ST MARY’S UNIVERSITY

SCHOOL OF GRADUATE STUDIES

MBA IN ACCOUNTING & FINANCE

Course Title: Advanced Business Taxation

Course Code: MAF 652
Credit hours: 2

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 Course Description

• Advanced Business Taxation course is designed to provide students

with a sound understanding of taxation in general and the Ethiopian
tax system in particular.
• It will consider the problems and options in theory while at the same
time providing some insight into the practical implications of taxes.
• Furthermore, this course intends to create awareness among students
about the role of taxation in the financial management of
businesses; and also to enable students appreciate the role and
significance of taxation in economic development.
• The course will thus provide the skills necessary to appreciate the
concepts and principles underlying the various aspects of a tax
system.

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• This course is designed with the objectives of enhancing
the awareness of students about
• the significance and role of taxes in financing government
expenditures,
• familiarizing students with the features of good tax system,
• enabling students know how the Ethiopian Tax system
operates and advise stakeholders accordingly.

• Moreover, it aims at enabling students visualize the

domestic and international tax issues and problems,
and come up with sensible contribution towards them.
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 LEARNING OUTCOMES

Upon successful completion of this module, students should be able to:

1. To identify the characteristics of taxes and taxation in general;

2. Understand the objectives and principles of a tax policy proposal and conflicts
among some of them;
3. Explain the problems in the application of the principles of a tax policy
proposal like equity principle;
4. Comprehend the types of taxes and tax system and practical problems in
deciding on tax bases (income, value added and other tax bases);
5. Explain the various issues in international taxation regime including issues of
taxation of foreign source incomes, international double taxation and
international tax avoidance through subsidiaries and transfer prices;
6. Comprehend on the role of taxation in financial decision makings such as
investment, dividend and finance decisions;
7. Distinguish between tax avoidance and evasion; and
8. Examine the Ethiopian tax system in the context of the theoretical
01/24/2024underpinnings of taxation. 4
 Contents

Course Content:
Chapter One: Taxation – an introduction
1.1. A general overview
1.2. Basics of taxation
1.3. Characteristics of tax
1.4. Objectives of taxation
1.5. Principles of taxation

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 Chapter Two: Tax systems and taxes

2.1. Single and Multiple tax systems

2.2. Direct Vs indirect taxation
2.3. Ad Valorem Vs Unit taxes
2.4. Tax on Income
2.5. Tax on commodities
2.6. Tax on wealth
2.7. Presumptive taxation
2.8. Tax administration and tax compliance

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 Chapter Three: International taxation issues

3.1. International taxation Vs domestic taxation

3.2. Residence and source based taxation
3.3. Global and territorial systems of taxation
3.4. Methods for preventing double taxation
3.4. Taxation and MNE
3.5. Tax Havens and transfer pricing

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 Chapter Four: Taxation and corporate financial decision making

4.1. Taxation and choice of finance

4.2. Taxation and choice of company location

Chapter Five: Tax evasion and avoidance

5.1. Tax avoidance
5.2. Tax planning
Features of tax planning
Basics of tax planning
5.3. Tax evasion
Causes of tax evasion

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 Chapter Six: The Ethiopian tax system

6.1. Income Tax in Ethiopia

6.1.1.Employment income tax
6.1.2. Income from Rental of Buildings
6.1.3. Business Income Tax
6.1.3. Withholding taxes on payments and imports
6.2. Value Added Tax in Ethiopia
6.2.1. Taxable transaction
6.2.2. Taxpayers
6.2.3. Tax Credit
6.2.4. Record keeping requirements

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 Teaching and Learning Strategies

• The subject will be taught using a combination of

lectures , material preparation and article reviews.

• These classes will be supplemented with both printed

and electronic learning materials and resources.

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 Mode of Assessment: Assessment 1: Article Review (Group ): Weight : 20%
Task: The article review is designed to assess students'
understanding of the theories and concepts of the issue
discussed in the article to demonstrate that students have met
objectives as outlined above.[ you are expected to choose any
two articles from the articles given to you and review as per
the guideline]
Assessment 2: Tax System In Ethiopia(Group):Weighting: 30%
Task: You need to choose one chapter based on the course outline
and you are expected to prepare your own notes. This will
assess students' understanding of the theories and concepts of
advanced business Taxation.
Submission Date for all assignments:
Assessment 3: Final Exam Face to Face (Individual): Weighting:
50%
Task: This exam, consisting of cases and short answer questions,
will test students' understanding of the theory and their ability to
apply the theory to business decisions.
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 Chapter One: Taxation – An Introduction

1.1. A general overview

Meaning of Public finance
Public finance vs Private finance
Components of Public Finance
1.2. Basics of taxation
1.3. Objectives of taxation
1.4. Principles of taxation

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 1.1. A General Overview

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 Public Finance: General Introduction
What is Public Finance?
• The term public finance is a combination of two
words. Namely public and finance.
• The ‘public ‘ is represented by the government or
state.
• The other word ‘finance’ means money resources.
• The money resources in the form of income and
expenditure.
• The public finance refers to the systematic study of
the operations of public income and expenditures of
the public authorities.
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• Definitions
Adam smith- “ Public finance is an investigation
in to the nature and principle of the state revenue
and expenditure’.

Prof. Dalton- “public finance is concerned with

income and expenditure of public authorities and
with the mutual adjustment of one another.”

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• Findlay Shirras;’ ‘ Public finance is the study
of principles underlying the spending and
raising of funds by public authorities”.

• H.L Lutz- “ Public finance deals with the

delivery, custody and disbursement of
resources needed for conduct of public or
government function.”

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• Harold Groves - “Public finance is a field of enquiry that
treats on income and outgo of governments (i.e. federal,
state and local).”

• Richard Musgrave - “The subject matter of public finance

is logically, though not solely, concerned with the financial
aspects of the business of the government.”
• C.F. Bastable - “Public Finance deals with expenditure and
income of public authorities of the state and their mutual
relation as also with the financial administration and
control”
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• By this definition, we can understand that public finance deals
with
– income and expenditure of government entity at any level be it
central, state or local.
– However in the modern day context, public finance has a wider
scope – it studies the impact of government policies on the economy.
– concerned with the financial aspects of the business of the
government
– Deals with the financial administration and control
– study principles underlying the spending and raising of funds by
public authorities”.

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 similarities Between Private Finance And
Public Finance
1.Maximum Advantage
2.Precedence of Income
3.Scarcity of resources
4.Borrowings
5.Adjustment of Income and Expenditure

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1. Maximum Advantage
– The objective of the both is to secure the maximum
advantage out of the expenditure.
– Private individual tries to maximum Utility out of his/her
expenditure and Government Wishes to achieve maximum
social Advantage out of its Expenditure
2. Precedence of Income
 In private finance, the Income must precede expenditure.
 In public finance as well, the revenue has to be raised before
the expenditure can be met.

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3. Scarcity of resources
Scarcity of resources in relation to ends is a factor common to
both.
The private individuals as well as the state have to adjust their
scarce resources to meet multiple ends.
4. Borrowings
Both the private individuals as well as the state have to resort to
borrowing when expenditure exceeds revenue.
5. Adjustment of Income and Expenditure
Both the public and private finance always face the same problem,
i.e., the problem of adjustment of income and expenditure.

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 Differences Between Private Finance and
Public Finance
1. Determination of Expenditure
2. Differences in credit status
3. Right to print currency
4. The law of Equi - marginal utility
5. Nature of Budget
6. Compulsory character
7. Coercive Method
8. Secrecy of the budget
9. Elasticity of finance
10. Pattern of Expenditure
11. Time Duration
12. Differences in objective
13. Effect on Economy
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1. Determination of Expenditure
• Government first determines the volume of expenditure that it
has to incur on different heads to perform their obligations and
then tries to find out the resources to meet this expenditure.

• Individual first considers his/her income and then determines

the volume of expenditure, it has to incur on different heads or
items of consumption

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2. Differences in credit status
 The credit of a private individual is, at best, limited.
 An individual can borrow a limited sum of Money for a
limited source
 Private individuals can rise credit only within the economy
 It means that the private finance has a limited source
 The government enjoys a very high degree of credit in the
market
 It can borrow large amounts not only from its citizens
but also from the foreigners

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3. Right to print the currency
 The government has a source of income which is not
available to the private individual
 The government can print notes which are legal
tender within the country
 The government often resorts to the printing press
to cover the deficit in the budget engendered by war or
an economic crisis
 The private individual enjoys no such right of
printing the currency
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4. The Law of Equi – Marginal utility
 The private individual arranges individual Expenditure in accordance
with the law of Equi- Marginal Utility
 A Private Individual distributes his income between consumption and
savings in such a manner as to equalize their marginal utility
 A Private individual tries, as far as possible, to apply the law of Equi –
Marginal Utility to his Expenditure
 The government does not give as much importance this law as a private
individual does
 Modern governments sometimes incur certain types of
expenditure from which they do not derive any advantage
 They do incur this type of expenditure to satisfy certain sections of the
community
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 5. Nature of Budget
– Surplus budget is always god for a Private
Individual
– Private individual spend less than their
income and save something
– The government generally Prefer deficit
budget
– Government spends more than its income

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6. Compulsory Character
 Public finance is known for its compulsory Character

 The public authorities cannot avoid or postpone certain

expenditure Eg; Expenditure on Defense public
administration, maintenance of law etc.

 Private finance is voluntary in nature

 Individuals can plan to postpone their expenditure

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 7. Coercive Method
– The government can use coercive methods to
collect revenue
– For example government can raise non repayable
loans
– No citizen can refuse to pay taxes if he is liable
to pay them
– Private individuals cannot use force to get their
income
– Individuals have to earn their income by their
own efforts.
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 8. Secrecy of the Budget
 The budget of an individual is covered in mystery

 Secrecy is maintained in budget of the private finance

 But in the case of government budget there is no

secrecy is maintained

 In a democratic country , the government presents its

budget before the parliament where it is widely
discussed and subjected to criticism
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9. Elasticity of Finance
 Public Finance is more elastic/flexible than private
finance
 There is no much scope for changes in private finance
 In Public finance drastic changes can be done
Example – A private individual cannot effect any special
increase in his income nor he can bring about any special
changes in his expenditure
 But, the government can increase its income imposing
new taxes. Likewise it is also in a position to make the
necessary changes in its expenditure

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10.Pattern of Expenditure
The Public expenditure is governed by deliberate
economic policy of the government.

The economic, social and political requirements of the

country are considered while planning the public
expenditure
Private finance is influenced by habits, fashion, customs,
status and personal needs of the individual

Immediate objective of the private finance is maximization

of their satisfaction
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11.Time Duration
 In public finance state allocate resources on various
projects which yield return only in the future. Example
investment in education
 It means public finance has a long term perspective.
 In private finance private individuals tries to satisfy
their present needs and are interested in obtaining quick
returns
 It shows that private finance has a short term
consideration

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12.Differences in objectives
The objective of private finance is to fulfill private
interest.

The objective of Public finance is to secure the

maximum social advantage to the society

The motive of private expenditure is personal benefit.

The motive of public Expenditure is social Benefit.

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13.Effect on Economy
• Private expenditure, being small in relation to public
expenditure, has only a marginal effect on the economy

• Public expenditure being in gigantic size has a

tremendous impact on the economy

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 Objectives of Public Finance
1. To Secure adjustments in allocation of Resources
2. To maintain economic stability
3. To accelerate economic development
4. To secure distributive justice
5. To reduce economic inequalities
6. To achieve full employment
7. To achieve optimum utilization of resources
8. To increase rate of capital formation by increasing the
rate of saving and investment

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 COMPONENTS OF PUBLIC FINANCE

1. Public Revenue
2. Public Expenditure
3. Public Debt
4. Financial Administration
5. Economic Stabilization

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 1. PUBLIC REVENUE

• The income of the government through all sources is

known as public revenue.

• This component deals with the different sources and

methods of raising the revenue to the government

• It also studies about the classification of taxes, burden

of taxes, effects, taxable capacity etc.

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 2. PUBLIC EXPENDITURE
• Public expenditure refers to the expenditure incurred
by the public authorities.

• This component deals with the principles and problems

related to the allocation of government spending

• It also studies about the classification of public

expenditure, its effect, public expenditure policies of
the government, and trends in public expenditure

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 3. PUBLIC DEBT
• Public debt refers to the loans raised by the
government both internally and externally.

• This component of public finance studies the need for

and methods of raising public debt and problems
related to raising and repayment of public debt.

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4. FINANCIAL ADMINISTRATION
Financial administration refers to the study of different
aspects of public budget.

It deals with the organizing and disbursing of the

finances of the state.

The objective of framing budget, the methods of framing

it, authorizing and audit etc., are studied under this

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5. ECONOMIC STABILIZATION
 this component of public finance studies the use of
public revenue and public expenditure to secure economic
stability and growth.

It includes various economic policies and measures of the

government that are used to achieve full employment,
balanced growth and optimum use of resources.

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 PUBLIC REVENUE
• Government needs to perform various functions in the field
of political, social and economic activities to maximize
social and economic welfare .
• In order to perform these duties and functions government
require large amount of resources.
• This resources are called Public Revenue
• The term Public Revenue can Be used in two senses
• Public Revenue Narrow sense:
• It includes only those sources of income of the
government which are described as revenue resources
• Wider sense It includes all the income & receipts of
the government irrespective of the sources
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PUBLIC REVENUE
• Narrow sense
- it includes only those sources of income of the
government which are described as revenue resources.
• These sources are not subject to repayment.
Eg:- tax, fee, fines etc.
• Wider sense – it includes all the income and receipts
of the government irrespective of their sources.
Eg:- loans raised by the government which is to be
repaid.

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 PUBLIC REVENUE
• In Aggregate public income or the public revenue is the
income of the government through all the sources.

SOURCES OF PUBLIC REVENUE

• The sources by which a government earns its income
are classified into two categories.
a. Tax Revenue
b. Non Tax revenue
1.Administrative Revenue
2.Commercial Revenue
3. Other revenues
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 • Tax revenue is the income that is gained by governments through
taxation.
• Taxes are compulsory contribution levied by the state for meeting
expenses in the common interests of all citizens.
• Tax revenue can be classified into:
(1) direct taxes and
(2) indirect taxes.
• Direct Taxes: A tax is said to be direct, if the tax payer bears the burden
of the tax. He cannot shift the burden to any other person. Example –
Income tax, wealth tax and gift tax.

• Indirect Taxes: Indirect tax is shifted by the payer to others. If sales tax
is imposed on sugar, the producer or dealer who pays it passes it on to the
next buyer and ultimately the burden is borne by the consumer. Example-
Sales tax.
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 NON – TAX REVENUE SOURCES

• Non-Tax Revenue sources of public revenue which are

raised by the government from other than tax in the
economy.

1. ADMINISTRATIVE REVENUES
2. COMMERCIAL REVENUE
3. OTHER REVENUES

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1. ADMINISTRATIVE REVENUES

a. Fees
b. Special Assessments
c. Fines and Penalties

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a. Fees Prof. Seligman – “A payment to cover the cost of each recurring service
undertaken by the government, primarily in the public interest, but arranging a
measurable special advantage on the fee payer” (Essays in Taxation)
• Fees is a payment charged by the government to bear the cost of
administrative services rendered in public services.
• Fees is not a voluntary payment it is a compulsory payment.

b. Special Assessment :-
• Prof. Seligman – “A compulsory Contribution, levied in proportion to the
special benefit derived to cover the cost of special improvement to property
undertaken in the public interest.”
• Example - by the construction of roads, schools etc are going to yield some
common benefit to the society. Because of this the values or the rent of the
property may increase.
• So that the government can impose some levy on these special assessments to
recover a part of expenses incurred.

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c. Fines and Penalties
These are not an important source of public
revenue.
Fine - punishment imposed for infringement of law.

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2. COMMERCIAL REVENUE
• Public authorities own and manage commercial and
industrial enterprises
• Example – Railways, Post, different modes of Transport
and other public sector industries
• The income earned by these public sector enterprises by
selling the goods to the citizens is known as the
commercial activity
• In other words commercial revenue is the income
earned by the government by involving in commercial
activities

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3. OTHER REVENUES
a. Gifts, Grants and Donations
b. Government properties
c. Public borrowings
d. Recovery of loans
e. Miscellaneous Sources

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a) GIFTS, GRANTS & DONATIONS: Government earns
income in the form of gifts, grants and donations
offered to it by the citizens, institutions and foreign
governments and international institutions for
different purposes
 For example grants by the international monetary
institutions for rehabilitation work during the natural
calamities
b) GOVERNMENT PROPERTIES
• Government earns income from public property like
land, Buildings, mines, forests, fisheries etc.,

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c) PUBLIC BORROWINNGS
• Public authorities can borrow from various sources both internally
and externally
• These sources include borrowings from its citizen, foreign
government, commercial banks, central bank of the nation,
international Monetary institutions like IMF, IBRD ( World Bank) ADB
etc.,
• These borrowings to be repaid in the future.
d)RECOVERY OF LOANS
• Governments may get revenue by way of recovery of loans due from
debtors to it
e)MISCELLANEOUS SOURCES
• Government may also get some revenue by auctioning Confiscated
goods, printing of currency notes, etc.,
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• PUBLIC EXPENDITURE

• Public expenditure is that expenditure which is incurred by the public

authorities (central, State or Local Governments) either for protecting
the citizens of for satisfying the collective needs of the citizens or for
promoting their economic and social welfare.

• Public expenditure is the money spent by government entities.

Logically, the government is going to spend money on infrastructure,
defense, education, healthcare, etc. for the growth and welfare of
the country.

• This area studies the objectives and classification of public

expenditure, effects of expenditure in different areas, effects of
public expenditure on various factors such as employment,
production, growth, etc.
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• Public expenditure may be broadly grouped under two
heads.
• They are
A. Revenue Expenditure
B. Capital Expenditure
REVENUE EXPENDITURE
• Revenue expenditure refers to the expenditure incurred
by the government for the day-to-day administration
• Revenue expenditure classified into
1. Civil Expenditure
2. Defense expenditure
3. Grant in aid to other governments
4. Miscellaneous expenditure
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1. CIVIL EXPENDITURE
• Civil expenditure refers to the expenditure of the
government pertaining to the maintenance of justice,
law and order.

• Civil Expenditure Includes

1. Expenditure on General Services
2. Expenditure on Civil Services
3. Expenditure on Economic Services
4. Expenditure on Public Debt Service

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 1. Expenditure on General Services
• It involves the expenditure on Parliament,
Legislatures, Maintenance of embassies, government
departments, police force, Salaries of govt. Employees,
Ministers etc.,
2. Expenditure on Social Services
• It refers to the expenditure of the government on
social and Welfare activities
• It includes the expenditure on drinking water
facility, education, health, housing and various other
social security measures
• This kind of expenditure improves the social welfare
and standard of living of the people

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 3. Expenditure on Economic Services
It is the expenditure incurred on the development
of economic Activities
It includes promotion of industries, agriculture,
transport, trade communication, irrigation, banking etc.,
It helps in improving the productive capacity of the
economy
4. Expenditure on Public Debt Services
It includes the interest payments on the public debt
and repayment of public debt

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2. DEFENCE EXPENDITURE
• It includes the expenditure on defense forces,
production of arms and ammunition, pension to retired
defense personnel, etc.

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3. Grants-in-Aid

• It consists of the financial assistance given by

government to other governments.

•For example grant given by the central

government to the states and union territories for
financing their economic projects

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4. Miscellaneous Expenditure
• It includes the expenditure of the government in
providing subsidies to industrialists, exporters, relief and
rehabilitation of the people during the natural calamities,
financial aid to the economically vulnerable sections and
regions

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 B. Capital Expenditure
• It refers to the expenditure incurred on creating
permanent revenue yielding assets.
It includes
i. Developmental Expenditure: Development
expenditure: It is that expenditure which is incurred on
economic and social development of the country.
ii. Repayment of Public Debt
iii. Loans and Advances to other Governments

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 Role of public Finance in a Developing
Economy
1. To increase the rate of Capital Formation
2. To increase the rate of economic growth
3. To Achieve optimum utilization of resources
4. To Achieve Full Employment
5. To Reduce Economic inequalities
6. To Counteract inflation

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 Taxation and Other Disciplines
• Economics & Taxation
– Taxation is used as one of the tools of fiscal policy or
other economic measures and taxation uses different
economic models
• Public Finance and Taxation
– Taxation is used as a system of collecting public money
(public revenue)
• Tax Law and Taxation
– Tax Laws provide the rules & regulations that are used
to guide taxation so that the system will be streamlined.
• Politics and Taxation
– Political decisions on tax related issues directly or
indirectly affect the environment of taxation.
– In political campaigns, taxation is an instrument to win
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 1.2. Basics of Taxation

• Taxation, Tax definition:

• The most important source of revenue of the government is
taxes.
• The act of levying taxes is called taxation.
• Taxation is defined as a system of collecting money – tax
revenue – to finance government operations.
• All governments require money to undertake different
functions.
• The required money – taxes – is collected from the citizens.
• Without taxes to fund its activities, government could not
exist.

• Taxation is a compulsory collection of money by

government;
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 Definition of Tax
• A tax is a compulsory charge or payment imposed by
government on individuals or corporations without any
expectation of direct return in benefit”

• Tax is defined as a compulsory contribution levied on

persons, property, or businesses for the support of
government for economic and social operations.

• In other words, it is money paid to a government from

people and organizations to fund its programs and
services(public expenditures).
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• Taxes Transfers resources from private to public
consumption.

• Taxes are involuntary levies without a quid pro quo(a

thing given in return for something else);

• Thus, tax can be defined as “an involuntary fee or

more precisely, “unrequited payment” paid by
individuals or business to a government

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Essential characteristics of tax include:

1. It is an enforced contribution
2. It is generally payable in money.
3. It is proportionate in character, usually based on the
ability to pay
4. It is levied on persons and property within the
jurisdiction of the state
5. It is levied pursuant to legislative authority, the power
to tax can only be exercised by the law making body
6. It is levied for public purpose
7. it is commonly required to be paid a regular intervals.

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 1.3. Objectives of Taxation
• Tax objectives are goals that are expected to be
achieved through the taxation system.
• Tax measures influence economic activities –taxation
affects various decisions;
• savings, investment and labor supply
• Objectives of taxation may differ between developed
and developing countries.
• A tax system by itself cannot be expected to achieve all
the goals fully.
• It has to fit in the overall framework of policies and
measures of the government.

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• Initially, governments impose taxes for three basic
purposes:

1. To cover the cost of administration,

2. Maintaining law & order in the country and
3. For defense.

• But now government’s expenditure pattern changed and

gives service to the public more than these three basic
purpose.

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Con’t
 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
2. Removal of inequalities in income and wealth
3. Ensuring economic stability
4. Reduction in regional imbalances
5. Capital accumulation
6. Creation of employment opportunities
7. Preventing harmful consumptions
8. Beneficial diversion of resources
9. Encouragement of exports
10. Enhancement of standard of living
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Why do governments bother to tax? Alternatively,
government could:

• Finance its expenditures by printing money;

• Compulsorily seize the goods or services it needs, or
• Borrow money.

Problems with the above alternatives:

• Printing money merely debases(degrade) the currency
and causes inflation;
• Compulsory acquisition is a crude and not very fairly
distributed form of imposition and in any event under
our constitution requires just compensation and
• Borrowed money must be repaid or interest bill met.

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 1.4. Principles of Taxation
• How should a tax system be designed to raise a given
amount of revenue?

• What criteria should be used to evaluate the

advantages and disadvantages of a particular tax
system or tax policy proposal?

• It is concerned on criteria to be observed in

formulating tax structure.

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• There are various criteria (principles) that can be
followed in evaluating a tax policy proposal (tax
structure);

• Some of them are in conflict against each other;

• Some of the criteria such as equity are subjective;

• People may disagree on the relative importance

of the criteria;

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• A good tax system should not affect the ability and
willingness of the people to work, save and invest.

• If not, it will affect the development of trade and

industry and the economy as a whole.

• Thus, a sound tax system should contribute in the

economic development of a country.

• Hence, “taxation should not be like killing the goose

that lays golden eggs”.

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• Adam Smith (1776, ed 1952) calls them canons of a tax
system.

• There are four canons of taxation as prescribed by

Adam Smith (1776, ed 1952).

1. Equity
2. Economy
3. Certainty
4. Convenience

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• Smith’s canons were later extended by other
writers to include:

1. Neutrality
2. Productivity
3. Buoyancy
4. Flexibility
5. Simplicity etc

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 1. Equity

• One vital principle of a good tax system is fairness

(equity).
• This canon requires the tax system to be equitable.
• Taxes imposed should be fairly and equitably distributed.

• Everyone agrees that the tax system should be equitable,

i.e., that each taxpayer should contribute his/her
“fair share” to the cost of government.
• But difficulties in the use of this concept arise.
• There is no such agreement about how the term “fair
share” should be defined.

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• What a “fair share” means in practice is the subject of
endless contention and debate.

• It is endless because equity is intangible or non-measurable

and pronouncements on it reflect subjective attitudes.

• There are two types of thought in this connection:

1. The benefit principle
2. The ability to pay principle

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• Benefit principle
• An equitable tax system is one under which each taxpayer contributes
inline with the benefits which he/she receives from public services.

• The truly equitable tax system will differ depending on the

expenditure structure.

• The benefit criterion, therefore, is not one of tax policy only, but of
expenditure policy.

• Under this approach the total expenditure should be determined and

then the share of each taxpayer on government expenditure should be
known;
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• Ability to pay principle

• the tax problem is viewed by itself independent of expenditure

determination.

• A given total revenue is needed and each taxpayer is asked to

contribute in line with his/her ability to pay.

• The subjects of every State ought to contribute towards the

support of the government, as nearly as possible, in proportion
to their respective abilities;

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• leaves the expenditure side of the public sector untouched;

• Yet actual tax policy is largely determined independently of

the expenditure side and an equity rule is needed to provide
guidance.

• The ability to pay principle is widely accepted as this guide.

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• The ability to pay principle relates taxes paid to some measure of
ability to pay, such as overall wealth, income or consumption;

• No agreement on which one is best measure of ones ability to

pay;

• Ability to pay may vary depending on the measure chosen;

• For example, a taxpayer’s ability to pay, measured by overall

wealth, may differ significantly from his or her ability to pay
measured by income;

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• Limitations of both principles

• For the benefit principle to be operational, expenditure

benefits for particular taxpayers must be known.

• It fails to provide the revenue needed to finance transfers-

redistribution role of taxes is not properly handled.

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• For the ability to pay approach to be applicable, we must
know how this ability is to be measured.

• The ability to pay approach better meets the redistribution

problem, but it leaves the provision for public services
undetermined.

• These are formidable difficulties and neither approach wins on

practicality grounds.

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Horizontal and vertical equity
• Taxation according to ability to pay calls for people with
equal capacity to pay the same, and for people with
greater ability to pay more.

• The former is referred to as horizontal equity and the latter

as vertical equity.

• Vertical equity concerns people in unequal economic

circumstances.
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• Horizontal equity states that people who are
“similarly situated” should be taxed alike.

• It leaves open the essential question of what is meant

by “similarly situated”.

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 2. Certainty

• 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 all be clear to the taxpayer
and to every other person.
• Certainty pertains to objectivity.

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 3. Convenience

• The mode and timing of tax payments should

be convenient to taxpayers.

• This canon recommends that unnecessary

trouble to the taxpayer should be avoided,
otherwise various ill-effects may result.

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 4. Economy

“every tax should be so designed as both to take-out

[deduct] and to keep-out of the pockets of the people
as little as possible over and above what it brings into
the public treasury of the state” (Smith 1776, (1952
ed), p 362).
• taxes should not cause an unnecessary burden to
the society in the form of costs over and above the tax
liability.

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• IN ADDITION TO THE ACTUAL PAYMENT OF
TAXES, TAXES INDUCE OTHER COSTS:
A. Compliance and Administrative costs (Tax
Operating Costs)
B. Efficiency Costs

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 A. COMPLIANCE AND ADMINISTRATIVE COSTS (TAX
OPERATING COSTS)

– Tax compliance costs : Costs incurred by taxpayers

and third parts in the process of complying with
the requirements of a tax legislation;

– Tax administrative costs can be broadly viewed as resources

sacrificed by the public sector in connection with a tax system.

• Public sector costs of taxation conceptually constitute

those costs which would not have been incurred if the
tax had never been introduced (Sandford et al. (1989)).
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• Convenience and certainty canons deal with the tax
compliance costs while the economy canon is
concerned with both the administrative and
compliance costs;

• The economy canon deals with efficiency costs as

well

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 B. Efficiency Costs
Economic Efficiency
• Economic efficiency can be thought of as the
effectiveness with which an economy utilizes
its resources to satisfy people’s preferences.

• When resources are directed to their highest

valued uses the economy is said to be efficient.

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• If there are distortions in resource allocation, that
would reduce people’s well being in a variety of ways
that can include a loss of output or consumption
opportunities;

• These reductions in well-being are efficiency costs,

also called deadweight losses, excess burdens (excess
because they are costs in addition to the tax liability)
or welfare losses.
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• The total cost of taxes from a taxpayer’s point of
view:
=tax liability + efficiency costs + compliance costs

• Tax induced costs to the economy =

= efficiency costs + compliance and
administrative costs;

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 5. Productivity –

• Also called canon of fiscal(financial)

adequacy.
• The tax system should be able to yield
enough revenue for the treasury and
the government should have no need
to resort to deficit financing.

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 6. Buoyancy

• the tax revenue should have an inherent

tendency to increase along with an increase
in national income, even if the rates and
coverage of taxes are not revised.

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7. Flexibility –

• It should be possible for the authorities without undue delay to

revise the tax structure both with respect to its coverage and
rates, to suit the changing requirements of the economy and of the
treasury.

8. Simplicity

• the tax system should not be too complicated.

• Complex tax system is difficult to understand and administer and
breeds problems of interpretation and legal disputes.

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 Summary
• Among the various requirements for a good tax
structure the following are major importance,
although they are not meant to be all- inclusive:
– Revenue yield should be adequate.
– The distribution of the tax burden should be
equitable.
– Taxes should be chosen so as to minimize
interference with economic decisions in
otherwise efficient markets. Imposition of
“excess burdens” should be minimized.
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 Concept Questions
1. What is a tax?
2. Discuss the objectives of taxation.
3. What are the characteristics of good tax
system?
3. Discuss the canons of taxation enumerated by
Adam smith.
4. What is the difference between tax buoyancy
and productivity?
The End
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