Tax – features and types

Tax is a compulsory levy imposed by the government or its agency on individuals and firms or on goods and service.

FEATURES OF TAXATION

• It is a compulsory levy that must be paid by the individuals or corporate bodies.
• Tax is meant for the general welfare of everybody.
• It is levied by the government or its agencies
• People must attain certain age before they start paying tax.
• It is a payment made as a sacrifice.

PRINCIPLE OF A GOOD TAX SYSTEM

Adam smith in his book ‘Wealth of Nation” in 1776 has lead down certain principles of a good tax system which he called canons of good tax system. A good tax system has the following qualities:

EQUALITY OR ABILITY TO PAY: People should be made to pay tax according to their abilities.

ECONOMY: The amount spent in the course of collecting tax should be smaller than the amount collected.

CERTAINTY: The method and time of tax collection should be convent to the tax payer.

CERTAINTY: Tax payer should know the exact amount they are expected to pay as tax, when and how to pay it.

FLEXIBILITY: The tax system should be flexible enough for adjustments when the need arises.

SIMPLICITY: A tax system should not be difficult to administer and understand.

REASON OR WHY GOVERNMENT IMPOSED AXED

1. TO RAISE REVENUE: Taxes are used to raise revenue for government.
2. TO REDISTRIBUTE INCOME: Through the Pay as You Earn (P.A.Y.E) system, government can narrow the gap between the rich and the poor by introducing progressive taxation.
3. TO CONTROL INFLATION: Taxes can be used as anti-inflationary devices. Government can do this by increasing direct tax without increasing its expenditures.
4. TO STOP THE IMPORTATION OF DANGEROUS OR HARMFUL GOODS: Taxes imposed on such goods are high in order to discourage their importation
5. FOR THE PROTECTION OF INFLATION INDUSTRIES: This is done by heavily taxing foreign made goods in order to discourage their importation.

THE ECONOMICS EFFECT ON TAXATION

1. It reduce production
2. Tax increase prices of goods
3. It reduces the income of workers
4. It discourages savings

SYSTEM OF TAXATION

1. PROGRESSIVE TAX: This is a tax system where higher tax rate falls on high income earners and lower tax rate on low income earners. In order words the high income earners pay more tax than the low incomes earners e.g. Pay As You Earn.
2. PROPORTIONAL TAX SYSTEM: Under this system, every tax payer pays equal proportion of his or her income. The slight difference between proportional and progressive tax system is that while progressive tax rates varies with income, proportional tax rates is usually fixed, but the amount of tax payable varies in both cases.
3. REGRESSIVE TAX: regressive tax is a tax system where the tax rate decreases as income increase. In this case, the higher the income of a consumer, the lower the rate of tax. In regressive tax, a poor person pays a higher proportion of his income than a rich person. A good example is regressive tax is a poll tax flat rate tax.

Direct tax is refers to the type of tax imposed directly on the income of individuals or organisations by government or its agency. Such income would include wages, salaries, profit rents and interests. The burden (incidence) of direct taxes falls directly on the payers.

TYPES OF DIRECT TAX

1. PERSONAL INCOME TAX: This is refers to tax levied on the income of an individual, usually during a period of one year. Personal income tax is usually progressive ,i.e. the rate of tax increases as income of the individual increases
2. COMPANY TAX: it is levied in the profit made by the companies that operates in a particular country. It is also known as corporate tax.
3. POLL TAX: This is a flat rate tax usually imposed on those with low incomes.
4. CAPITAL TAX: this is the type of tax levied on property on capital assets e.g. land, cars, personal houses etc.
5. CAPITAL GAINED TAX: An increase in the value of capital assets is called a capital gain. A capital gains tax is tax levied on the gains or profits derived from the sale of land and capital assets.
6. EXPENDITURE TAX: This is tax levied on the part of a person’s income which is actually spent. This type of taxation is used to encourage saving.

ADVANTAGES OF DIRECT TAXES

1. Direct taxes are more equitable: They lead to a more equitable distribution of income.
2. Direct taxes are convenient to payers: Most direct taxes are due when the tax-payer can afford to pay. Salaried workers usually pay at the end of each week or month and the tax is deducted before payment is made.
3. They are cheap to collect: Under the P.A.Y.E system, the cost of collecting direct tax usually very small.
4. They are non-inflationary: They do not increase prices and therefore, are not- inflationary because money is taken from consumers and then purchasing power is thereby reduced.
5. They are progressive in nature: Income tax is usually administered with a graded scale, i.e. the more or higher an income, the more tax the person has to pay.

DISADVANTAGES OF DIRECT TAXES

1. They discourage savings: When tax is removed from one’s income, savings may become very difficult.
2. They discourage investment: High tax on individuals and corporate bodies discourages potential investors from investments.
3. Disincentive to hard work: High incidence of tax can discourage people from working hard as they always believe that the more one works hard, the higher the tax one has to pay.
4. Direct taxes are prone to tax evasion: People and firms could make false declarations of income in order to pay less tax.
5. They are inconvenient: Tax payers always feel the pains any time certain amount of money is deducted from their salaries.
6. They reduce purchasing power: When tax is imposed on the income of a worker, the balance may be small thereby reducing the purchasing power of such income earner.

INDIRECT TAXES

Indirect taxes are taxes levied on goods and services.

The producers or sellers bear the initial burden of tax before shifting them to the final consumers in the form of increase in prices.

TYPES OF INDIRECT TAXES

1. Custom Duties or Tariffs: These are grouped into two:
2. Import Duties: Import duties are taxes levied on goods imported or brought into the country from other countries. They are paid initially by the importer.
3. Export Duties: These are taxes levied on goods sent out (or exported) to other countries. Such tax is paid by the exporter.
4. Excise Duties: These are taxes levied on certain goods produced within the country, that is, on locally manufactured goods.
5. Sales Tax: This is tax levied on the sale of certain commodity.
6. Purchase Tax: This tax is imposed on certain consumer items such as cars, radios, and television sets etc.
7. Value Added Tax (VAT): This is the type of tax imposed on goods and services at each stage of production.

CLASSIFICATION OF INDIRECT TAXES

1. Ad Valorem Tax: an ad valorem tax is a tax imposed on commodities in accordance with their respective values and at specified percentages.
2. Specific Tax: This is a fixed tax sum imposed (or charged) per unit of a commodity irrespective of its value.

ADVANTAGES OF INDIRECT TAXES

1. Sources of government revenue: Indirect tax is used to generate substantial revenue for government.
2. Protection of Infant industries: Indirect taxes can be used to protect infant or local industries when heavy taxes are imposed on imported goods.
3. To check importation of harmful commodities: Commodities that are considered harmful are taxes heavily in order to discourage their importation.
4. Easy and cheap to collect: As soon as a consumer purchases in taxed commodity, he has paid the tax.
5. Prevention of dumping: High import duties can be imposed on certain imported goods as a way of discouraging dumping of such goods.
6. To correct balance of payment deficit
7. Indirect taxes do not discourage hard work

DISADVANTAGES OF INDIRECT TAXES

1. They increase prices of goods: This is because the amount paid as taxes is shifted to the consumers in form of high prices of goods.
2. Indirect Taxes are regressive in nature: This is because both the poor and the rich buy goods on which these taxes are imposed from the same source and at the same price.
3. They are unreliable sources of revenue.
4. Indirect taxes may generate inflationary trends within the economy.
5. It discourages investment: High custom duties on raw materials or finished products do discourage prospective investors.

Problems Associated with Tax Collection

1. False declarations of income : Many workers especially those in private firms do not declare their real income.
2. Improper book of account: Majority of the trader keep improper or no book of account at all.
3. Tax evasion : Many people not fulfil their civic responsibility by paying tax at as when due.
4. Ignorance of the importance of taxation
5. Mismanagement of government funds
6. Wrong belief of the people: Many people think that the money collected is for the tax collectors and therefore refuse to pay.

INCIDENCE OF TAXATION

The incidence of taxation refers to the burden of tax with reference to where this burden rests.

The incidence or burden of taxation lies on the person who finally pays the tax.

TYPES OF INCIDENCE OF TAXATION

1. Formal Incidence: This refers to the initial effects of tax on the tax object i.e. tax payer. The payer of a direct tax bears the initial burden of tax. For indirect taxes, the producers or middlemen bear the initial burden of taxation.
2. Effective Incidence: The effective incidence of tax makes reference to who bears the final burden of taxation.

For example, a person who pays income tax bears the full burden of the tax and he cannot shift to another person. In the case of indirect taxes, the burden of taxation may be borne by the producer (seller) or the consumer, or it may be shared between the producer (seller) and the consumer. The extent to which the producer (seller) or the consumer will bear the burden of indirect tax will depend on the elasticity of demand for the commodity which is taxed.

1. Incidence of indirect tax when demand is perfectly inelastic: The burden of an indirect tax on a commodity whose demand is perfectly inelastic is borne by the consumer.

In this case, the whole tax burden can easily be shifted to the consumer by the producer (or seller) in the form of higher prices because increase in price does not bring about any change in quantity demanded.

1. Incidence of indirect tax when demand is perfectly elastic: If demand for a commodity is perfectly elastic, the producer or seller will bear the whole burden of taxation. This is so because any attempt to increase price will make the demand for the product fall to zero. The tax burden under this situation cannot be passed to the consumer.
2. Incidence of indirect tax when demand is moderating elastic or is moderately inelastic: if the demand is moderately elastic or moderately inelastic, the burden of taxation will be shared between the producer (or seller) and the consumer. The more inelastic the demand for the commodity, the more the burden of tax is shifted to the consumer. On the other hand, the more elastic the demand for the commodity, the greater the burden of taxation the produce (or seller) bears.
3. Incidence of tax when demand unitary: If demand is unitary, the tax burden is shared equally between the producer (or seller) and the consumer.