What is Tax / Taxes?
A tax is a compulsory payment made by citizens and corporate bodies to the government to enable it carry out its responsibilities. Examples include income and property tax.
Types of Tax
Direct taxes are taxes levied directly on individuals or institutions and the burden of the tax falls directly on those individuals or institutions. Examples include personal income tax, capital gains tax and company income tax.
Advantages of Direct Taxes
- Being generally more progressive, direct taxes help redistribute income, more so, since they are based on ability to pay.
- Direct taxes are more easily designed, administered, assessed and collected.
- They can be used to check inflation and control aggregate expenditure.
Disadvantages of Direct Taxes
- Direct taxes discourage people from working hard and eaming more since the more you earn the more you pay.
- They discourage. investment since they discourage savings.
- It is easier for self-employed people to avoid payment of taxes.
Indirect taxes are taxes levied on the. activities of an individual or institution arid the burden of the tax may be shifted. Examples are VAT – ad valorem tax, etc.
Advantages of Indirect Taxes
- They yield more revenues than direct taxes because they are collected at source.
- They are easier to administer and collect.
- They can also be used to control undesirable imports.
- They cannot be avoided or evaded.
- They can be used to protect domestic production from foreign competitors.
Disadvantages of Indirect Taxes
- Indirect taxes may encourage smuggling in an attempt to avoid tax payment.
- It is regressive. It is not possible to get the rich to pay more than‘the poor.
- It may lead to inflation because the burden of the tax is passed on to consumers in the form of higher prices.
Value Added Tax (VAT)
Value added tax majorly called VAT is a form of turnover tax which takes into account the value added by successive processes of producing a good or rendering a service. The tax is at a flat rate of 5% on vatable goods and services.
Objectives of Value Added Tax (VAT)
- To eliminate or maximize the distortions to private savings caused by taxation;
- To improve the transparency and predic-tability of indirect taxation;
- To shift its incidencetowards expenditure rather than income;
- To influence individual consumption and allocative decisions.
Advantages of Value Added Tax (VAT)
Merits of Value Added Tax (VAT) include the following:
- It ensures shifting taxation towards consumption rather than income thereby making it difficult for people to evade it;
- It makes indirect taxation of this type relatively easier to administer;
- It reduces the nation’s dependence on oil with its attendant uncertainties in the global market;
- It tends to make taxation equitable because the more you consume, the more you pay.
Disadvantages of Value Added Tax (VAT)
Value Added Tax (VAT) demerits include the following:
- It is an impoverishment tax;
- It is an unfair and unjust tax because both the rich and poor pay the same rate of tax on consumption.
- It is confused with genuine VAT practised elsewhere in the world.
Progressive tax is the type of tax that is designed or scheduled in such a way that as income increases, the rate increases. So high income earners feel the burden more. For example PAY AS YOU EARN (PAYE).
Proportional tax is the type in which all tax payers pay the same proportion or percentage of their income as tax. Suppose 10% is the tax rate, a worker earning $1,000 per annum will pay $100 while another earning $5,000 will pay $500. Though the latter pays a larger amount than the former, the rate of payment (10%) is the same or proportional.
Regressive tax is a type which makes the poor to part with a greater proportion or percentage of their income than the rich. Indirect taxes, for instance, which are fixed sums added to the prices of things purchased by consumers irrespective of their incomes are regressive. Therefore regressive tax aggravates inequality of income.
Poll tax is a flat rate tax usually imposed on low income earners in the country. For example, every adult could be asked to pay $900 per year as tax. Those who pay poll tax are usually exempted from the payment of personal income tax. It is a regressive form of taxation because each payer pays the same amount irrespective of his income.
Specific tax is a fixed tax sum imposed or charged per unit of a commodity irrespective of its value. For instance, a fixed rate of $120 could be imposed on every bag of rice produced locally or imported.
Note that specific taxes on imported goods are flat rate taxes.
Capital Gains Tax
Capital gains tax are taxes levied on the gains or profits derived from the sale of land and capital assets. For example, if someone buys an hectare of land in a strategic location in England – North London, for a sum of £1.3 million and resells it for £2.3 million it follows that he has made a profit of £1 million on the land. It is this gain of £1 million if taxed that is known as capital gains tax.
Note that the higher the gain, the greater the tax derived from it.
Incidence and Effect of Tax
A distinction is often made between the impact and incidence of taxation. Most taxes on production and expenditure are initially levied on the producer or manufacturer. Since he pays the tax directly, the initial burden or impact of the tax is on the producer or the manufacturer.
But, the manufacturer, in selling his product will try to recover his payment of the tax by including it in his price. In doing so, he shifts the tax on to the final consumer who now bears the incidence of the tax. The incidence of taxation therefore refers to where the final burden of taxation rests.
However, if the manufacturer is unable to shift the tax on to the consumer, then he bears both the impact and incidence of the tax, though this depends on the elasticity of demand for his product. If the demand is elastic, an increase in price as a result of the tax will discourage consumers to buy the product and the manufacturer has to bear the full burden of the tax.
If however, the demand is inelastic, he can successfully shift the burden to the consumers.
Difference Between Tax Evasion and Tax Avoidance
Tax evasion is an attempt by individuals not to pay the appropriate tax rate by giving false information about his/her income.
Tax avoidance is an effort to escape/dodge payment of tax by taking advantage of loopholes in the nation’s tax law.