of the benefits government conferred to the people
• Tax is a prime source of government revenue
• levied by the law-making body of the state.
• commonly required to be paid at regular periods or intervals.
 Purposes of taxation

a) Revenue collection: Tax is the prime source of government

revenue of the modern governments. Without this tax revenue
government can not carry out its regular development, security
and other activities. In Bangladesh around 80% government
revenues come from tax.
b) Reduction of inequalities in income & wealth: Taxation reduces
the inequalities in income and wealth by taxing rich
people heavily and conferring benefits to the poorer section of the
people.
c) Accelerating economic growth: Tax revenues are used for the
development activities which ensure economic development. On
the other hand it encourages people to save and invest more which
also is helpful for economic development.
 Purposes of taxation
d) Controlling consumption: Tax is not only a source of
government revenue, through taxation government also tries to
control the consumption of some unhealthy goods like drugs, wine
etc. to ensure good and sound health of the citizens. This taxation
also works a tool to control the consumption of luxurious goods
and services.
e) Protection of local industries: In the markets today we see an
uneven competition between the foreign companies and the local
poor companies. It is very tough to sustain in the market for the
poor local companies because of globalization. In this kind of
situation government reduces the tax rate for the poor local
companies and increase the tax rate for the foreign companies.
Even the local companies enjoy more tax incentives so that they
can sustain and make a good position in the market.
f) Economic development: By all other things overall economic
development of the country can be ensured.
 Canons of taxation
Canons: Canons are the administrative aspects of taxation regarding rate, method
of levy, collection time and method and other rules and regulations . These work
like a constitution. In otherword the good characteristics that are required for a
good tax system are called the canons of taxation. Adam Smith gave four canons
that are still regarded as classic. Those four canons are as under
a. Canon of equality: It says that the burden of tax should be equally or equitably
distributed among the people according to their income level. The rich people
should pay high tax and the poor people should pay less tax. It should bear
equally, so as to give no individual an advantage.
b. Canon of certainty: The more complex the rules of taxation are, the more
they can be subverted and evaded. As the tax code becomes a
hieroglyphic that can be understood only by specialists, only those who
can afford to pay the specialists can take advantage of its loopholes! Not
only that: in a "democratic" society in which wealth distribution is
grossly unbalanced, taxes on production are inherently disposed toward
becoming more and more complex. Why? Because wealthy special
interests can pay to influence legislation!
 Canons of taxation
c) Canon of economy: According to this canon the tax system should
be designed in a way to both to take out and to keep out of pockets of
the people as little as possible. It says to ensure a tradeoff between tax
payer’s burden and government’s demands.
d) 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
contributor to be paid.
There are some other canons as well like-
e) Canon of simplicity: The tax system of the country should be easy
and simple. It must be easy understanding.
f) Canon of elasticity: The tax system and associated rules and
regulations should be simple and elastic so that the authority can
revise and change when and where necessary.
g) Canon of diversity. h) Canon of functional efficiency etc.
 Tax classification
Taxes can be classified in many ways.
1) On the basis of number of taxes:
i) Single tax ii) Multiple tax
2) On the basis of impact and incidence of tax:
i) Direct tax: Direct taxes are those taxes which are entirely paid by
the persons on whom they are imposed. Direct tax can not be shifted
to others. Ex- income tax, land revenue tax.
ii) Indirect tax: These tax burden can be shifted to others. Indirect
taxes are imposed on sales and purchase of goods or services not on
personal services or income. Ex- VAT, customs duty.
 Basic differences between Direct and indirect tax
Basis Indirect tax Direct Tax
Taxable event Purchase, sales, manufacture Taxable income or wealth of
of goods of provision of service person.
Levy & Collection Levied and collected from the Levied and collected from the
consumer but paid or assessee.
deposited to treasury by
assessee or dealer.
Shifting of burden Possible Not possible
Point of collection At the time of sale or purchase At the end of an income year.
(periodically)
 Merits and Demerits of Direct and Indirect Tax
Tax Merits
Direct • It is equitable since it is
progressive.
• Economical because it incurs low
admin costs.
• Elastic in nature so changes are
possible
• Certain about rate, method and
other issues.
• Based on tax payers ability.
Indirect • Convenient to pay because it is
included with price.
• It is difficult to avoid/Evade
• It ensure high revenue collection
• Equitability is ensured by taxing
rich people heavily.
• It is used as controlling tool.
Demerits
• There is scope to avoid tax by the
dishonest tax payers.
• It is unpopular because burden can
not be shifted.
• Some times direct taxes are found to
be arbitrary.
• Collection of direct tax is not
satisfactory because of possibility of
tax avoidance.
• It seems to be inequitable because of
same rate for both poor and rich.
• Uneconomical because collection of
indirect tax involves many stages and
more admin costs.
• Possible cheating by the retailers.
• It increases the market price which
may cause inflation.
 On the basis of structure of tax rate
a) Proportional tax: Here the tax rate remain same whatever the level
of income is of the tax payers.
Merits: Easy and simple to calculate.
Demerits: Not based on the canon of equitability, can not
reduce in equalities.

b) Progressive tax: The rate of tax increases with the increase of

income. Higher the inco9me higher the tax.
Merits: Equitability in ensured, Rich people pay more tax
Reduces inequalities.
Demerits: Arbitrary fixation of rate maybe done when govt. needs
more funds, Discourage to increase income level, People hide
income.
Regressive tax: In this tax system the tax burden falls heavily on the
poor people because tax rate decreases with the increase of income.
Merits: Increase savings and investment, increases net government
income because additional savings are reinvested, people are
encouraged to earn more.
Demerits: Ability to pay is not considered so poor people become
poorer, it increases inequalities.
Digressive tax: This tax is midly progressive. Here tax rate increases
with the increase of income upto a certain limit and then remain
unchanged. First 250,000 tax rate 0%
Next 400,000 10%
Next 500,000 15%
Next 600,000 20%
Next 30,00,000 25%
Rest amount 30%
SUPER TAX: New in Bangladesh, applicable for super income people.
Classification on the basis of tax elasticity:
Elastic & Inelastic tax

Classification on the basis of change of government

revenue: Positive tax and Negative tax

Classification according to tax authority:

Central tax & Local tax
Classification on the basis of tax base:
Income tax, Wealth tax, VAT, Expenditure tax
 Characteristics of a good tax system
• Taxes should be levied on the basis of basic principles
• If equitability and convenience in properly ensured
• Tax system should include both direct and indirect tax
• A number of taxes not a single tax
• Efficient and sufficient manpower
• Tax payers should be well informed timely
• Cost effective
Roles of tax in the economic development of a country
• Government revenue generation
• Proper/Optimum allocation of resources
• Reducing inequalities
• Public sector and private sector development
• Economic growth
• Price stability
• Control mechanism
 Impact, Incidence and Effect of Tax
Tax liabilities impose a burden on the tax payer because it needs
sacrifices of something. This tax burden does not always fall on the
shoulder from whom it is collected. In many cases the tax burden is
shifted to some other persons who pay the taxes finally. Regarding the
tax burden there are three concepts:
Tax impact: Tax impact is the immediate money burden. When tax is
imposed on the person, who has legal responsibility to pay tax. Tax
impact is carried by the person on whom it is imposed.
Tax incidence: Tax incidence is the final money burden. It falls on the
person who ultimately pays the tax. The incidence of tax is on the
person who can not shift it to others.
Tax Effect: The imposition and collection of tax need cooperation of
various people at various stages. Tax makes changes in the economic
position of the country which is referred to as tax effect.
 Important concepts
Can a tax on land values be shifted?
Taxes on commodities are usually passed on to the consumer in higher prices. What is to stop
landowners from doing the same thing? That is, can a landowner increase the rent charged to
tenants so as to pay the land value tax and still collect the same net rent as before?
Remember: land is not produced by labour. It is fixed in quantity and its price is a monopoly price
(all the traffic will bear). A tax on labour products increases the cost of those products and this is
reflected in the price. If the new price meets consumer resistance, the supply of that product is
checked.
But a tax on land does not affect either its cost of production (it is not produced) or its supply
(which is fixed). Thus its price is not increased (for it is already all the traffic will bear), and the tax
falls directly on the owner. The rent of land is determined by the margin of production and it is a
certain amount whether taxed or untaxed. A tax on land is simply a division of the rent between
the owner and the community.

Tax shifting
Single point shifting vs. Multi point shifting
Forward Vs. backward shifting (sales & Purchase transactions respectively)

Pass through vs Non pass through entities

Legal tax payers vs Real tax payers