principles of taxation by dr vinay kumar singh additional director (p&r)-ii, national academy of...
TRANSCRIPT
PRINCIPLES of
TAXATION
byDr Vinay Kumar Singh
Additional Director (P&R)-II, NATIONAL ACADEMY OF DIRECT TAXES, NAGPUR
Induction course for 65rd batch of IRSNADT, Nagpur, Dec’2011
We will try to cover…Principles of taxation
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
We will try to cover…Principles of taxation
What is a tax ?
•Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
TAXPrinciples of taxation
Why are there taxes ?
Tax is a compulsory charge on resources (usually money) imposed by an authority on people without a quid pro quo exchange of goods/ services.
Characteristics of tax
I. CompulsoryII. Charge on resources, usually moneyIII. Imposed by an ‘authority’IV. Imposed on peopleV. No good or service provided in exchange of tax in
a quid pro quo mannerDifferent from a ‘fees’ which is charged in exchange of goods or services provided on a ‘quid pro quo’ basis
We will try to cover…Principles of taxation
What do we need a tax ?
• Concept of tax
•Need for taxes– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
NEED FOR TAXESPrinciples of taxation
What is the role of market ?
Private individual Vs. Social Institutions– Consumption & Production are private activities– What is required from social institutions to help
these ‘private’ activities ?– How can society provide this help ?– What are the main social institutions ?• Family
– Tribes, communities
• Market• Government
NEED FOR TAXESPrinciples of taxation
What is the role of Government ?
The role of Markets– Transaction cost of buying & selling– Consumption efficiency
– Markets allow people to buy what they want– Allocation of resources for consumption which maximizes welfare
– Production efficiency– Markets allow producers to produce what is ‘in demand’– Efficient production least wastage; efficient resources in
production
Markets allow people to ‘privately’ consume and produce goods which allow people to consume what they prefer, within the given resources available
Efficient markets maximize social welfare
NEED FOR TAXESPrinciples of taxation
Why do we need redistribution of income ?
The role of Government1. Public Goods
• Not rivaled• Not excludable
– National defense; Law & order (protection of property rights); Regulations– Roads, Broadcasting
– Free-rider problem need financing from Society-Governments
2. Redistribution of Income• Markets do not alter initial endowment
– Often worsen INEQUITY Rich have capital Returns on capital further worsen the difference between rich & poor
NEED FOR TAXESPrinciples of taxation
How do we finance the Government?
The role of Government
3. In case of Market failures• Public goods are not provided efficiently by market• EXTERNALITIES: Benefit / Harm to society of private actions
(consumption / production)– Positive Externality : benefit to society
– Negative Externality : harm / loss to society
• Monopolies: produce less, charge more, society loses, INEFFICIENT– ‘Economy of scale’ industries
• Information asymmetry: Efficient markets require perfect information
• Asset Bubbles & Busts
We will try to cover…Principles of taxation
Can taxes be avoided?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
ALTERNATIVES TO TAXPrinciples of taxation
Why taxes ?
Ways of financing Government– TAX– Fees & charges
e.g. Fees for healthcare, fees for schools, electric / water charges
– Borrowing– DOMESTIC– EXTERNAL
– Aid / donations– Business profits (from PSEs)– Lease or Sale of assets / Disinvestment– Seigniorage (printing of currency)
– INFLATION TAX
– Penalties
ALTERNATIVES TO TAXPrinciples of taxation
What about taxes ?
Ways of financing Government
– TAX
– Fees & charges
– Borrowing
– Aid / donations
– Business profits (from PSEs)
– Lease or Sale of assets
– Seigniorage (printing of currency)
– Penalties
PEOPLE NOT READY TO PAY FOR PUBLIC GOODSAVOIDABLE UNPREDICTABLE AMOUNT
VERY UNPREDICTABLE
FIRST NEEDS INVESTMENT; RISK OF LOSSESGOVERNMENT USUALLY NOT GOOD IN DOING BUSINESS
DEBT NEEDS TO BE PAID BACKDANGER OF DEBT TRAPUNPREDICTABLE AMOUNT
NOT SUSTAINABLE IN LONG RUN IF ALL ASSETS ARE SOLD GOVT WITH NO AUTHORITY
PRINTING OF CURRENCY INRCREASES MONEY SUPPLY INFLATION EVERYONE LOSES INFLATION TAX
AVOIDABLE UNPREDICTABLE AMOUNT
ALTERNATIVES TO TAXPrinciples of taxation
Negative aspect of taxes ?
Ways of financing Government
– TAX
– Fees & charges
– Borrowing– Aid /
donations– Business
profits (from PSEs)
– Lease or Sale of assets
– Seigniorage (printing of currency)
– Penalties
SUSTAINABLE
PREDICTABLE
ALLOWS AUTONOMY NO OBLIGATION FOR
SERVICES OR SUPPLY
CREATES NO LIABILITIES (for later generations)
NEEDS NO INVESTMENT (by earlier generation)
AUTONOMY FROM DONORS’ REQUIREMENTS
DOES NOT NEED GOVT TO DO BUSINESS
(which it is not good at)
DOES NOT REQUIRE ANY SALES OF ASSETS
NO INFLATION
CAN BE COLLECTED WITHOUT RULE BREAKING
LESS ECONOMIC INEFFICIENCY
CAN BE MORE EQUITABLE
ALTERNATIVES TO TAXPrinciples of taxation
SHOULD WE HAVE TAXES ?
Ways of financing Government
– TAX
– Fees & charges
– Borrowing– Aid /
donations– Business
profits (from PSEs)
– Lease or Sale of assets
– Seigniorage (printing of currency)
– Penalties
NO QUID PRO QUO IN RETURN MOST DETESTED
USUALLY DISTORTS ECONOMIC BEHAVIOUR
can be economically inefficient
OFTEN REQUIRES COMPLEX LAWS, RULES &
PROCEDURES
COMPLIANCE & ADMINISTRATIVE COSTS
real burden on the society
PROBLEMS:
TAX (LEGAL) DISPUTES
TAX EVASION
TAX AVOIDANCE
CORRUPTION
ALTERNATIVES TO TAXPrinciples of taxation
REVENUE IS THE BACKBONE OF ADMISTRATION
Ways of financing Government
– TAX
– Fees & charges
– Borrowing– Aid /
donations– Business
profits (from PSEs)
– Lease or Sale of assets
– Seigniorage (printing of currency)
– Penalties
We will try to cover…Principles of taxation
How are taxes designed ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax
• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
TAX DESIGNPrinciples of taxation
What kind of rules ?
TAX DESIGNSet of rules on the basis of which a tax is charged from the people
RULE BASED TAXTax imposed by a set of rulesRules avoid arbitrariness in taxationIncrease objectivityMake it more predictableReduce dissatisfaction & disputesReduce cost of tax collectionAllow better planningLimit discretion of tax collectorCreate TAXPAYER RIGHTSREQUIRE RULES
ARBITRARY TAXTax imposed without any rulesArbitrariness in taxationIncrease subjectivityMake it less predictableIncrease dissatisfaction & disputesIncrease cost of tax collectionPlanning is very difficultHigh discretion of tax collectorNo TAXPAYER RIGHTSDo NOT REQUIRE RULES
TAX DESIGNPrinciples of taxation
What is a tax base?
TAX DESIGNSet of rules on the basis of which a
tax is charged from the people
TAX =
ALL OTHER FEATURES THAT AFFECT TAX LIABILITY OF TAXPAYERS
EXEMPTIONS OF TAX-BASEDEDUCTIONS FROM TAX LIABILITYDIFFERENTIAL TAX RATESVARIABLE TAX RATESOTHER SPECIAL PROVISIONS
BASIC DESIGN
SPECIFIC FEATURES
TAX BASE
TAX RATEX
Note:Tax design refers to Rules that
decide who will pay tax and how much
Tax design does not include “procedural rules” which decide the following:-how and when the tax will be paid-to whom-when-what if not paid-who will collect-who will decide if there is a dispute / mistake- what procedure needs to be followed, by whom & how
TAX DESIGNPrinciples of taxation
What is a LUMP SUM TAX ?
TAX BASEELEMENT ON WHICH TAX IS IMPOSEDA person is taxed on the basis of presence of
the tax base e.g. income, wealth (different from income),
property owned, property transacted, livestock, sales, purchases, manufacturing, trade, exports, imports, services, transportation, vehicles, fuel, water, inheritance, interest and expenditure, windows
TAX DESIGNPrinciples of taxation
Why not tax unhappiness, anger, jealousy?
TAX BASEELEMENT ON WHICH TAX IS IMPOSED
CHARACTERISTICS OF A TAX BASE
1. VARIABLE2. LINKED WITH ECONOMIC ACTIVITY
Consumption of valueProduction of valueStorage / owning of valueTransfer of value
3. OBJECTIVE QUANTIFICATION POSSIBLE
TAX DESIGNPrinciples of taxation
What can be the range of tax rate ?
TAX RATETAX CHARGED ON PER UNIT OF TAX
BASE
Usually expressed as ‘percentage’ or ‘proportion’ e.g. 20% (one-fifth) or 33.3% (one-third) per annum;
Oras amount of tax per unit of tax base,
e.g. one ounce of silver for every acre of landRs. 1000 for every square feet of commercial property
TAX DESIGNPrinciples of taxation
What about income-tax rates?
TAX RATETAX CHARGED ON PER UNIT OF TAX BASE
FIXED RATE – Rate does not change with a change in quality or quantity of tax base
VARIABLE RATE – Rate changes with a change in the quantity of tax basePROGRESSIVE: Tax rate increases with increase in quantity of tax baseDEGRESSIVE: Tax rate increases with increase in quantity of tax base, but the rate of this “increase” reduces with rise of tax baseREGRESSIVE: Tax rate falls with increase in quantity of tax base
DIFFERENTIAL RATE – Tax rate changes with quality (characteristics) of tax base
e.g. Capital gains, Agricultural incomeCustom duty of different goods imported
TAX DESIGNPrinciples of taxation
Any other examples?
SPECIFIC FEATURES
EXEMPTIONS OF TAX-BASETAX BASE ON WHICH NO TAX IS LEVIED
TYPESPERSON SPECIFICe.g. charitable trust exempted from income-taxACTIVITY SPECIFICe.g. income from exports exempt from income-taxQUANTITY SPECIFICe.g. Income not charged up to a certain limitQUALITY SPECIFICe.g. Vacant unused land exempt from property tax
TAX DESIGNPrinciples of taxation
Why is tax design important ?
SPECIFIC FEATURES
DEDUCTIONS FROM TAX LIABILITYREDUCTION OF THE TAX PAYABLE ON THE
BASIS OF PRESENCE OR ABSENCE OF SOME OTHER PRE-REQUISITES, WITHOUT AFFECTING THE TAX BASE AND TAX RATE, AS PER PREDEFINED RULES
e.g. deductions from income-tax on the basis of savings / medical expenditure / investment in special industry or backward areas / expenditure for research / charitable donations
TAX DESIGNPrinciples of taxation
Why do we have complex tax designs?
SIGNIFICANCE OF TAX DESIGN
AFFECTS ECONOMIC EFFICIENCY OF TAXExemptions, deductions, differential tax rates cause distortion of economic behavior
AFFECTS DISTRIBUTION OF TAX BURDEN IN THE SOCIETYProgressive tax more equitable (rich pay more tax than poor)
AFFECTS COSTS OF COMPLIANCE & ADMINISTRATIONSimple design easy to comply & administer less costs
TAX DESIGNPrinciples of taxation
Why do we have complex tax designs?
INCOME(TAX BASE)
TAX
RA
TE
QUANTITY BASED EXEMPTION OF
TAX BASE
QUALITY BASED EXEMPTION OF TAX BASE
DEDUCTION FROM TAX LIABILITY
30%
20%
10%
TAX PAYABLE
1.6 Lac
3 Lac
5 Lac
TAX CLASSIFICATIONPrinciples of taxation
What is a DIRECT tax?
Many different ways
– Benefit based taxation Vs Faculty based taxation– Direct Vs Indirect– Primary Vs Secondary– Tax on person Vs Tax on property Vs Tax on income– Tax on value at different times: ‘On
acquisition’ Vs ‘for possession’ Vs ‘On consumption’– Proportioned Vs Apportioned– Tax on “goods” Vs Tax on “bads”– Tax on capital Vs Tax on labour– Progressive Vs Digressive Vs Regressive– Accounts based taxes Vs Physical verification based taxes
TAX CLASSIFICATIONPrinciples of taxation
What about Inheritance tax?
DIRECT TAX
Collected from the person who bears its burden(taxpayer pays it from his own resources)
Usually Linked with a resource – current or expected
More predictable Levied per unit of time
EXAMPLESWealth tax, Income tax, Property
tax, Land tax, Corporate tax, Gift tax, Interest tax, Expenditure tax
INDIRECT TAX
Collected from the person who does not bear its burden(taxpayer collects it from others and pays)
Usually Linked with a transaction – as & when it takes place
Less predictable Levied per transaction
EXAMPLES
Sales tax, Central or State Excise, Property transaction tax (Stamp Duty), Value Addition Tax (VAT), Consumption tax
We will try to cover…Principles of taxation
What are the economic effects of taxes ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification
• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
ECONOMICS OF TAXATIONPrinciples of taxation
When is the market perfect ?
QUANTITY
PRIC
E
SUPPLY (MC)
DEMAND (MB)
MARKET EQUILIBRIUM
Q
P
MARKET DYNAMICS IN A PERFEC T MARKET
CONSUMER SURPLUS
PRODUCER SURPLUS
SOCIAL WELFARE = CS + PS
ECONOMICS OF TAXATIONPrinciples of taxation
What is ‘DWL’?
QUANTITY
PRIC
E
SUPPLY (MC)
DEMAND (MB)
NEW MARKET EQUILIBRIUM
Q’
P
MARKET DYNAMICS after a TAX is imposed on transactions
After-tax P
SUPPLY AFTER TAX (MC + TAX)
ECONOMY SHRINKS
People consume lessPeople produce lessTotal welfare from private economic activities falls
Tax
C S
P S
TAX REV
SOCIAL WELFARE = CS + PS + REV
DWL
ECONOMICS OF TAXATIONPrinciples of taxation
When are the effects of taxes on economy ?
MARKET DYNAMICS after a TAX is imposed on transactions
DEAD WEIGHT LOSS
LOSS OF ECONOMIC ACTIVITY RESULTING FROM THE DISINCENTIVE RESULTING FROM TAX
ECONOMICS OF TAXATIONPrinciples of taxation
What is significance of DWL?
EFFECTS OF TAX ON ECONOMY
– Tax increase the ‘cost’ of consumption / production
– Prices rise– “TRANSFER” of resources from
‘people’ to ‘government’ – Finance Govt. activities Public
goods, Redistribution – TAX ‘disincentivize’ economic
activities Dead weight loss
ECONOMICS OF TAXATIONPrinciples of taxation
Should we have taxes?
EFFECTS OF TAX ON ECONOMY
– Dead weight loss is the real “COST” of a tax
– Other ‘real costs’ of taxes :• COST of ADMINISTRATION• COST OF COMPLIANCE
All taxes lead to some distortion of economic activities, which distorts the market equilibrium, market efficiency and social welfare
ECONOMICS OF TAXATIONPrinciples of taxation
Who bears the burden of the tax ?
WHEN TO TAX & HOW MUCH ?
– TAX is justified if Benefits from tax are more than the costs of tax
BENEFITS– Public goods / service– Social welfare gain from redistribution– Gain from modification of behaviour
COSTS– Dead weight loss– Cost of administration– Cost of compliance– Losses from modification of
behaviour
ECONOMICS OF TAXATIONPrinciples of taxation
What does this ‘TAX INCIDENCE’ depend upon?
QUANTITY
PRIC
E
SUPPLY (MC)
DEMAND (MB)
Q’
TAX INCIDENCE - the burden of taxation in a market
SUPPLY AFTER TAX (MC + TAX)
Tax
C S
P S
Tax burden (INCIDENCE) on buyers
Tax burden (INCIDENCE) on sellers
PRICE FOR BUYER
PRICE FOR SELLER
ECONOMICS OF TAXATIONPrinciples of taxation
What about income-tax?
QUANTITY
PRIC
E
SUPPLY (MC)
DEMAND (MB)
Q’
TAX INCIDENCE (BURDEN) ALWAYS FALLS ON THE ‘SURPLUS’ (CS / PS)
SUPPLY AFTER TAX (MC + TAX)
Tax
C S
P S
Tax burden (INCIDENCE) on buyers
Tax burden (INCIDENCE) on sellers
PRICE FOR BUYER
PRICE FOR SELLER
Flatter (ELASTIC) SUPPLY curve Less PRODUCER SURPLUS Less TAX BURDEN ON SELLER
Flatter (ELASTIC) DEMAND curve Less CONSUMER SURPLUS Less TAX BURDEN ON BUYER
ECONOMICS OF TAXATIONPrinciples of taxation
Any other arguments? What does empirical evidence suggest ?
EFFECTS OF INCOME-TAX ON ECONOMY : The usual argument
• Tax on income reduces incentive to work• Work (& income) come at the cost of LEISURE (free time)• Everybody would like to have both income & leisure has to make a
choice between the two• Principle of diminishing returns: The marginal value of both leisure &
income falls with more of it• As one works more, the leisure he has reduces & income rises the
marginal value of income falls while marginal value of leisure rises• Till the time, marginal value of income is more than the marginal value
of leisure, he is willing to work more• When the marginal value of income becomes less than marginal value
of leisure, he reduces his wok to a point where marginal value of income EQUALS marginal value of leisure
• Income-tax reduces the marginal value of income so the person is likely to work less
ECONOMICS OF TAXATIONPrinciples of taxation
How?
EFFECTS OF INCOME-TAX ON ECONOMY The usual argument : Tax on income reduces incentive to work
Depends upon whether income & leisure are ‘SUBSTITUTES’ or ‘COMPLIMENTS’
If they are substitutes, income-tax will disincentivize workIf they are compliments, income-tax can actually make the person work
more ( e.g.. Imagine a person with family. Fall in income (by tax) leads to fall in living
standard. Instead of living in a smaller flat or shifting children to a cheaper school, the person may prefer to work overtime or take up some extra work)
In real life, they are probably partly substitute & partly complements, so effect is mixed
Empirical evidence suggests that in real life, income-tax does not change the work supply in case of full time workers, but it reduces the work supply by part time workers ( retired / students / housewives)
ECONOMICS OF TAXATIONPrinciples of taxation
What if they are compliments?
INCOME
LEIS
URE
(H
OU
RS)
BUDGET CONSTRAINT without income-tax
0
EFFECT OF INCOME-TAX on willingness of people to workassuming income & work are SUBSTITUTES
INDIFFERENCE CURVES
Income-Tax
WORKING HOURS when No Income-tax
LOSS OF WORK DUE TO INCOME-TAX BUDGET CONSTRAINT
with income-tax
ECONOMICS OF TAXATIONPrinciples of taxation
What is LAFFER CURVE?
INCOME
LEIS
URE
(H
OU
RS)
BUDGET CONSTRAINT without income-tax
0
EFFECT OF INCOME-TAX on willingness of people to workassuming income & work are COMPLIMENTS
INDIFFERENCE CURVES
Income-Tax
WORKING HOURS when No Income-tax
ADDITION OF WORK DUE TO INCOME-TAX
BUDGET CONSTRAINT with income-tax
We will try to cover…Principles of taxation
What are the economic effects of taxes ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation
• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
LAFFER CURVEPrinciples of taxation
What is our own experience?
TAX RATE
REVE
NU
E
Max Revenue
0
EFFECTS OF INCREASING TAX RATE
Higher tax rates disincentivize economic activity, leading to shrinking of tax base( e.g.. Will you do business if tax rate is 96% ? ….remember, government does not share your RISK )
Higher tax rate can lead to :Greater dead weight lossGreater tendency to EVADE TAX Greater costs of admin, compliance
LAFFER CURVE
Revenue maximizing TAX RATE
BEYOND A POINT, HIGHER TAX RATES LEAD TO LOWER TAX REVENUE
We will try to cover…Principles of taxation
What are the economic effects of taxes ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve
• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
IDEAL TAXPrinciples of taxation
Can we achieve all ?
CHARACTERISTICS OF AN IDEAL TAX
Economically efficient
Equitable
Neutral
Generates adequate revenue Predictably
Simple to comply and administer
-Minimum cost of administration
-Minimum cost of compliance
IDEAL TAXPrinciples of taxation
Which tax is most efficient ?
CHARACTERISTICS OF AN IDEAL TAX
ECONOMICALLY EFFICIENT
- A tax is economically efficient when it does not create any disincentives against economic activity by people
-For a perfectly efficient tax
Dead weight loss = zero
-In case of an economically efficient tax the resources taken up by the government exactly equal the reduction in resources employed for private economic activities
-There is some economic inefficiency associated with all taxes
IDEAL TAXPrinciples of taxation
Which tax is most equitable ?
CHARACTERISTICS OF AN IDEAL TAX
EQUITABLE
- A tax is equitable when it is borne only as per the ability to pay
-For a perfectly EQUITABLE tax
If two persons have different amount of resources, the ‘additional resources’ of the richer will be taxed first, and when they are exhausted, the remaining tax will fall equally on both
-An equitable tax leads to Redistribution of resources
-Redistribution of resources creates a disincentive against economic activity
IDEAL TAXPrinciples of taxation
Can we achieve all ?
CHARACTERISTICS OF AN IDEAL TAX
NEUTRAL
-A tax is neutral when the burden of tax on two persons with equal resources is equal, irrespective of their economic activities, and other characteristics (like age, gender, education, race, religion, caste, profession, marital status, place of residence, preferences for consumption, production and wealth)
-For a perfectly NEUTRAL taxTwo persons with equal resources will always be taxed equally irrespective of whatever they are and whatever they may do
-A neutral tax is usually more economically efficient
-Very difficult to have a tax that is neutral to economic preferences
IDEAL TAXPrinciples of taxation
Most predictable tax ?
CHARACTERISTICS OF AN IDEAL TAX
ADEQUATE & PREDICTABLE
-A tax should ideally be able to collect sufficient resources for the Government financing in a predictable manner
-For an ADEQUATE & PREDICTABLE taxA single tax is sufficient, so multiplicity of taxes and the multiplicity of costs associated with them are avoided. The revenue collected is exactly as predicted
-A single adequate & predictable tax is always preferable, if other objectives are also fulfilled
- Every tax can be avoided by modifying economic activities, so a single tax may be less predictable than a combination of taxes
IDEAL TAXPrinciples of taxation
Which is an ideal tax ?
CHARACTERISTICS OF AN IDEAL TAX
SIMPLE TO COMPLY & ADMINISTER
-A tax should ideally be simple to comply for the tax payer, simple to administer for the tax administrator, with no difficulties in interpretation and no possibility of legal disputes
-For an ideally SIMPLE taxCost of compliance = zeroCost of administration = zero
-Simple tax requires simple tax design, simple law and simple procedure of reporting
- Simple tax design may not be economically efficient, equitable, neutral and adequate
IDEAL TAXPrinciples of taxation
Which is an ideal tax combination ?
CHARACTERISTICS OF AN IDEAL TAX
No ideal tax
Since no single tax achieves the characteristics of an ideal tax alone, so Governments resort to multiple taxes with the aim of
- Minimizing economic efficiency- Achieving more neutrality- Achieving Equity- Minimizing evasion & ensuring adequacy & predictability
of revenue
-This can increase costs of compliance & administration
We will try to cover…Principles of taxation
What are the economic effects of taxes ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax
• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
TAX BUOYANCY & ELASTICITYPrinciples of taxation
How do we calculate Tax Buoyancy ?
TAX BUOYANCY
Change in tax revenue in response to one unit change in tax base
( For National statistics, the tax base usually taken is GDP, as a proxy to the economic activity – remember most tax-bases are related to economic activity)
Higher Tax Buoyancy (More than 1) Tax Revenue rises faster than the economic growth As economy grows, the Government can expand its activities OR reduce tax rates
Low Tax Buoyancy (Less than 1) Tax Revenue rises slower than the economic growth As economy grows, the Government will need to cut down its activities OR increase tax rates
(Note : Data for different years should be adjusted for INFLATION )
BaseTax in change %
RevenueTax in change % Buoyancy Tax
TAX BUOYANCY & ELASTICITYPrinciples of taxation
Which method is preferable ?
TAX BUOYANCYChange in tax revenue in response to one unit change in tax base
CALCULATING TAX BUOYANCY : MANY DIFFERENT WAYS
(i) Calculate Tax Buoyancy for different years, then take an average(ii) Calculate Tax Buoyancy for the duration by using data at the beginning
and at the end of that period(iii) As (ii) above, but using ‘averaged’ data, e.g.. Use average of first two
years , and use average of last two years (iv) Using Regression techniques
(i) Regress log of Tax Revenue on the year(ii) Regress log of Tax Revenue on the log of the Tax Base (GDP)
BaseTax in change %
RevenueTax in change % Buoyancy Tax
TAX BUOYANCY & ELASTICITYPrinciples of taxation
What is the use of calculating Buoyancy / Elasticity?
TAX ELASTICITY
Change in tax revenue in response to one unit change in tax base, that would have happened if there was no change in tax rate and tax design
( ‘Adjusted’ refers to the adjustments in actual tax revenue , to arrive at the tax revenue that would have been there if there were no changes in tax rate and tax design)
Tax Elasticity is a more accurate indicator of how tax revenue is responding to the change sin tax base, so more reliable for planningIt is a hypothetical concept, requiring adjustments in actual dataMore difficult to calculateUsually not used for tax revenue arising from multiple taxes
BaseTax in change %
RevenueTax in change % Adjusted ElasticityTax
We will try to cover…Principles of taxation
How are the taxes complied with ?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy
• Voluntary compliance Vs. Administered compliance
• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
TAX COMPLIANCEPrinciples of taxation
What are the pros & cons of each system ?
Compliance with tax laws can be either voluntary or administered
VOLUNTARY TAX COMPLIANCE
The taxpayer calculates his tax liability himself, pays the tax and informs the Tax Administrator
Self assessment Payment of tax Reporting (filing of return)
ADMINISTERED TAX COMPLIANCE
The Tax Administrator calculates the tax liability of the taxpayer and informs him, according to which the taxpayer pays the tax
Assessment by Tax Administrator Informs taxpayer Taxpayer pays the tax
TAX COMPLIANCEPrinciples of taxation
Role of Tax administrator ?
VOLUNTARY TAX COMPLIANCE
Requires elaborate set of rules that allow objective computation of tax liability
Tax Administrator does not look into the tax liability of every taxpayer
Needs a credible deterrent to disincentivize tax evasion
Lesser cost of compliance and administration
ADMINISTERED TAX COMPLIANCE
Require less elaborate rules
Tax Administrator has to look into the tax liability of each & every taxpayer
Need for deterrence is limited
Higher costs of compliance and administration
TAX COMPLIANCEPrinciples of taxation
Compare the two systems
VOLUNTARY TAX COMPLIANCE
Role of Tax Administrator is to create a system that will:
FACILITATE TAX COMPLIANCEEasy to calculate taxLess confusionsSimplified procedures for
reporting
CREATE CREDIBLE DETERRENCE Catch tax evadersPunish them
ADMINISTERED TAX COMPLIANCE
Role of Tax Administrator is to :
EFFICIENT ASSESSMENTSExpedient AccurateTechnically sound(in law &
accounting)
EFFICIENT FOLLOW-UPExpedient communicationMonitor tax payments by
taxpayers
TAX COMPLIANCEPrinciples of taxation
Which system do we follow ?
VOLUNTARY TAX COMPLIANCE
Tax administration needs Strategic efficiencyEfficiency of taxpayer servicesAbility to guide taxpayersAbility of creating a Credible Deterrence
Emphasis is more on quality rather than on quantity
Costs depend upon the strategy chosen and efficiency of its implementation
ADMINISTERED TAX COMPLIANCE
Tax administration needsAbility to efficiently assess the tax payable by taxpayerExpedient action and communicationHigh skills in law, accounting
Emphasis is more on quantity rather than on quality
Costs depend upon number of taxpayers and cost of each assessment
We will try to cover…Principles of taxation
What is the difference?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance
• Tax avoidance Vs. Tax evasion• Economics of deterrence• Globalization & taxes
TAX AVOIDANCE Vs TAX EVASIONPrinciples of taxation
Which one do we target ?
TAX AVOIDANCE
Reducing tax liability by modifying economic or other activities in such a manner that is permitted by law
Involves no falsehoodLegally permissible
e.g..-Saving in a particular savings scheme-Deriving income from exports-Having a factory in a place where a tax holiday is in operation
TAX EVASION
Reducing tax liability by reporting or claiming something that is not true, or not reporting something that is true
Involves some falsehood or incomplete truthLegally not permitted
e.g..-False accounts / bills-Showing income as loan-Not reporting sales-Falsely claiming exemptions
We will try to cover…Principles of taxation
How to prevent tax evasion?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion
• Economics of deterrence• Globalization & taxes
ECONOMICS OF DETERRENCEPrinciples of taxation
How much deterrence ?
DETERRENCE
Reduced indulgence in particular activities due to perceived likelihood of adverse consequences
e.g.. - Late coming is deterred by deduction of C.L.- Crime is deterred by punishment- Jumping into fire is deterred by fear of burning- Errant behaviour is deterred by public criticism
ECONOMICS OF DETERRENCEPrinciples of taxation
BENEFITS & COSTS ?
PROBABILITY The statistical likelihood of an event happeningUsually described as a ‘fraction of 1’ or ‘percentage’
e.g.. 0.5 or 50%; 0.1 or 10%
ATTEMPT TO
EVADE TAX
SUCCESFUL EVASION
FAILURE(CAUGHT)
COST of NON-COMPLIANCE(ATTEMPTING
EVASION)
Probability = p
PENALTY
TAX SAVED
Probability = (1-p)
COST of VOLUNTARY
COMPLIANCE
COMPLY OR NOT TO COMPLY
ECONOMICS OF DETERRENCEPrinciples of taxation
How to increase voluntary compliance ?
BENEFIT
{Probability of ‘not being caught’ X Tax evaded } + Cost of voluntary compliance
COST
{Probability of ‘being caught’ X Penalty} + Cost of attempting evasion
DETERRENCE if COST > BENEFIT
ECONOMICS OF DETERRENCEPrinciples of taxation
What is credible deterrence ?
BENEFIT: {Probability of ‘not being caught’ X Tax evaded } + Cost of voluntary compliance
COST: {Probability of ‘being caught’ X Penalty} + Cost of attempting evasion
DETERRENCE if COST > BENEFIT
Deterrence can be increased by:
Reducing cost of voluntary compliance
Increasing cost of tax evasion
Increasing probability of catching ‘evaders’
Increasing the Penalty
Reducing tax liability
ECONOMICS OF DETERRENCEPrinciples of taxation
Can higher penalties create deterrence?
CREDIBLE DETERRENCE:
General belief in the credibility of deterrence
Belief that attempt to evade will lead to penalties, that it is not wise to attempt evasion, that the likelihood of being penalized is dangerously high
Note:
Probability of being caught is a function of expectations
Expectations are based on information available
Awareness about Cases of successful non-compliance and evasion lower the expected likelihood of being caught Weaken the deterrence
Awareness about Cases of attempted evasion being caught and penalized increase the expected likelihood of being caught Strengthen the deterrence
We will try to cover…Principles of taxation
How globalization impacts taxes?
• Concept of tax• Need for taxes
– Role of Government : Public goods & Redistribution of income– Behaviour modification
• Alternatives to tax• Tax design & classification• Economics of taxation• Laffer curve• Characteristics of an ideal tax• Tax elasticity Vs. Tax buoyancy• Voluntary compliance Vs. Administered compliance• Tax avoidance Vs. Tax evasion• Economics of deterrence
• Globalization & taxes
Globalization & TaxesPrinciples of taxation
Is globalization beneficial ?
GLOBALIZATION
Increasing mobility of Capital and skills
Competitions among nations to attract Capital and skills
TAXES play a role : Higher taxes deter Capital and Skills, especially Double taxes
Since 1970s, a fall in maximal marginal rates of taxation have been observed in many nations
Falling tax rates raised fears of ‘RACE to BOTTOM’
Empirical evidence suggests that while the maximal marginal tax rates have fallen, the total tax revenue collections have NOT fallen, and instead generally risen (Laffer curve effect ?)
Customs duties have been affected more
Direct Taxes : Problem of double taxation DOUBLE TAX AVOIDANCE AGREEMENTS
Principles of taxation
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