Advanced Taxation

(Acfn 622)
Semester 1, 2012
 PART ONE INTRODUCTION
1.1. Taxation, basic concepts :

taxation is a compulsory collection of money

by a government;
transfers resources;
governments compel the payment of taxes:
to fund services which are mainly public and which
cannot be provided through the market system;
people otherwise would not be willing to pay for
these services;
to accomplish some redistribution role;
Government revenue might not be just tax
revenue:
A government may charge fees for certain
services such as registration of legal documents
and supply of other commodities for which the
government may enjoy a monopoly;
Fines for a certain offence (like for example,
polluting the waterway, tax evasion etc );
Fines are compulsory payments without any quid
pro quo;
But, fines are not taxes; they are used to curb
certain offences not to raise revenue for the
government;
Characteristics of taxes include:
Compulsion
Direct benefit is not the main condition (levies
without quid pro quo )
Impose obligations – tax cannot be escaped
Common interest
Regular and periodic payment
Why do governments bother to tax?
Alternatively, a government could:
Finance expenditures by printing money;
Compulsorily seize the goods or services it
needs, or
Borrow money.
Problems with the above alternatives:
Printing money merely debases the currency
and causes inflation;
Compulsory acquisition is a crude and not very
fairly distributed form of impost and in any
event under our constitution requires just
compensation and
Borrowed money must be repaid or interest
bill met.
 Government Revenues as a Share of GDP in
OECD Countries (1870-1995)
About About
1913 WWI 1920 1937 WWII 1960 1980 1990
1870 1995
EXPENDITURES
Labor, Goods and Services 4.6% 11.4% 12.6% 17.9% 17.4% 17.3%
Investment 2.0% 2.8% 3.4% 3.8% 3.2% 3.5% 2.9%
Transfers 1.1% 4.5% 9.7% 21.4% 23.2%
of which: Social Security 18.1%
Interest 2.5% 2.2% 3.1% 3.4% 3.1% 4.5%

Total expenditures 10.8% 13.1% 19.6% 23.8% 27.9% 43.1% 44.8% 45.6%
REVENUES
Indirect Taxes, Customs 1.8% 1.7% 1.6% 2.2% 0.8% 0.5%
Indirect Taxes, Domestic 3.0% 3.0% 3.4% 4.9% 11.6% 11.8% 13.5%
Direct Taxes 2.4% 2.6% 3.2% 3.4% 9.5% 13.5% 14.0%
Social Security Contributions 7.1% 10.5% 12.1%
Other Receipts 3.4% 3.6% 3.3%

Total Revenues 10.6% 11.8% 19.2% 21.6% 28.7% 40.1% 42.2% 43.4%

Gross Public Debt Stock 47.9% 59.2% 66.3% 78.1% 42.9% 46.4% 60.4% 71.0%
Government Employment as
2.4% 3.7% 5.2% 12.3% 17.5% 18.4%
Share of Total Employment
Source: Vito Tanzi and Ludger Schukenecht, Public Spending in the 20th Century
Items do not always add to total in year due to missing values for member countries in some years
 Trends in Government Revenues

Revenues Over Time:

 In OECD countries, revenues increased from about 10% of GDP in 1870
to about 40% of GDP in 1980, and have increased slowly since then to
about 44% of GDP.
 World Wars and introduction of social security schemes in 1930s
resulted in introduction of broad based taxes: income taxes, followed by
sales tax, followed social security contributions (generally payroll taxes),
followed by VAT replacing sales tax.
 Customs duties peaked in 1930s and are now insignificant revenue
source with rounds of trade liberalization under GATT/WTO over the last
50 years.
 Trends in Government Revenues

Revenues Across Countries

 Central governments in high-income countries receive about two-
thirds of their tax revenues from direct taxes – half from income taxes
and remainder from payroll taxes funding social security. Remainder
third comes from indirect taxes, primarily the VAT/Sales Tax and
Excises.
 Low-income countries receive about two-thirds of their tax
revenues from indirect taxes: VAT, customs duties and excise duties.
 amongst high-income countries, taxes mostly range from 20% to about
40% of GDP; amongst low-income countries taxes mainly fall in 10% to
25% of GDP range. Tables tax to gdp .doc
Tax Capacity
Size of government (and taxation) in a country is
a political choice, but this choice is constrained
by the structural characteristics of economy
that affect the feasibility and costs of collecting
taxes.

Cost-effective tax administration is impacted by

availability or absence of “tax handles” in an
economy.
 Tax Capacity (Contd.)
Tax handles – structural features of economy that
make tax collection feasible and lower costs of
collection
High share of trade in GDP
Small agricultural sector (small subsistence and small scale
farming sector) or large corporate cash-crop farm sector
Large mining/mineral sector
Large tourism sector
Large corporate sector
Small informal sector
Well developed accounting profession
Large information technology sector
High per capita income
High level of literacy, education or human capital
 Tax Capacity (contd)
Effect of tax handles on tax revenue yield can be estimated across
countries to the extent that measures of tax handles are available
For example: Y is GDP and other variables are measures of sector
values
per capita income Yp positive
exports (manufacturing) X / Y positive
extractive (mineral) industries E / Y positive
agriculture A / Y negative
tourism  / Y positive
Using data from less developed countries, a regression equation is
estimated of tax capacity:
T/Y = constant + a*Yp + b*X/Y + c*E/Y + d*A/Y + e*/Y
Estimated (T/Y) is tax capacity or “average” tax yield of a country
with the specified structural characteristics or tax handles.
Tax Effort
Tax effort is the actual tax yield of a country
relative to the tax capacity of the country.
Tax effort = (Actual T/Y)/(Tax capacity T/Y)
If tax effort > (or <) 1, then country is collecting
more (or less) than the average tax yield for
countries with similar characteristics
Tax effort affected by both tax structure (tax rates,
bases, etc), tax administration and compliance.
 Tax effort can be increased by increasing tax rates,
expanding tax bases, improving tax enforcement
and compliance, etc