Major Revenue

Sources
 Direct Taxes
Are taxes that fall directly on the income or assets
of physical or legal persons (corporations and
foundations). It include taxes on personal income
and corporate profits; taxes levied on payrolls or
wages usually to help fund social insurance
activities; and taxes on wealth and property,
including taxes on estates and assets passed by gift
or through inheritance.
 Indirect Taxes
Taxes that fall indirectly on income or assets, because they
are levied on their use. Thus, indirect taxes are levied
mainly on production, consumption, exports, and imports.
It include taxes on goods and services, sales, or value
added, including excise taxes. Special taxes linked to
consumption or production, such as taxes imposed on
utility bills or computer service contracts, or levies on oil
or gas production (as opposed to the profits of oil and gas
exporters), are also indirect taxes.
 Personal Income Tax

• Tax levied on income received by physical persons.

• Are generally levied on all or most types of income
that people receive, including wages and salaries,
consulting fees and other income from personal
businesses, interest, dividends, rental income, various
government benefits, prizes and gambling profits,
and, in many countries, capital gains from the sale of
assets such as real estate and shares of stock.
 Under in “Global” income tax

All forms of income are combined to determine

taxable income and then taxed according to a
common set of tax rates.
 Under in “Schedular” system

Different kinds of income are taxed at

different rates; for example, capital gains,
which raise a variety of issues, may be taxed
more lightly than wages, salaries, and
interest earnings.
Tax analysts have traditionally argued that tax burdens under an income tax should
reflect the “ability to pay.” Ability to pay typically reflects a variety of factors.

• First, taxpayers are assumed to need a certain minimum income for

subsistence. Only income above this level should be taxed.

• Second, taxpayers can exclude from taxable income certain unusual

and unavoidable expenses deemed to reduce their ability to pay tax.
These include casualty losses and high medical expenses.

• Third, once taxable income is determined, the “ability to pay”

argument is sometimes used to justify progressive taxation, subjecting
progressively higher levels of income to higher marginal tax rates.
THE NATURE OF
THE PERSONAL
INCOME TAX
RAISES A VARIETY
OF ISSUES.
Double taxation of savings.

• Taxes on personal income inevitably subject

income used for savings to double taxation.

• discourages saving by reducing the return

on income saved.
Double taxation of dividends.
• Corporate profits paid as dividends, rather than
retained by the firm, are subject to double taxation
when households must include dividends in their
taxable income.

• Another option is to eliminate the corporate income

tax and allocate all corporate profits to shareholders.
Taxing non-cash income.

• Taxing income received in the form of in

kind benefits.
 The marriage penalty.

• Under a progressive income tax in which the tax

rate applies to total household income, two-
earner households may pay more in tax as a
married couple than if they were not married.
Taxing world-wide income.

• As globalization leads growing numbers of people to

work in countries outside their official homelands, the
taxation of households on world-wide income has
become a critical issue.

• Taxing individuals on their world-wide income

eliminates this inequity.
 Taxing capital gains
• capital gains, the increase in value of assets held
• add to taxpayers’ net worth.
• taxing capital gains raises a variety of issues. These include:

• These include:
a. When to recognize the gain
b. How to value the gain.
c. What can capital losses offset?
 Tax allowances to encourage behavior

•Use the personal income tax to provide

incentives for certain objectives.
 Reaching “hard-to-tax” incomes
• A key challenge facing any personal income tax is the
difficulty of taxing certain kinds of income that can be
easily hidden, because of limited record keeping or
the difficulty of monitoring and verifying taxpayer
records.
 The degree of progressivity

•Countries differ in the progressivity of

their personal income tax.
 Adjusting the income tax for inflation
• Because most tax laws define exemptions and
exclusions in very specific amounts, their value
declines with inflation. To prevent this, many
countries index their tax codes for inflation, often
raising the amounts by the observed rise in the
consumer price index since the previous year.
Taxing income versus consumption

• Taxing consumption rather than income provides more

incentives for savings, thereby providing greater financing for
investment and possibly inducing more economic growth.

• Consumption taxation has its own drawbacks. These include:

• a. Opportunities for windfall gains and losses
• b. Changes in marginal tax rates
• c. Issues in tax administration
Administrative issues regarding a personal income tax

• Requiring estimated or advanced payments of

tax provides another way to improve the
efficiency and yield of a personal income tax.
 THE CORPORATE
INCOME OR THE
PROFIT TAX
The corporate income or profit tax
• Is a major source of revenue in many countries. Nevertheless, average
tax rates have fallen in most countries during the last several decades,
and its contribution to total revenues has declined in developing
countries since the early 1990s,

• The corporate income tax has several points of interaction with the
personal income tax. As noted earlier, taxing corporate profits leads to
a double taxation of dividends when dividends received by
households are subject to the personal income tax.
 Incidence
• A perennial issue facing the corporate income tax is who bears the
burden of the tax. Although the tax is nominally imposed on
corporate profits, under some circumstances a corporation can shift
the tax forward, onto consumers.
 Issues of complexity and Equity.
• Taxing corporate profits typically makes a country's tax system more complex,
because the proper definition of corporate income involves allowing
deductions for the depreciation of plant and equipment, the depletion of
mineral assets, and changes in inventories (stocks) of unsold goods.

• Applying a "first in — first out" ("FIFO") rule may undervalue inventory

changes if goods produced earlier can be sold for higher prices today. On the
other hand, a "last in—first out" ("LIFO") approach may allow firms to
overvalue the cost of producing older items, thereby understating true
corporate profits.
 Creating a bias toward debt finance

• The corporate income tax is often considered to distort how firms

choose to finance investment, because interest payments are
normally a deductible business expense, but dividend payments are
not. Because dividends not only are not deductible, but may be
subject to double taxation.
 Various policy measures can address the
problem.
A. integrating the corporate and personal income tax, or exempting
dividend payments from tax,to address the double taxation of
dividends
B. taxing corporate cash flow, rather than profits, in which case both
dividend and interest
payments qualify are deductions, since they reduce corporate cash flow

C.Providing a special tax allowance for the dividends associated with

issuing equity
 Taxing multinational firms

• Tax rates and provisions vary across (and sometimes within) countries,
multinational firms can minimize their corporate tax liabilities through
the artful use of transfer pricing, which involves the pricing of good
produced in one jurisdiction and then shipped to another for further
processing or final sale. Charging artificially high prices for
components, a multinational firm can minimize the profits earned in a
high-tax jurisdiction.
 Tax incentives
• To promote investment and make the business climate
more competitive, countries often grant firms tax
incentives, including accelerated depreciation or other
allowances for investment, special rebates on other taxes,
tax breaks for exporters, and the creation of free trade
zones, or outright exclusion from tax for a specified period
of time either on all profits or on all profits resulting from
specific activities or investments.
PAYROLL TAXES
 Payroll Taxes
Taxes imposed on wages and salaries. They are typically
separate from personal income tax, which are levied on
a much broader set of income sources.
• In most countries...

• Payroll taxes are used to fund Social insurance programs such as various
social funds in Eastern Europe and the Social Security program in the US.

• In a few countries like Malaysia and Singapore, mandatory contributions

are imposed to accumulate balances in individual provident fund
accounts that can be used to finance pension, pay for housing or
university tuition or fund a portion of medical expenses.

• Although in most countries, payroll taxes are levied both on employers

and employees, and research suggest that workers typically bear a large
portion, if not all, of the Burden of the taxes
 Payroll taxes offer the advantage of simplicity.

• They are typically easy to collect, although in some countries

enforcement at smaller firms has sometimes proved difficult. Because
they are levied only on wages and salaries, they are typically
regressive since non-wage income, which forms a larger share of the
income of upper-income households, is exempt from the tax.

• Where the tax is levied only on income up to a ceiling, as in the USA,

tax is even more regressive, since households with earnings above the
ceiling pay no more in tax than those at the ceiling
• Payrolls are levied only on wages up to ceiling amount, the tax
may discourage employment, and because firms pay no more
tax on an employee once his or her wage has reached the
ceiling. Thus, payroll tax may encourage some firms to limit the
number of employees and instead impose overtime on their
workers, to minimize labor costs.
 
• For this reason, countries like Singapore sometimes vary the
employer's rate of social insurance contributions, lowering the
rate during recessions to discourage layoffs and then restoring
it when the economy becomes stronger
• Payroll taxes may also discourage employment if, together with the
personal income tax, they result in a high effective tax rate on labor.

• In the Ukraine during the early 1990s, for example, the combined
impact of the personal income tax and social insurance levy was a
marginal tax rate on labor exceeding 50%. For firms seeking unusually
qualified employees, the resulting high marginal rate meant that gross
wages had to be very high to yield a particular level of after-tax income.

• Similarly, in the United States, highly paid independent contractors,

who are liable for both the employer's and employee's shares of Social
Security, can face a marginal tax rate of more than 50% : 35% from the
federal income tax, 13.8 percent from the Social Security tax,14 plus as
much as 6.5 percent or more from state and local income taxes.