Tax System
A tax system refers to a set of all the taxes that a
Chapter 2
Tax systems and taxes
Single and Multiple tax systems
Single tax system is where there is only one tax
in place.
It is claimed that taxpayers are more certain of
their liabilities in a single tax and this can help in
reducing costs of collection.
Against this claim note the following problems:
identification and choice of an appropriate
single tax,
the adequacy and growth of revenue,
Multiple tax system
A multiple tax system is with several tax
structures being used in the system.
Any worthwhile tax system in a modern economy
will be a multiple tax system.
(1) a modern economy is not one-objective
economy.
It tries to forge ahead simultaneously along the
paths of growth, equitable distribution of income
and wealth, economic stabilization and so on.
Since no single tax can be expected to help the
economy on all fronts, a choice for a multiple tax
system becomes inevitable.
Taxation
nation imposes; which includes:
the tax administration,
tax rules & regulations and
tax forms.
Tax systems can be classified in different ways
Multiple and single tax system
Direct vs indirect
Ad Valorem and unit
Proportional, progressive and regressive etc
One simple form of a single tax is the poll tax, or
the head tax;
Poll tax is imposed on a person simply because
he/she is there in the society and not because
he/she has an income, or wealth, or is following
any particular trade or profession etc.
Poll tax is against the principle of equity assessed
in terms of either the benefit principle or the
ability to pay principle.
It does not enable governments to raise sufficient
amount of revenue;
(2) Income of a modern economy originates from
many sources.
It would be highly unjust to tax income
originating from any one source and leave out
others.
Equity would demand that the government should
tax all the important sources of income in an
equitable manner.
Single (multiple) tax systems are different from
single (multiple) stage taxes
1
 Direct vs Indirect taxation
One way of distinguishing between direct and
indirect taxes has been in terms of the incidence
and impact of taxation.
Tax incidence and impact - concerned with the
issue of who bears the burden of taxes;
Tax impact initial burden tax is borne by
those who make the payment of taxes to the
government;
tax impact concerns where the tax first hits;
When the incidence and impact are not at the
same point, the tax is said to have been shifted.
shifting occurs through changes in prices, wages
and returns on investments.
Tax shifting may be of two types:
Forward shifting to the next person in the
supply chain
Backward shifting to the party who
supplied inputs
Theories of Tax Shifting
Three prominent theories of tax shifting
1. The concentration theory
All taxes ultimately concentrate on one
object
Tax levied on anything concentrated on
landlords but agriculture is not the only
profession with surplus
2. The diffusion theory
Tax burden is diffused over different parts of
societytaxed person shifts it to someone
else
Taxation
Tax incidence ultimate burden tax is borne
by those whose real incomes are reduced as a
result of taxes;
tax incidence concerns its ultimate resting
point;
Tax incidence -economic incidence
Tax impact -legal incidence (statutory
incidence);
The initial and final burdens of a tax may be
quite different
When a tax is imposed on some person, it is
possible to transfer to a second person
Factors of Tax Shifting
Two sets of factors influence tax shifting
1. Internal factors
Elasticity of demand more elastic demand is
shifted less
Elasticity of supply more elastic supply is
shifted to the buyer
2. External factors
Public policy, Customary prices
Geographic coverage, Substitutes
Market structure
General business conditions
Cont.
3. The supply and demand/Modern theory
The most acceptable approach tax can be
shifted through purchase and sale arrangements
and price adjustments
Not as such easy to identify the incidence of
corporation income tax;
Tax Impact is on the corporation itself
The burden of corporation income tax is shifted
to other groups of people through lower
income (to employees and investors) or higher
prices (to consumers);
2
 Businesses as such do not bear the incidence of any tax.
Taxes imposed (i.e, with impact) on business always
result in burdens (incidence) on people in one of three
capacities;
1.Consumers-to the extent a tax is forward shifted,
consumers pay higher prices than they otherwise would
to pay and thus have their real incomes reduced.
2. Workers and other resource suppliers to the extent a
tax is backward shifted, workers and other factors of
production receive lower payments, and thus their real
incomes reduced;
3. Business owners To the extent a tax can be neither
forward-shifted nor backward shifted, the owners of the
taxed business suffer reduced real incomes;
In the case of direct taxes, liability is determined
with direct reference to the tax paying ability of the
taxpayer
In the case of indirect taxes, such an ability is
assessed indirectly.
For example, income tax is a direct tax.
Here the tax paying ability is assessed directly in
relation to the income of the assessee.
Income tax, gift tax, inheritance tax, wealth tax,
corporation taxes are examples of direct taxes.
Excise taxes, sales taxes, VAT , import and export
duties, taxes on rail and bus fares and so on are in the
category of indirect taxes.
Demerits of direct taxes include
Unpopular- require payment in one lump sum
Inconvenience- as tax payers submit statements
Possibility of evasion- taxes on honesty
Arbitrary- no logical principle of progression
Adverse effect on will to work and save- if higher
taxes are imposed
Taxation
The distinction between direct and indirect taxes
is ambiguous;
Most writers define direct taxes as those, which
are imposed initially on the individual or
household that is meant to bear the burden.
Indirect taxes-taxes imposed at some point in the
system but are meant to be shifted to the final
bearer of the burden.
Corporations do not actually bear the ultimate
burden of the corporate income tax; instead,
other groups of people bear the burden of the
corporate income tax
Merits of Direct Taxes
Equitable- based on the principle of progression
Certainty- the rate and the amount are known by
tax payer as well as collector
Reduce inequalities- rich people taxed more to be
distributed to the poor
Elasticity- more tax revenue simply by changing
the rates
Civic Consciousness- civic responsibility among
tax payers
Adverse effect can be avoided- by modifying the
rate
Merits of Indirect Taxes
Convenience- paid in small amounts
No evasion- difficult to evade as they are record
based
Elastic if levied on goods of inelastic demand
Wide Coverage- every member of the community
can be taxed
Can be progressive- heavy tax on luxurious
goods
3
 Demerits of Indirect Taxes
Regressive- fall more on low income group than
high income ones
Administrative cost- generally heavy
Discourage savings- more spending on basic
commodities
Uncertainty- cant be accurately estimated
No civic consciousness
Adverse effect on efficiency- reduce
consumption and productivity
Cause inflation- prices of taxed goods keep on
rising
Cont
Recessionrising prices and falling demand;
prices must come down by exempting
producers and input suppliers from indirect
taxes
Arguments against Ad Valorem taxes
Difficult to administer take custom duties it
is difficult to determine the value of various
goods imported from several countries
Difficult to select the appropriate basis of
value
Once the value is known -the next question
might be whether to use CIF value, local
selling price etc.
Taxation
Role of Indirect Taxes in Underdeveloped
Economies
Diversion of Resources
From consumption to production goods. Eg.
Automobile vs building
From imported to domestically produced goods
Revenue effect generate much revenue
Checking and correcting price behavior effect
Inflationmoney supply exceed resources;
taxes reduce money supply
Deflationlack of money supply; reducing
taxes stimulates the economy
Ad Valorem Vs Unit taxes
Such a distinction is in terms of the unit of
measurement of the tax base;
Ad Valorem taxes are when the tax amount is
scheduled according to the value of the item
being taxed;
the tax automatically gets linked with the value of
the item and would move along with its value;
i.e., in the period of boom, the tax liability tends
to rise and in times of recession the tax liability
also declines;
Unit (specific) taxes
are those imposed on per item or per unit
basis;
use the weight, length and some other unit of
measurement;
Examples:
Sales taxes are mostly ad valorem.
Excise duties are sometimes specific,
sometimes ad valorem and some times a
combination of the two;
4

Arguments for unit taxes
Less chance of tax evasiontax is imposed
based on units of measurement which are easily
ascertainable;
Easy to administer and collectonce the item
is identified it is easier to administer;
Arguments against unit tax
Static revenue yield it wont generate large
amount of revenue during periods of price
increases;
Tax Rates
Tax rate-the amount of a tax per unit of the tax
base;
Statutory (nominal) tax rates;
Effective tax rates;
Marginal tax rates;
Average tax rates
For example, if for an income of Br. 10,000 the
tax liability is Br. 1000 and for an income of Br.
11,000 the tax liability is Br 1320; Average tax
rates for the two incomes:
= br. 1000/Br. 10,000 = 10%
= Br. 1320/Br. 11,000 = 12%
Proportional tax structure
The tax rate remains unchanged for each unit of
the tax base; Average tax rate per tax base is
constant
Example on proportional tax system
Tax base(Br) Tax rate(%)(AV,TR) Amount of
tax (Br)
2000 10 200
5000 10 500
10000 10 1000
In proportional taxation since by definition the
average tax rate remains unchanged, the marginal
rate always remains equal to the average rate.
Taxation
Proportional, Progressive and
Regressive
Classification is on the basis of the degree of
progression of a tax the nature of the tax rate
Make use of both tax base and tax rates;
Tax base and tax rates
the base of a tax is the legal description of the
object to which the tax applies;
For example the base of an excise duty is the
production or packing or processing of a
specific good or importation of a specific good;
the base of an income tax is the income of the
assessee defined in terms of certain rules ;
Cont
Marginal tax rate would be the additional tax
liability Br. 320 divided by additional tax base
namely Br. 1000 i.e., 32%.
Is this tax structure proportional, progressive
or regressive?
1. Proportional tax structure
Proportional tax structure is also called a flat tax
system;
The tax liability increases in the same proportion
as the increase in income;
Arguments for proportional tax
Arguments for proportional tax system include:
simple in nature;
uniformly applicable;
Arguments against proportional tax system include:
Inequitable distributiona system of
proportional taxation would not lead to an
equitable and just distribution of the burden of
taxation.
Inadequate resourcesproportional taxation
means the tax rates for the rich and poor are the
same.
Tax system wont be productive.
5
 Progressive structure Arguments for progressive tax
The tax liability as a percentage of income
(average tax rate) increases as income increases;
structure
Reduce the inequality of income and wealth
If the rate rises as the tax base increases, we have
;reduces income disparity
progressive tax;
Revenue productivity
Average tax rate increases when tax base
increases. Stabilizing the economy
If the tax rate structure is progressive, then the Arguments against progressive tax
marginal rate would be rising as the tax base structure
increases;
Ideal progression is impossible
Further the marginal tax rate would lie above the
Disincentive to work, save and invest
average rate of tax. Eg. Employment IT in Ethio

Regressive tax structure In regressive tax schedules both the average and
The tax liability is a smaller percentage of a the marginal tax rates fall as the tax base
taxpayers income as income increases; i.e increases;
average tax rate decreases as tax base increases
Marginal tax rate lies below the average tax rate;
It takes a larger percentage of income from
Notes:
people whose income is low; the poor are taxed
at a higher rate the concept of progressiveness is with
reference to only the money (or money
Example
equivalent) burden of a tax.
Income (Br) tax rate (%) tax payable (Br)
4000 20 800 It is not being translated into real burden or
6000 15 900 the sacrifice which the taxpayers undergo.
10000 12 1200
20000 10 2000

In terms of sacrifice, for example, a proportional Income taxes

income tax will be regressive because it would
involve a proportionately greater sacrifice of
utility on the part of the lower income taxpayers.
Depending upon the rate at which marginal utility
of income to taxpayers falls, even a degree of
progressiveness in money terms might turn out to
be regressive in its real burden.
Tax revenues generated from:
Income
Commodities
Property
What is income?
Economists use Schanz-Haig-Simons (S-H-S) model in
defining income;
Income is the amount actually consumed during the
period plus net additions to wealth.
Income (sources) = Consumptions + savings (uses)
Income is the money value of the net increase to an
individuals power to consume during a period.
The S-H-S criterion also implies that any decreases in an
individuals potential to consume should be subtracted in
determining income.
Income = Consumptions + savings (uses) - lost pp

Taxation 6
 Items Included in S-H-S Income
Items ordinarily thought of as income includes:
wages and salaries,
rents,
dividends and
interest etc.
Employer contributions to pensions and other
retirement plans.
Employer contributions for employees insurance.
Transfer payments;
Capital gains-both realized or unrealized;
Decisions about what should be included in
income are inevitable;
Hence there are departures from the S-H-S
criterion;
Non taxation of unrealized capital gains;
Non taxation of imputed income;
Nevertheless, the S-H-S criterion has often been
regarded as an ideal toward which policymakers
should strive;
Holmes(2008) further noted that IASBs
accounting frameworkstatement of accounting
concepts -reflects the S-H-S model by treating
income as:
an increase in economic benefits derived by an
entity during an accounting period in the form of
inflows or enhancement of assets (decreases in
liabilities), which result in an increase in wealth.
Taxation
Income in kind
From the S-H-S point of view, it makes no
difference whether benefits are received in monetary
form, or in the form of goods and services.
A number of difficulties arise in using the S-H-S
criterion as a basis for constructing a tax system;
Capital gains and losses: may be very difficult to
measure, particularly when they are unrealized.
Imputed income from durables also presents
measurement difficulties. Eg. Renting ones
residence to others and renting others residence to
oneself
Accounting definition of income
Holmes (2008) noted that during the last 75
years accounting has undertaken periodic
income measurement in the context of
businesses on the basis of actual transactions.
Using historical costs and matching concepts
among others;
More recently, a modified historical cost has
been adopted;
Recent years accounting definition of income
has moved and continued to move to the S-H-S
definition of income
Income taxes
Taxes imposed on income determined through
the pertinent tax rules
Individual income tax and corporation taxes
Individual income tax is literally defined as tax
on income from all sources other than
incorporated businesses.
Individual income tax includes taxes on wages,
interest, dividends, rent, capital gains, profits
from unincorporated business operations;
7
 Global income basis and scheduler income
basis of individual income taxation;
Global income basis -income from all sources are
added together to get the overall tax base;
The basic principle is that the taxpayers income
from all sources be combined into a single or global
measure of income (global method).
Scheduler income basis instead of aggregating the
various sources of income together it adjusts each
source of income for any deduction and exemption
and apply the tax rate appropriate for each source of
income.
For example, dividends are governed by dividend tax
law, interest by interest tax law, etc.
Deductions worth noting in connection with taxes
Interest is deductible but not dividends,
Both are costs of capital
Likely to create distortions in the choice between
debt and equity financing;
Likely to lead to thin capital;
Depreciation, inventory (CGS) etc ;
Depreciation methods accelerated method of
depreciation, straight line method (depending on
the tax law in question);
Bad debt recognition
Allowance and direct charge-off methods;
Specific rules are usually laid down as to when
a debt can be considered bad (for tax purpose);
Typically, a firm must undertake a sequence of
steps, such as reminder letters and court orders
or hiring of bill collection agencies before a debt
can be considered bad.
The direct charge-off method appears to be the
most common method for tax purpose;
Taxation
Corporation income tax
is the levy on the taxable income of corporations
computed in accordance with the GAAP subject to
the legal tax regulations pertinent to the matter.
Tax Accounting Methods
The accounting method for computation of the
corporate income tax base could be;
cash basis
accrual accounting basis; or
modified cash basis
Accrual basis appears to have wider application;
Inventory valuation methods
Inventory valuation methods-FIFO, LIFO etc;
Some countries have tax codes, which specify a
particular valuation method to be adopted, while
others only specify that a firm should choose any
valuation rule it pleases but cannot change it
from year to year.
The Ethiopian tax law specified the method of
inventory valuation method as weighted average
Additional provisions are needed for items of
income or expenditure that are prone to mis-
reporting or undervaluation;
The most important of these are entertainment and
transportation expenses.;
Typically, these are allowed as expenses only up to
specified limits;
Income side income likely to be misreported is
income derived from credit transactions;
Tax laws put a rule when to recognize credit sale
for tax purposes;
8
 Corporation tax rates
Rates may be bracket rate where there are a
number of rates in a sliding scale or graduated rate
where there is only one rate applicable for all or
almost all of the corporations subject to
corporation income tax.
Further considerations (depending on the tax law
in question)
Investment tax credit
Allows taxpayers to deduct a certain percentage
of the costs of assets acquired in the year of
purchase from total tax liability;
Carry Forward & Carry Back of Losses
Carry forward of losses occurs when tax laws allow a
company to deduct losses from taxes payable in
future years;
Loss carry back when tax laws allow companies to
receive a refund from taxes paid in previous years;
Differences among countries in respect of LCB and
LCF:
the number of years for which carry forward or
carry back are permitted,
the percentage of losses that can be carried forward
or back (the loss offset rate) and
the amount of past or future profits that can be used
for carry back or forward .
a common rule is to permit 100% of loss to be carried
forward for between 6 and 10 years.
Introduced in 1948 in France;
Many of African countries introduced VAT in the
1960s and 1970s while many of Asian countries
introduced VAT in the 1980s and 1990s;
There are over 140 countries throughout the
world that adopted the VAT;
In Sub-Saharan Africa 33 out of 43 countries in
the region and 9 countries in North Africa have
adopted VAT ( Bird and Gendron 2007);
A few countries that do not have VAT so far
include the US, Iraq, Iran, and Cuba etc;
US is the only OECD (Organization for
Economic Cooperation and
Taxation
If the investment tax credit was K and the
acquisition price was q , the effective price of the
asset would be (1-k)q.
The value of an ITC to the firm does not depend on
the corporate income tax rate;
Because the ITC is subtracted from tax liability
rather than taxable income.
ITC was used in the USA before 1986s tax reform;
For example, in the early 1980s, equipment with a
tax life of three years was eligible for a 6% credit,
and all equipment with a longer life was entitled to
a credit of 10%
Taxes on commodities
These taxes include value added tax (VAT), sales
tax, excise, customs duties etc.
Value added taxation
In some countries VAT is referred to as goods
and services tax (GST) like in Australia, New
Zealand and Canada.
Value added tax is a consumption tax
Tax on the value added to a product at each stage
of production, paid by each producer, and
recouped in the sale price of the product;
Why adopt the VAT?
Reasons for countries to adopt VAT:
Unsatisfactory sales taxes (tax cascade)
Sales taxes
When a taxed product passes from manufacturer
to wholesaler and then to retailer, tax on tax
occurs (cascade tax);
Many of the early users of VAT switched from
various forms of cascade taxes;
VAT was developed from ways to mitigate the
disadvantages of the cascade tax;
For example in France VAT was introduced in an
attempt to mitigate the disadvantages of the
cascade tax;
9
 As a result, the French government first allowed a
credit for the tax content of purchases of raw
materials against the sales tax liability and second
a credit for the tax content of capital purchases;
Other causes of dissatisfaction include:
complexity of administration, and
the complex and multiple relationship between
traders and government when many taxes are
used.
For example take the case of Korea;
A reduction of other taxation or to simply
increase revenue
Cont
For example, Switzerland and the UK were
dragged to the adoption of VAT simply to enter
the EEC (EU)
Other reason for the spread of VAT to especially
developing and transitional countries is the
advocacy role played by the IMF;
The IMF the leading Change Agent in tax
policy in many developing and transitional
countries
Defining the aggregate base of VAT
At macroeconomic level the total sum of all value
added in an economy (GDP) can be determined in
reference to National Accounts;
GDP -total sum of all value added in an economy;
In practice, we define VAT base according to how
we treat different types of expenditures for VAT
purposes;
There are three approaches in defining the base
for VAT;
Production VAT; income VAT and consumption
VAT
Taxation
Some countries look to a VAT not only to replace
existing sales taxes but also to increase revenue;
The other reason for the spread of VAT has been
caused by the European Economic Community
(now called EU) requiring the adoption of
VAT(GST) as a condition of entry to the common
market environment of continental Europe
embracing the UK as well.
The main reason for requiring the adoption of
VAT was EU countries contribute from their
revenue raised from their VATs to fund the
activities of EU.
What is value added?
value that a business adds to the goods and
services that it purchases from others;
A business adds value by processing or handling
these purchased items using its own labor force,
machinery and other capital goods
The value that a producer adds to his raw
materials or purchases before selling the new or
improved product or service (Tait 1988);
So value added can be looked at from additive
(profit + wages) or subtractive (output inputs)
sides (Tait 1988);
Production type: investment expenditures are
not deductible from the base of the VAT (P-VAT);
Income type: investment expenditures are first
capitalized and then depreciated as under an
income tax (I-VAT);
Consumption type: investment outlays are
treated in the same way as purchases of raw
materials and intermediate products (C-VAT);
Investment expenditures are directly deducted in
the computation of the VAT base; Considered as
input
The base of the typical VAT in most countries is
determined under C-VAT (consumption type
VAT);
10
 Cont
This is done by allowing the VAT paid on the
purchase of investment goods to be claimed by
businesses as a credit against their VAT
liabilities on outputs immediately;
The C-VAT is the narrowest of the three
potential tax bases;
By making different provisions with respect to
the treatment of investment goods, a VAT can be
transformed into three distinct taxes, each of
which has different efficiency effects;
Cont
4.Subtractive indirect does not calculate the
value added; instead the rate is applied to the
components of value added separately (invoice
credit method);
VAT=T (output) T (input);
Subtractive indirect is the invoice credit
method; the original EU model and is used by
most countries;
The built-in audit trail may sometimes fail:
1.On the final consumption transaction since there
is no financial incentive for the final consumer
to collect invoices; Possibility of evasion since
sales are made without invoices
2.It fails in connection with exempt or input taxed
goods since there is no credit on these goods
businesses do not have the incentive to collect
invoices;
3.It also fails in connection with businesses that
are outside the VAT legislation framework
(including small businesses);
Taxation
Methods of calculating VAT
For a particular business, value added =wages +
profit or output input;
Four methods Tait (1988);
1.Additive direct or accounts method
VAT=T (wages + profit);
2.Additive indirectthe value added is not
calculated; instead the tax rate is applied to the
components of value added separately;
VAT=T (wages) + T (profit);
3.Subtractive directsometimes called business
transfer tax; VAT=T (Output Input);
The four methods produce the same result the
difference is in their approach;
Subtractive indirect method invoice credit
method. Why is this so popular?
It is transaction based a technically superior
method since transaction is an easily noted and
tracked event;
Good audit trail the invoice credit method
creates a good audit trail since invoices are
needed for credit purposes; one can check the
accuracy of the claim using invoices as
evidence; Objective evidences
Origin and destination principle
Deal with the imposition of VAT on transaction that
cross the border;
Origin principle allows the taxation of the
commodity in the country of origin (production);
Allows commodities crossing the border to be taxed
in the country of the exporter;
Under this principle exports are VAT taxable but not
imports;
Destination principle -commodities cross the border
VAT free (in the country of export) and subject to
VAT in the country of consumption (destination);
Many countries use this principle in that exports are
zero rated (VAT free) but imports are taxed;
11
 Single and Multiple stage VAT
Single stage VAT-imposes VAT on one level of
the chain in the production process giving credit
for taxes paid on inputs;
Multiple stage VAT -levies VAT at several stages
in the chain of the production process giving
credit for VAT paid on inputs;
However, there are countries that do not tax the
retail stage; tax only manufacturers or
wholesalers stage and leave the retail stage out of
the VAT net;
International practice
The generally accepted practice is that VAT should
be imposed with limited number of positive rates;
Rates vary throughout the world; in the EU they
average between 15% -20% for the standard rate;
For example, UK and Germany 17.5%, Sweden
25%, Finland 22%, Greece 18% etc.
Indonesia 10%, Singapore 3%, Japan 5%, Vietnam
10%, Ethiopia 15%, Ghana 15%, Kenya 16% etc.
VAT free (VAT zero rate)
When a supply is made VAT free, the supplier does
not incur liability on the supply but can claim back
the VAT paid in respect of inputs (input tax is
refundable);
Cont
Registration criteria could be turnover, value
added, capital assets, number of employment,
number of owners, profit and type of business;
In practice, turnover has a wider application;
Reduced rates (multiple rates) are considered to be less
evil than exemptions
Exemptions given at an earlier stage in the
production and distribution chain are likely to
increase the effective taxation;
Taxation
VAT rates
The rate or rates at which VAT is levied is an
important consideration in the operations of VAT;
Single and Multiple Rates
Single rate -VAT system uses only one rate
(ignoring zero rate on exports) while the multiple
rates is to a system having many positive VAT rates;
A substantial number of countries operate VAT with
a single positive rate while there are a few countries
that use up to four rates.
In some countries there are different rates for
different regions or parts of the country;
Tax administrators prefer to use a single rate of VAT
but politicians may opt multiple rates
VAT exemption (VAT input taxed)
The supplier is not liable for the VAT on the
supply but cannot claim the VAT paid on the
input acquired (no refund of the input tax);
This gives only partial relief from the burden of
the tax;
Exemptions and zero rating are justified:
Equity consideration;
There are goods considered to be merit goods
including health, education, books, etc argued
to be tax free;
Existence of sectors that are difficult to tax-
like the financial sector, small businesses etc;
Standard exemptions (OECD 2001) include
transport of sick or injured persons; hospital and
medical care; human blood; organs; dental care;
education; non-commercial activities of NGOs;
sporting activities; and cultural activities;
However, there are departures from these
standard exemptions in various countries;
12
 VATs in developing countries;
VATs in developing countries appear to have
features that are quite different from VATs in
developed countries;
1. Registration for VAT
Registration requirements based on turnover;
Sector selected registration requirements;
Voluntary registration is nonexistent or
restrictive;
3. VAT exemptions
Exemptions are given in some countries on food
items, financial services, education, medical
services, etc.;
Developing countries such as Kenya tend to
have a very long list of exempted goods and
services;
4. VAT refunds
T(Output)<T(Input)=Refund
Many developing countries try to give refunds to
exporters;
5. Accounting and reporting
In most developing countries there is no room to
accommodate the capacity and size of
businesses;
Accrual basis of accounting mostly in use again
with no due consideration for the compliance
costs burden of VAT on small businesses;
Require monthly filing of VAT returns
regardless of the size of businesses;
VATs vary among countries;
Taxation
Other mechanisms include prohibiting VAT
unregistered businesses from participating in
government auctions;
2. VAT rates
Some developing countries have multiple rates
against the usual advice for a single positive
rate;
For example Kenya, Lesotho, Mali have more
than one positive rate (multiple rates);
Some developing countries zero rate domestic
transactions apart from exports;
For non-export businesses many countries
require the net credit (refund) claim to be carried
forward and offset against future VAT liabilities;
Developed countries - mostly refunds are made
immediately;
Example New Zealand refund is made within
15 days;
Excise taxes
Excises are taxes levied on particular products
and services with discriminatory intent;
Excises are imposed to add to the progressivity
of the tax structure and also to discourage bad
habits;
Excise taxes are imposed traditionally on
products such as alcohol, tobacco, petroleum
products and automobiles;
Other excisable goods include electricity, gas,
telecommunication, electric household
appliances etc;
13
 Wealth taxes
income and consumption are associated with a time
dimension;
the concept of income would be meaningful when
it is put in the context of some time interval;
income and consumption are known as flow
variables;
amount of tax applies to some time interval
A stock variable is a quantity at a point in time, not
an amount at some time interval.
Wealth is a stock variable because it refers to the
value of the assets an individual has accumulated at
a point in time;
Why tax wealth?
1. Wealth taxes help to correct certain problems that
arise in levying a comprehensive income tax;
By taxing wealth of which unrealized gains
become a part, the problem in income taxation
may be remedied;
2. The higher an individuals wealth, the greater his
or her ability to pay, other things including
income being the same; in line with the ability to
pay principle;
3. Wealth taxation reduces the concentration of
wealth, (undesirable socially & politically)
Property (wealth) taxes is imposed on the
holding of certain properties;
Estate and gift taxes are imposed on the transfer
of wealth;
Estate and gift taxes are levied at irregular
intervals on the occurrence of certain events;
The estate tax (inheritance tax) on the death of
the wealth holder;
Gift tax when property is transferred between the
living;
Taxation
Wealth taxes are imposed on assets one has
accumulated;
Wealth (Property) can be divided into real
property and personal properties;
Real properties- land and anything attached to
the land;
Personal properties - anything moveable.
Personal property taxes are collected on
registered vehicles including motor vehicles,
trailers, planes, and boats;
4. Wealth taxes may be considered as payments
for benefits that wealth holders receive from
government;
One might argue, for example, that a major
goal of defense spending is to protect our
existing wealth (from foreign enemies) ;
Presumptive taxation
Presumptive taxation is the application of
indirect means to ascertain tax liability;
A presumptive income tax is based on some
measure of economic activity that surrogates
for the tax base, rather than the actual tax base
(taxable income itself);
Presumptive taxation is employed mainly in
countries where hard to tax taxpayers
comprise the majority of the population and
administrative resources are scarce;
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 In these countries most taxpayers lack the
financial transparency (proper books) that allows
for effective taxation by the government;
In developing countries most taxpayers 1.
especially small ones do not have the resources
needed to maintain proper books of accounts;
In these situations, presumptive taxation may be 2.
the most appropriate method of tax
administration. 3.
4.
Presumptive taxation uses a variety of
alternative means of determining the tax base
and assessing the tax liability;
Estimate of income using factors like type of
profession (sector), number of employees,
resources used etc;
Using assets:- Commercial property, business
vehicles;
Using turnover or gross receipts, purchases
and wages;
External indicators of income: personal
wealth;

Standard assessment standard assessment assigns

lump-sum taxes to taxpayers on the basis of occupation
or business activity;
Standard assessment does not take into account taxpayer-
specific conditions, such as losses in a particular year;
As a result it can be regressive by imposing equal tax on
individuals in the same category with different incomes.
Estimated assessment -Each taxpayers income is
End of Chapter 2
individually estimated based on indicators like proxies of
wealth specific to a given profession or economic
activity;
Takes individual circumstances (like loss in a given year)
into account ;

Taxation 15