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Chapter Two

Taxation: The Source of Public Revenue

After completing this chapter you are expected to: Discuss the overview of taxation Discuss the meaning of tax Explain the objectives of taxation Understand the characteristics of taxation

2.1 Overview of taxation

Taxation is a system of raising money to finance(soldiers and police, build dams &roads, to operate schools and hospitals, and for hundreds of other purposes) of government Taxes are as old as civilization. There has never been a civilization that has not collected taxes. The first civilization that we know that started in Sumeria, in todays Iraq, the inhabitants accepted the need to pay tax to 2 finance a great war.

However, even when the war was over, the taxmen did not want to give up their privilege of collecting taxes. In Ancient civilizations of Palestine, Egypt, and Babylonia, rulers earned income in the form of food from their land, and metals from their mines. They taxed farmers by requiring them to give some proportion of crops to the state. People were also forced to work for the rulers because the kings were the sole owner 3 of everything.

Poll taxes were a major source of revenue in Egypt during 323 BC- 30 BC. The government of ancient Athens (Greece) relied on publicly owned silver mines, tribute from conquered countries, a few customs duties and voluntary contributions from citizens for revenue. Romans used to pay poll taxes in earlier days, but govt exempted citizen from this tax in the 2nd century. More than 100 years later, Emperor Augustus introduced land and inheritance tax. 4

During the Middle Ages (5th to 15th century AD), Europeans were subject to many forms of taxation such as land tax, poll tax, inheritance tax, and toll tax (payment for the use of roads, bridges etc). Roman Catholic Church also collected tithe, fees, fines, and tolls. These urban centers collected revenues using taxes on property as well as sales tax from certain items.

During 16th and 17th centuries European states relied heavily on the revenue generated from the Kings own states and from tax on land. The power of Parliament grew steadily and in 1689 the English Bill of Rights guaranteed that the king could not tax without parliaments consent. By18th century England started imposing various taxes on transactions. Taxes on imported goods assumed greater importance.

In the late 19th and 20th centuries, concerns about both fairness and ability of tax systems to generate tax revenue led governments to enact income tax. The first progressive income tax was first introduced in Prussia in 1853. Other countries like Britain, United States, and France introduced progressive income tax in 1906, 1913, and 1917 respectively. Although income taxes generated little revenue at first, they play a major role in all modern tax 7 system today.

2.2. Meaning and definition of tax

A tax is a compulsory charge imposed by the Government without any expectation of direct return or benefit to the tax-payer. This implies that there is no quid pro quo relationship between the government and the tax payer. Taxes can also be defined as payments extracted by government from people and organizations to fund public expenditure, without rendering proportionate benefit, by the use of 8 law

In a modern state, government is expected to offer public goods like: Defense, high ways, etc. These public goods have the characteristics of none excludable (consumption of such goods by one person is impossible to exclude others) and non rival (once a good is provided, the additional cost of another individual consuming the good is zero). There is no price mechanism to protect non excludability & none rival in consumption goods, as a result, Private sectors cannot supply it. Therefore, government is forced to levy taxes to9 finance these and other necessary expenditures.


The act of laying a tax or of imposing taxes, as on the subjects of a state, by government, or on the members of a corporation or company, by the proper authority is known as taxation. Not only financing of public goods, Taxation is one of the component of fiscal policy and it can enable government to stabilize the economy and adjust the income distribution. We also argued that taxation should be efficient and contribute to economic growth.

It constitutes an involuntary saving by taxpayers which is diverted to government for use in resource allocation.


2.3 Characteristics and Objective of Taxation

Characteristics of Taxation
i) Tax is a compulsory contribution: no taxpayer can refuse the payment on the ground that he/she doesnt receive any direct and immediate benefit. ii) The taxpayer will be required to pay tax if it is due form him: Taxes cannot be demanded from a person if it is not required to be paid. For example, tax on liquor cannot be collected from a person who doesnt drink liquor. 12

Characteristics of Taxation
III) Taxes are levied by government: Nobody else has the right to do so. By any means necessary and feasible, the government will claim its right to collect taxes by the use of law. IV) Common benefits to all: The expenditure incurred by government through the collection of tax is meant for all the people regardless of who pays tax and who do not. V) No Direct benefit: When an individual pays taxes, he cannot expect to receive an immediate, direct, and equivalent amount of service from the government in return.


VI) Certain Taxes are levied for specific objectives: Government levies tax on certain goods in order to reduce its consumption by the public too. For example, Government levies taxes on luxury goods to reduce its consumption and divert the resources to production and distribution of essential goods. VII) Attitude of Taxpayers:


VII)Tax system goes in harmony with the National objectives: It tries to accommodate the problems of taxpayers. The system should be flexible with the changing requirements of the economy. VIII) Funding public expenditure:Money collected from taxes will be used for expenditures such as construction of roads, payment of salaries of civil servants, financing of public programs and projects etc.

Objectives of Taxation:
Revenue generation, however, is not the only objective of taxation, though it is clearly the prime objective. The specific purposes of levying taxes may be summarized as follows: Supporting the operations of government Influencing the macro economic performance of the economy. Governments achieve this through its fiscal policy.

Carrying out the functions of the government such as national defense and providing government services. Redistributing resources between individuals or sections in the population.


General Objectives: In the beginning, Government imposed taxes for three basic purposes these are, to cover the cost of administration, maintaining law and order in the country, and for defense. But, in modern days, there have been a lot of changes in the Governments expenditure pattern. Today, the Government is in the position to restore social justice in the society by way of providing various social services like education, employment, pension, public health, housing, sanitation and the development of weaker 18 sections of the society.

Non-tax revenues are not sufficient to meet the entire expenditures. Hence, Government imposes taxes of various types. The general objectives of taxes include: 1. Raising Revenue 2. Removal of Inequalities in Income &Wealth. 3. To change peoples behavior. 4. To reduce private consumption 5. To promote Economic growth and stability 19

6. Reduction in Regional Imbalances 7. Capital Accumulations 8. Beneficial Diversion of Resources. 9. Creation of Employment Opportunities 10. Encouragement of Exports