Chapter Three

General Overview of Taxation

Dr. Messele G.

1
 Outline
• General Overview of Taxation
• Taxation - a brief introduction
• Taxation- concepts and characteristics
• Objectives and principles
• Characteristics of good tax system
• Approaches to tax equity: The benefit and the
ability-to-pay principles
• Equity and Efficiency
• Tax compliance and Tax Evasion
2
 Overview
• Taxation is the most common method of
financing government activities.
• The services themselves are provided to the
community without charge, and the necessary
funds are collected by requiring persons to make
compulsory payments to the government in
accordance with some established criterion,
such as property owned or income received.

3
• The payment of the tax does not in itself enable
the taxpayer to receive any governmental services
to which he would not otherwise be eligible.
• The individual has no choices in the matter if he is
eligible for payment on the basis of the standards
established.
• A tax is a compulsory charge imposed by the
Government without any expectation of direct
return in benefit.
4
• Tax imposes a personal obligation on the people
to pay the tax if they are liable to pay it.
• Tax is an involuntary fee or more precisely,
unrequited payment, paid by individuals or
businesses to a government (central or local).
• A good tax system should not affect the ability
and willingness of the people to work, save and
invest.

5
 General Characteristics of Tax
• Tax is a Compulsory Contribution
• Benefit is not the Basic Condition
• Personal Obligation (it is the duty of a taxpayer
to pay it and in no way he can escape from it)
• Common Interest (is used for the general and
common benefit of the people as a whole)
• Legal Collection (can be levied only by the
Government)

6
 General Characteristics of Tax…
• Element of Sacrifice (is paid without any direct
return in benefit)
• Regular and Periodical Payment (almost all the
taxes are annual taxes)
• No Discrimination (Tax is levied on all people
without any discrimination of caste, creed, etc. but
according to their ability to pay)
• Wide Scope (levied not only on income but also on
expenditure and capital)
7
 Objectives of Taxation
• Raising Revenue
• Removal of Inequalities in Income and Wealth
• Ensuring Economic Stability (affects production and
consumption – depression & inflation times)
• Reduction in Regional Imbalances
• Capital Accumulation (concessions or rebates given
for savings or investment)
• Creation of Employment Opportunities (giving tax
concessions or exemptions to small entrepreneurs
and to the industries) 8
 Objectives of Taxation …
• Preventing Harmful Consumption (By way of imposing
heavy excise duties on the commodities)
• Beneficial Diversion of Resources (imposition of heavy
duties on non-essential and luxury goods discourages the
producers of such goods)
• Encouragement of Exports (like 100% relief from income
tax)
• Enhancement of Standard of Living (by way of giving
various tax concessions to certain essential goods, the
Government enhances the standard of living of people)
9
 Classification of Taxes
Direct taxes
• are all levied directly on the taxpayer who
receives the income
• is a tax whose burden falls directly on the
person or thing taxed and cannot be shifted to
another person or thing
• Examples of direct taxes
– Corporation income tax

10
• Estate tax - tax on the property
• Gift tax - a tax on the value of gifts received by an individual
• Individual income tax - tax on the income of individuals or families,
generally applied to wages, salaries, tips, interest, and dividends. It
is also called personal income tax
• Inheritance tax -A tax on the income (including property) received
by an heir from the estate of a person who has died
• Payroll tax -A tax on wages and salaries
• Poll tax - A tax of a specific monetary amount imposed directly on
an individual. The other name used is a lump-sum tax or head tax.
• Pollution tax -A tax levied on a company that produces air, water, or
soil pollution over a certain level established by the government.
• Property tax is a tax on property, usually meaning only real
property, such as land, buildings or houses, and machinery. Personal
property, such as furniture, vehicles, or jewelry, is largely excluded,
as is intangible property, such as money, stocks, bonds, or bank
deposits. 11
 Merits of Direct Taxes
• Ensures the Principle of Ability to Pay
• Reduces the Social and Economical Inequalities
• Certainty (the amount is certain)
• Economy (lower cost of collection)
• Elasticity
• Educative Effect (creates civic consciousness
among taxpayers)

12
 Limitations of Direct Taxes
• Arbitrary in Nature
• Difficulties in the Formulation of Progressive Tax
Rates
• Inconvenience (e.g. submission of the income returns,
disclosing the sources of income etc.)
• Possibility of Tax Evasion
• Limited Scope
• Disincentive to Work, Save, and Invest
• Expensive to Collect (contacting a large number of
taxpayers)
13
 Indirect taxes
• Indirect taxes are taxes on goods and services.
• They also referred to as commodity or
consumption taxes, since they are paid only
when a particular transaction of goods or
services is affected.
• These taxes comprise sales tax; value added tax,
excise tax, import duty, export duty, and other
taxes.

14
 Indirect taxes…
• There are two ways of levying indirect taxes: on per
unit basis and on percentage basis (ad-valorem).
• A per-unit tax is one where the amount charged is
always the same on each unit.
• Examples of these are the duties on alcohol and
cigarettes.
• An ad-valorem tax, by contrast is one where the tax is
charged as a percentage of the value of the good.
• This is where Ethiopian VAT comes in, as it is always
15% of the value of the goods or services.
15
 Indirect taxes…
Examples:
• Excise tax
• Sales tax
• VAT
• Customs duties
• Turnover taxes

16
 Merits of Indirect Taxes
• Convenience: to the taxpayers since the tax is included in the selling
price. Tax is small so that the payer does not feel its burden, i.e., it is less
burdensome.
• Wide Scope: indirect taxes are paid by all both poor and rich.
• Elastic: The revenue from the indirect taxes can be increased. It can be
done by increasing and decreasing the rates of taxes.
• Tax Evasion is less Possible: Indirect taxes are included in the selling
price of the commodities. So, evading of such tax becomes very difficult.
• Substantial Revenue
• Progressive X
• Effective Allocation of Resources: by imposing heavy excise duties on
low priority goods and by granting relief to industries producing high
priority goods.
• Discourages the Consumption of Articles Injurious to Health
17
 Limitations of Indirect Taxes
• Ability to Pay Principle is Violated: Indirect taxes are
regressive in nature.
• Uncertainty: the revenue generated from them is
uncertain.
• Discourages Saving: the people have to spend more on the
purchase of the goods.
• High Cost of Collection: Indirect taxes are uneconomical as
they involve high cost of collection.
• Civic Consciousness is Not Created: taxpayers are not
aware of their contribution to the State.
• Inflationary: The indirect taxes cause an increase in the
price all around. 18
 Differences between Direct and Indirect
Taxes
• Shift ability of the Burden of Tax: In the direct taxes, the impact and
incidence fall on the same person. In the case of indirect taxes, the
impact 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.
• Principle of Ability to Pay: Direct taxes conform to the principle of
ability to pay. But, indirect taxes are borne and paid by the weaker
sections of the society also.
• Measurement of Taxable Capacity: In the case of direct taxes, tax-
paying capacity is directly measured. In the case of indirect taxes,
taxable capacity is measured indirectly. (for example, the luxurious
articles are levied at the higher rate of taxes on the assumption that
they are purchased by the rich people). (Reading Assignment)

19
 Differences between Direct and Indirect Taxes…

• Principle of Certainty: in the case of direct taxes Both the

Government and the taxpayer know what amount is to be
paid. In the case of indirect taxes, it is not possible.
• Convenience: Direct taxes cause much inconvenience to the
taxpayers since they are to be paid in lump sum.
• Civic Consciousness: People felt the burden of direct taxes
directly.
• Nature of Taxation: Direct taxes are progressive in nature
whereas Indirect tax are regressive in nature.
• 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.
20
 Tax Base, Tax Rate and Principles of Taxation
• According to Adam Smith, "a tax is a contribution
from citizens for the support of the Government."
What is Taxed? Defining the Tax Base
Tax base The measure or value upon which a tax is
levied.
The tax base is the item or activity that is taxed.
Defining the tax base involves specifying both
What is taxed?
What is not taxed?
tax rate structure The percentage of a tax
base that must be paid in taxes—25 percent
of income, for example. 21
 Tax base
• It is a measure upon which the assessment or
determination of tax liability is based.
• For example, taxable income is the tax base
for income tax and assessed value is the tax
base for property taxes.
• Total of taxable asset, income and assessed
value of property within the tax jurisdiction of
a government. It may include income tax,
Property tax, and commodity tax
22
• However, tax is an important instrument for the
development of economy of the country.
• While framing the tax policy, the government
should consider not only its financial needs but
also taxable capacity of the community.
• Besides the above, government has to consider
some other principles like equality, simplicity,
convenience etc.

23
Principles of Taxation:
Principles Advocated by Adam Smith:
• No one has yet come up with a better set of
criteria for judging a tax than the Canons of
Taxation first proposed by Adam Smith more than
two hundred years ago.
• Adam Smith in his book, “Wealth of Nations” has
explained the four canons of taxation that are
mentioned above.
• All accepts them as good taxation policy. We shall
now explain them briefly.

24
I. Principles of Equality (Adam Smith)
• A good tax system should be based on the ability
to pay of the people.
• People should bear the public expenditure in
proportion to their respective abilities.
• Tax burden should be more on the rich than on
the poor.
• The ability to pay may be determined either on
the basis of income and wealth or on the basis of
consumption i.e., luxury or necessity.

25
II. Principles of Certainty (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 should be clear and plain to
the contributor and every other person.
III. Principles of Convenience (Adam Smith)
• 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 pay it.

26
IV. Principles of Economy (Adam Smith)
• This principle states that the minimum possible
amount should be spent on tax collection and the
maximum part of the collection should be brought
to the Government treasury.
• The canon of ‘Economy' is naturally sub-divided into two
parts viz.,
Taxation should be inexpensive in collection', and
Taxation should retard as little as possible the
growth of wealth.

• It may also be remarked that there is a close connection

between "Economy" and "Productivity", since the former
aids in securing the latter.
27
 Principles Advocated by Others
V. Principles of Productivity
• The tax system should be productive enough i.e.
it should ensure sufficient revenue to the
Government and it should encourage productive
activity by encouraging the people to work, save
and invest.
VI. Principles of Elasticity
• The taxes should be flexible (i.e., it should be
levied in such a way to increase or decrease the
tax revenue depending upon the need.
28
VII. Principles of Diversity
• The burden of the tax should be distributed widely on
the entire people of the country.
• It should not depend upon one or two types of taxes
alone.
VIII. Principles of Simplicity
• This principle states that the tax system should be
simple, easy and understandable to the common man.
• If the tax system is complex and vague, the taxpayer
cannot estimate his/her tax liability and it will cause
irregularities in the payments and leads to corruption.

29
IX. Principles of Expediency
• A tax should be levied after considering all
favorable and unfavorable factors from different
angles such as economical, political and social.
X. Principles of Co-ordination
• There should be a proper co-ordination between
different taxes imposed by various authorities
(both Central and State).
Xi. Principles of Neutrality
• The tax system should not have any adverse effect
(i.e., it shouldn’t create any deflationary or
inflationary effects in the economy. 30
 Types of tax equity
A) Horizontal equity
• This is a treatment of persons in the like
circumstances.
• This means equal treatment of equals that is
persons in the same circumstances should be
taxed to the same extent.
• In other words, all individual with identical
income are assigned equal are supposed to carry
the same tax burden.
31
 Types of tax equity…
B) Vertical equity
• An individual with difference economic ability are
assigned different tax burden which means the idea
that a tax system should distributed the burden fairly
across people with difference ability to pay.
• This implies that the person with higher income
should pay more in tax than one with less income,
but how much more?
• Tax may be proportional, progressive, or Regressive.
32
 Progressive tax
• A tax that imposes a heavier burden on those
more able to bear the burden than on those less
able to bear it is called progressive tax.
• When applied to income, which is the most
important tax base in developed countries, a
progressive tax is one that takes a greater
percentage of income from those with higher
incomes than from those with lower incomes.

33
Tax Rate
Real Tax Paid per Birr of
(%) Income

Tax Base - Income (Birr)

Progressive Tax Rate

34
Proportional tax
• It is a tax that imposes the same burden on
people or takes the same percentage of each
person's income i.e. a tax system in which tax
rate does not vary with the value of tax base in
other word it is a tax system where a tax rate
remains constant.

35
Tax Rate

Real Tax Paid per Birr of Income

Tax Base - Income (Birr)

Flat Tax or Constant tax or proportional tax rate

36
 Regressive tax
• It is a tax that imposes a heavier burden on those less
able to bear it.
• Applied to income, it is a tax that takes a greater
percentage of income from people with low incomes
than from those with high incomes.
• Under this assumption principle of Clinton tax
administration says the smaller income earning gets
more social benefit so that they should pay more tax
than the other. ( It is Republican…
37
Tax Rate
(%) Real Tax Paid per
Birr of Income

Tax Base - Income (Birr)

Regressive Tax Rate

38
 Requirements for a “Good” Tax Structure
• Simplicity of administration and increases in tax
compliance,
• Improve economic efficiency and reduce dead-
weight loss (taxes may reduce incentives to save
and invest, to the detriment of long-run
economic growth),
• Promote long-run economic growth,
• Maintain flexibility of tax system (is associated
with the macroeconomic stabilization goal),
• Honor society’s norms of fairness and equity.
39
 Approaches to Tax Equity: The Benefit and the Ability-
to-Pay Principles

I. Cost of Service Approach

• According to this theory, the basis of taxation
should be the cost incurred by the Government on
different services for the benefit of the individual
taxpayers.
• Each taxpayer has to pay the tax equal to the cost of
service to him.
• If the citizens receive any benefit from the
government, they must pay the cost thereof.
40
 I. Cost of Service Approach…
• By adopting this approach, the government gives
up its basic protective and welfare functions.
• Its only job is to recover the cost of service.
• The state is not concerned with the problems of
income distribution.
• No effort is made by the government to improve
income distribution or no notice is taken of the
policy of levying taxes according to the cost of
service principle.
• This deteriorates the income distribution further.

41
 Limitations of Cost of Service Approach
i. It is very difficult to estimate the cost of service to every
individual. For e.g., the government can estimate total
expenditure on the defense of the country.
• But it is difficult to estimate the expenditure incurred by
the government on the defense of a particular individual.
ii. The basis of cost service principle is not fair in a welfare
state. If cost is taken as the basis of taxation, the
government may not perform various functions which
may be very much desirable for the welfare of the
country.
iii. The cost of government services to individuals are fixed
arbitrarily, which may not be justified.
42
II. Expediency Approach
• The authorities have to reshape the tax structure
depending upon the changing political strength
of different economic groups.
• It is also clear that while choosing and imposing a
tax, the authorities would be making a great
mistake if they lose sight of the administrative
feasibility, the cost of collection, and so on.
• Therefore, when the government bends before
the pressures of various pressure groups and
formulates its tax policy accordingly, we call it the
expediency approach.
43
 Limitations of Expediency Approach
• This approach is criticized on the ground that to build up an entire
tax system solely on the considerations of expediency, must be full
of pitfalls.
• In certain cases, such a tax policy may be able to yield certain good
results like contributing to the equality of income distribution, or
reducing regional disparities but such results would be purely
accidental and not the fruits of any thoughtful efforts or plan.
• A taxation system has a role to play in helping the economy. It
should be based on equity and should contribute towards
augmenting welfare in general.
• But when the tax system ignores certain factors like economic
growth, equity, economic stability etc., it is not likely to be helpful
to the economy and would increase inequalities and socio-
economic injustice.
44
 III. Socio-Political Approach
• In contrast to the expediency approach, Adolph Wagner
advocated an approach in which social and political objectives
are the deciding factors for the distribution of tax burden.
• He wanted that each economic problem should be looked in its
social and political context.
• Accordingly, a tax system should not be designed to serve the
needs of the individual members of the society.
• But it should be designed for the welfare of the society as a
whole.
• He was in favor of using taxation for reduction in income
inequalities and he advocated that all small incomes should be
exempted from taxation.
• Wagner's ideas, though much criticized at that time, are now
the hall-mark of modern state's fiscal policies.
45
Socio-Political Approach…

• Adolph Wagner also advocated that the government should

formulate a tax policy to achieve political objectives in the
form of protecting the fundamental rights of the people.
• He advocated that the government should provide protection
to the life and property of the people by way of incurring
expenditure on defense and maintenance of law and order. In
the modern context, we may accept Wagner's stand by
including other economic and social objectives of the society
in which taxation could be a helpful tool.
• Equity should be the main criterion of every tax system,
without it, not only the tax system loses its fairness, it also
becomes a source of social, economic and political unrest as
well.

46
Limitations of Socio-Political Approach
• Socio-Political Approach, though having the merit of
equity, suffers from the following limitations:
i. This concept is more of academic nature than of much
practical relevance.
This is proved by the fact that in spite of the fact that
the government follows the policy of progressive
taxation, the gap between the rich and the poor has
been increasing at a very fast rate.
ii. This policy has encouraged tax evasion either on account
of loopholes or by adopting such methods that lead to
tax evasion. The problem of taxation has led to the
operation of a parallel economy which is causing
inflation in economy. 47
 IV. Benefit Principle Approach
• Benefit principle approach was accepted by the political
theorists of the 17th century.
• Taxation in those times was considered as a price for the
services rendered by the state.
• The entire philosophy was based on the contract theory of the
state.
• According to this approach the state provides goods and
services to the members of the society and they contribute to
the cost of these supplies in proportion to the benefits received.
• It is an exchange relationship.
• According to this approach, the burden of' taxation should be
divided among the people in proportion to the benefits received
from the state.
48
• The benefit approach is, in fact, a combination of two
Principles:
i. The cost of service principles, and
ii. The value of service principle.
• According to cost of service principles, the taxes should
be divided in proportion to the cost of services rendered
by the state.
• As per value of service principle, every individual should
contribute in proportion to the value of the services
he/she has received from the government.
• Both the principles come to the same conclusion that the
cost of services rendered by the government should be
recovered from individuals in proportion to the benefits
received by each of them. 49
 Limitations of Benefit Principle Approach
i. It is very difficult to estimate the benefit that an individual
receives from the expenditure of the government.
ii. If the basis of taxation is benefit, then the poor will have to pay
higher taxes than rich because the poor derives greater benefits
than rich from the expenditure of the government.
iii. Rich people have more capacity to pay taxes than poor;
therefore, it is clear that the benefit principle cannot ensure
just distribution of burden of taxation among different sections
of society.
iv. The principle is also not conducive to general welfare which
requires redistribution of income in favor of the poorer sections
through public welfare programs and services for their benefit.
v. A general objection to the whole approach is that this principle
is not based on the concept of equity in taxation.
50
 V. Ability to Pay Approach
• It is the most generally accepted theory.
According to this theory each person should
contribute to the income of the state in
proportion to his ability to pay.
• Every tax-payer should feel that he has made
equal sacrifice in the payment of tax.
• Equity implies just tax payment.
• When the tax payer is required to pay tax
according to his ability to pay, it may be called
equity in tax payment.
51
 V. Ability to Pay Approach…

• As Dalton puts it, "the burden of taxation’ should be so

distributed that the direct real burden on all taxpayers is
equal."
• According to Seligman, “the basic point of the ability to
pay principle is that the burden of society should be
shared amongst the members of the society so as to
conform to the principle of justice and equity."
• The ability to pay principle accepts the idea that tax is a
compulsory payment to the government without any
direct benefit.
• According to this approach, a citizen has to pay taxes
because he can, and his relative share in the total tax
burden is to be determined by his relative paying capacity.
52
 Justification to Ability Theory
• The supporters of the ability theory have justified it on
three grounds:
i. It has been justified on psychological effects of tax
payments upon individual taxpayer. Psychologically
every taxpayer should feel that he has made equal
sacrifice in the payment of a tax.
ii. It has been justified in terms of diminishing marginal
utility of income. As income increases, marginal utility
of additional unit of income decreases and vice-versa.
iii. Ability is known as the faculty interpretation. The
faculty is represented by the income, property and
wealth on an individual.
53
 Index of Ability to Pay:
• The theory of ability to pay involves the
fundamental problem, as to how to measure the
ability to pay of a person.
• There are two approaches which have so far been
advanced for this purpose
– The objective approach (the faculty theory has been
evolved to measure ability to pay) and
– The subjective approach (the sacrifice has been
evolved to measure ability to pay).

54
The objective approach…
The indices of ability to pay are as follows
• Property (ACCUMULATED WEALTH)
• Income (Only net income should be taxed. Gross
income cannot be treated as an index of ability to pay.
Secondly, it is necessary to classify income into earned
income (like salary) and unearned income (like income
from sale of shares)
• Size of the Family
• Consumption
– It is noticed that taxation on the basis of property and
income is not equitable and can be manipulated to evade by
the taxpayers in many ways.
55
The objective approach…
Prof. Fisher and Prof. Nicholas Kaldor advocated taxation on
expenditures.
– Firstly, consumption implies withdrawal of resources from the
economy. A man's capacity to pay taxes, therefore, depends upon to
what extent he withdraws resources to satisfy his consumption needs.
– Secondly, a person spending large amounts to meet consumption
(luxuries) has a greater ability to bear the burden of taxation.
– Thirdly, there has been a large scale evasion of taxes on income
because of the concealment of income by the taxpayers. Since
consumption of items especially consumption of items of luxury
cannot be concealed, it is stressed that the consumption expenditure
should be used as an index of ability to pay taxes.
– Fourthly, it is difficult to locate the different sources of income of an
individual. Therefore, his ability to pay cannot exactly be measured
since the expenditure on consumption can be located without much
difficulty, it would truly represent a man's capacity to spend and
hence his ability to pay taxes.
56
• In spite of the fact that expenditure on consumption can
be located to determine a person's ability to pay, yet is
suffers from various limitations:
1. If the consumption expenditure of a person is taken as
an index of his ability to pay then those who save and
invest will escape the tax burden. This is against the
canon of equity.
2. Lack of records of the consumption expenditure also
creates a major difficulty in locating a person's
consumption expenditure for taxation purposes.
3. Since different persons have different standards of
living, it will not be proper to tax higher consumption
expenditure of the people with higher standard of
living. 57
Subjective Approach:
• The subjective approach is based on the
psychological or mental reactions of the tax-payers.
• In this approach we estimate the burden felt by the
tax-payer or sacrifice undergone by him. Each tax-
payer should make equal sacrifice, if tax burden is
to be justly distributed.
• Conan Stuart and Edge worth have advanced three
concepts of equal sacrifice, viz.:
• (1) Equal Absolute Sacrifice
• (2) Equal Proportional Sacrifice
• (3) Equal Marginal Sacrifice.
58
• (1) Equal Absolute Sacrifice: Under the concept of equal
absolute sacrifice, each tax­payer should make equal absolute
sacrifice, i.e. the total disutility of a tax should be equal for all
tax-payers. In other words all should be treated equally under
law as well as in all affairs of government. According to J.S.
Mill, equity in taxation means equality in sacrifice.
• (2) Equal Proportional Sacrifice: According to this concept
also, no one is exempt from sharing the tax burden. In other
words, each tax payer should sacrifice the same proportion of
total utility or satisfaction derived from his total income.
• (3) Equal Marginal Sacrifice: Edge worth and later Pigou
concluded that least aggregate sacrifice' is the superior
principle of tax distribution, not because it is equitable, but
because it is derived directly from the basic utilitarian
principle of maximum happiness.
59
 Equity and Efficiency

Efficiency of Taxation:
• The levy of taxation, its efficiency highly
depends on the "excess burden" or “dead
weight loss” created by a tax levy. The effects
of taxes can be best understood with the
concept of dead weight loss.
Reading assignment

60
 Tax compliance and Tax Evasion

Tax Compliance cost

• Compliance costs: the costs to taxpayers and others
of paying taxes, over and above the tax itself (ie, the
cost of learning about the tax, keeping records,
preparing tax returns, dealing with tax auditors,
resolving misunderstandings with the tax
authorities, etc.);
• Compliance costs are defined as costs incurred by
taxpayers in meeting the requirements laid on them
by the law and revenue authorities, over and above
the actual payment of tax and over and above any
distortion costs inherent in the nature of the tax
61
General effects of Compliance costs:
• Compliance costs tend to be regressive between
individuals, and they form a higher proportion of
the total costs of the small than the large firms.
• Personal compliance costs are associated with the
Taxpayer’s occupation whereby the self-employed
with a small income has a higher burden.
• Compliance costs are not directly related to the
tax liability
• Compliance costs of changes in the tax system are
often high and highly variable.
62
Factors that influence the level of compliance
costs:
– The factors that influence the level of compliance
costs include:
– The extent to which tax collection procedures can be
routinised
– The size of the firm
– The type of firm
– In the case of sales taxes, the ratio of taxable
turnover to gross sales and the
– size of the average transaction

63
 Tax avoidance and Evasions
• Tax avoidance and evasions constitute a
problem in almost all economies.
• Tax avoidance is different from tax evasion,
while evasion is against the law; avoidance is
within the ambit of law.
• Tax avoidance refers to an attempt to reduce
tax payments by legal means, for instance by
exploiting tax-loopholes, whereas tax evasion
refers to an illegal reduction of tax payments,
for instance by underreporting income or by
stating higher deduction-rates.
64
 Tax avoidance and evasions…
• Tax evasion is the general term for efforts by individuals,
firms, trusts and other entities to evade the payment of
taxes by breaking the law.
• Tax evasion usually entails taxpayers deliberately
misrepresenting or concealing the true state of their affairs
to the tax authorities to reduce their tax liability, and
includes, in particular, dishonest tax reporting (such as
under declaring income, profits or gains; or overstating
deductions).
• By contrast tax avoidance is the legal exploitation of the tax
regime to one's own advantage, to attempt to reduce the
amount of tax that is payable by means that are within the
law whilst making a full disclosure of the material
information to the tax authorities. 65
 Causes of Tax Evasion:

• The following are the important causes for Tax

evasion:
a) Multiplicity of Tax Laws:
b) Complicated Tax Laws:
c) High Rates of Taxation
d) Inadequate Information as to Sources of Tax Revenue
e) Investment in Real Property
f) Ineffective Tax Enforcement
g) Deterioration of Moral Standards

66
 Remedies for Tax Evasion:

• If steps are not taken to reduce tax evasion, it

may cause irreparable harm. The following are
the remedies to prevent tax evasion.
1) Thorough Overhauling of Tax Laws:
2) Reduction in Tax Rates:
3) Replacement of Sales Tax & Excise Duties with VAT
4) Tax on Agricultural Income
5) Maintenance of Proper Accounts
6) Introduction of Expenditure Tax
7) Tightening of Tax Enforcement

67
Thank You!!!

68