Taxation: features, Reasons, Principles, Tax base and Tax rate, direct and indirect tax

CONTENTS

1. Definition  of Taxation
2. Features of Taxation
3. Reasons for the Imposition of Taxes
4. The Principles of Taxation
5. The Concepts of Tax Base and Tax Rate
6. Forms (Systems) of Income Tax
7. Direct And Indirect Taxes.
8. Problems Associated with Tax Collection in Nigeria.
9. Incidence of Taxation

DEFINITION

Taxation– is defined as the act of imposing a compulsory levy by the government on the income of individuals, firms, and goods and services. That is, itis a compulsory payment made by each eligible citizen towards the expenditure of the country. It is a compulsory contribution imposed by a government authority on goods, individuals, corporate bodies (business) without regard to the specific benefits that the taxpayer may receive.

FEATURES OF TAXATION

1. It is a compulsory levy that must be paid by individual or corporate bodies.
   1. It is levied only by the government or its agency
   1. It is a payment made as a sacrifice.
   1. It is meant for the general welfare of everybody.
   1. Tax payment has age limit.

REASON FOR THE IMPOSITION OF TAXES BY THE GOVERNMENT

1. To raise revenue for the government
2. Taxation is used to redistribute income i.e. to lower / reduce the income gap between the rich and the poor.
3. To protect infant industries – infant industries are newly formed industries that has to be protected from competition by already established industries.
4. To stop or discourage the importation of dangerous or harmful goods e.g cigarettes
5. Taxation is used as a fiscal device to control the economy i.e. to control inflation, deflation or influence the rate of consumption, investments and savings in the economy
6. To encourage industrialization e.g by tax rebates or tax holidays for industrialists
7. Taxes are also used to promote social services such as social insurance, poor and elderly relief, health insurance etc.

EVALUATION

1. Define Tax.
2. List four importance of tax to the govt.

PRINCIPLES OF TAXATION

Adam Smith in his book Wealth of Nation lays down four canons or attributes of a

good tax system. They are:

1. Principle of Equity: This principles emphasizes that the tax imposed must be in

consonance with the tax payer’s ability to pay. In other words, the tax imposed should be in fair proportion to the taxpayer’s income. The progressive tax system reflects this.

• Principle of Certainly: The tax payer must know how much he / she is to pay, in what medium, where, when and how the tax is to be paid.
• Principle of Convenience: The method and time of tax collection should be convenient to the tax payer e.g wage/salary earners at the end of the month, farmers during harvesting period etc.
• Principle of Economy: The cost of collection of taxes should be small relative to the amount collected. It will neither be frugal not prudent to use resources of N10,000 to collect In addition to the above, the following principles of a good tax system should be noted.

5.         Principle of Flexibility: A good tax system should be capable of being changed when conditions and situations warrant such changes.

6.         Principle of Neutrality: A good tax system should not be a disincentive to enterprise or productively i.e. it should not interfere unnecessarily with the supply and demand for goods, services and labour.

7.         Principle of Simplicity: A good tax system should be simple enough for easy understanding.

8.         Principle of Impartiality: There should be no discrimination in the collection of taxes.

9.         Difficult to evade: A good tax system should ensure that tax evasion / tax avoidance are kept at a minimum.

EVALUATION

1. Highlight the principle of tax.
2. What is tax base?

SYSTEMS OF TAXATION / FORMS OF INCOME TAX

1. Proportional Tax: This is a form of income tax in which the same rate of tax is applied to the respective income of taxpayers. For example, if government applies a tax rate of 10% on all taxpayer income, a worker earning N15,000 will pay N1500 tax while a worker earning N60000 will pay N6000 as tax.
2. Progressive Tax: In this case, the percentage levied (tax rate) increases with the size of one’s income. A progressive tax takes a larger percentages of income from people with larger income. It reduces inequality of income from people with larger income. It reduces inequality of income distribution eg Pay As You Earn (P.A.Y.E.)
3. Regressive Tax: In this case, the proportion removed as tax from one’s income decreases as the person’s income increases i.e. The higher the income, the lower the rate of tax eg Poll tax, indirect tax etc. A regressive tax aggravate inequality of income distribution

TYPES OF TAXATION

Taxes are divided into two broad categories namely direct taxes and indirect taxes

DIRECT TAX:

It is the type of tax which is imposed directly on income of individuals or organizations

by the government or its agency. The burden of direct tax is borne by the payer. Examples of direct taxes are (a) Income tax (b) Company tax (c) Capital gain tax (d) Poll tax etc.

ADVANTAGES OF DIRECT TAXES

1.         They are progressive in nature

2.         The incidence of direct tax is easy to ascertain

3.         They are easy to calculate

4.         Payers find them convenient to pay

5.         Some specific group of people or business could be granted exemption from payment of direct tax.

DISADVANTAGES OF DIRECT TAXES

1.         They discourage savings

2.         They discourage investments

3.         They are difficult to assess (determined with accuracy) eg company tax.

4.         Cases of tax evasion is high (frequent)

5.         They discourage hard work

6.         It may result to squabbles between taxpayers and tax officials

ECONOMIC EFFECTS OF DIRECT TAXES

1. Direct taxes lead to a reduction in disposable income and consequently a reduction in consumption.
2. It discourages savings
3. It discourages hard work
4. It discourages investments and this would, in turn cause unemployment.
5. It leads to a redistribution of wealth
6. It reduces capital available for a company in form of retained profits

EVALUATION

1. Give three examples of direct tax.
2. What are  the advantages of direct tax?

INDIRECT TAX

This is a tax levied on goods and services. They are initially paid by either the manufacturer or importer of the goods who, as far as possible shifts the burden to the consumers in form of high prices. Examples of indirect taxes are customs duties (import duty and export duty) excise duty, purchase tax etc.

CLASSIFICATION OF INDIRECT TAX

This classification  reflects the different methods of calculating custom duties.

Specific Tax:  the amount difference of tax to be paid depends on the quatity of goods bought so that the greater the quatity of goods bought the greater the tax to be paid.

Ad Valorem Tax: the amount of tax to be paid depends on the value or quality of the commodity. This value or quality is measured in terms of the price of the commodity. This means that goods which have higher prices are supposed to have higher values and are therefore taxed more heavily than goods whose values and thus prices are lower.

ADVANTAGES OF INDIRECT TAXES

1. Their collection is less difficult
   1. They cause less squabbles
   1. It yields more revenue to the government than direct taxes.
   1. They are not easy to evade
   1. The burden is shared among all sections of the society.

DISADVANTAGES OF INDIRECT TAXES

1.         It causes inflation i.e. increases in the prices of goods.

2.         It may cause scarcity of goods

3.         They are unreliable sources of revenue

4.         Indirect taxes are regressive in nature

5.         They are non-discriminatory i.e. some group of people cannot be granted exemption from paying.

6.         They restrict free trade between different countries.

ECONOMICS EFFECTS OF INDIRECT TAXES

1. It can lead to inflation
2. It encourages smuggling
3. It reduces production e.g. excise duties thereby causing scarcity of goods.
4. It discourages investment
5. It can lead to changes in the consumption pattern

EVALUATION

1. State three advantages of indirect tax.
2.  List four disadvantages of indirect tax

PROBLEMS ASSOCIATED WITH TAX COLLECTION IN NIGERIA

1. Corruption and non- challant attitudes of revenue officers / tax collectors.
2. Tax evasion and Tax avoidance
3. Lack of proper accounting records by business enterprises
4. Ignorance / illiteracy / mass poverty of the populace
5. Apathy of tax payers as a result of corruption in high places  
6. Government’s inability to provide essential infrastructure and amenities eg electricity does not encourage people to pay tax.
7. Failure to declare real income, especially those in private firms

TAX EVASION AND TAX AVOIDANCE

Tax Evasion–  refers to an illegal attempt not to pay tax or pay less tax. For instance, someone could make false declarations of income or tax could be dodged completely.

Tax Avoidance-  refers to the efforts of a tax payer not to pay tax by finding a legal course to reduce the amount paid as tax. For example, the taxpayer could discover a part of the tax law that is ambiguous. He can therefore take advantage of this and easily defend himself legally if he does not pay tax or if he pays less tax. Tax avoidance is a legal etc.

CONCEPT OF TAX BASE AND TAX RATE

Tax Base– refers to the item of the object which is taxed. i.e.  the amount of the salary wages, income, profits, gains or assets upon which the calculation of tax to be paid is based

Tax Rate– refers to the percentage that is applied to the tax base in order to calculate the amount of tax payable by the taxpayer.

EVALUATION

1. State the difference between tax evasion and tax avoidance
   1. List five problems associated with tax collection

INCIDENCE OF TAXATION

Incidence of Tax– refers to the point where the tax burden  finally rests. It is the final location of the tax burden in terms of the person who feels the financial pains of the tax payment.

Tax Burden– refers to the onus, the psychological pain effects as relate to the amount paid as tax. The burden of taxation is the financial pain in parting with a proportion of one’s income as tax.  The incidence or burden of taxation lies on the person who finally pays the tax. There are two types of tax incidence

a.         Formal incidence: this refer to where the in initial burden of taxation lies. The payer of a direct tax bears the initial burden of tax. For indirect taxes, the producers or the middlemen bears the initial burden of taxation.

b.         Effective incidence: This refers to who bears the ultimate or final burden of taxation. In the case of direct taxes the payer bears the full burden of taxation. He bears both the formal and effective incidence.

INCIDENCE OF TAXATION AND ELASTICITY OF DEMAND FOR GOODS

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 (or 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. Where the demand for the commodity is Perfectly Inelastic, the whole tax burden can easily be shifted to the consumer by the seller.
2. Where the demand for the commodity is Perfectly Elastic, the seller or producer will bear the whole burden of taxation. This is because any attempt to increase prices will make the demand for the commodity to fall to zero. The tax burden cannot, therefore be passed to the consumer.
3. Where the elasticity of demand for the commodity is Unitary, tax burden is shared equally between the producer / seller and the consumer.
4. Where the elasticity of demand for the commodity is moderately elastic or moderately inelastic, the burden of taxation will be shared between the producer (seller) and the consumer depending on the extent of the elasticity.

EVALUATION QUESTIONS

1.         Define the term – formal incidence of tax

2.         Show with the aid of a diagram, who bears the incidence of tax of a commodity having inelastic demand.

READING ASSIGNMENT

Amplified and Simplified Economics for sss by Femi Longe pages 366-378.

GENERAL REVISION

1. What is labour force?
2. Distinguish between labour and labour force.
3. Define the profit of a firm.
4. Different implicit and explicit cost.
5. What is wholesale trade?

WEEKEDND ASSIGNMENT

1.  A tax on a commodity whose demand is perfectly inelastic will fall heavily on the (a) consumer (b) manufacturers (c) wholesalers (d) retailers

2.  A tax whose rate increases as income increases is (a) an indirect tax (b) a progressive tax (c) a regressive tax  (d) a proportional tax.

3. Which of the following is not a principle of taxation? (a) certainty (b) convenience (c) economy (d) security

4.  Mr Bello’s income is $800 per month while that of Mr Jatau is $1200. If Mr Bello and Jatau pay $80 and $120 respectively as taxes, the tax system is …………… (a) progressive (b) regressive (c) proportional (d) ad-valorem

5.  A worker earns $80000 per annum. He pays $4000 as tax. What percentage of his income does he pay as tax? (a) 10%  (b) 8%  (c) 5%  (d) 4%.

THEORY

1.         What is an indirect tax?

2.         State three economic effects of taxation.