Public Finance

Spring 2025/2026
Lecturer : Professor Dr. Azza Hegazy

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 Public Finance and the Market Economy
Lecture Notes
(BIS)
Dr. Eman Hassan Ali
Professor of Economics

Dr. Asmaa M. Hussein Dr. Rasha M. El-Akkad

Associate professor of Economics Associate professor of Economics

Department of Economics and Foreign Trade

Faculty of Commerce & Business Administration
Capital University 2025/2026
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Chapter Seven
Taxation

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1- Defining Taxes:
▪ Taxes are financial burden imposed by (legislative authority) upon
individuals or property owners to support the government. It is levied
on a product, income, or activity.
▪ Taxes are compulsory payments associated with certain activities.
▪ Revenues collected through taxation are used to:
➢ Purchase the inputs necessary to produce government-supplied goods
and services, or
➢ To redistribute purchasing power among citizens

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2- Types of Taxes
➢ Direct Taxes
▪ Direct tax is a kind of charge, which is imposed directly on the taxpayer and
paid directly to the government.
▪ Direct tax cannot be transmitted by the taxpayer to someone else.
➢ Indirect Taxes
▪ Indirect tax is a tax collected by an intermediary (such as a retail store) from
the person who bears the ultimate economic burden of the tax (such as the
customer).
▪ Indirect tax can be shifted by the taxpayer to someone else.
▪ Indirect tax may increase the price of a good. 5
3-Tax Base
An item or economic activity upon which the assessment or determination of tax
liability is based.
Most commonly used tax bases:
➢ Income
➢ Consumption
➢ Wealth

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➢ Person’s income (Y= C+S) is the sum of the value of his annual
consumption of goods and services and annual saving.
- Income is often regarded as a good index of the ability to pay taxes.
- Total annual income in a nation is equal to the value of the total
consumption and savings of all people and organizations in the country.

➢ A person’s annual consumption is his annual income less the amount of

income saved that year. (C=Y-S)

➢ Wealth (W = S+I) represents the value of a person’s accumulated

savings and investments at any point in time. The annual flow of income
from the stock of accumulated wealth in a nation is the annual return to
saving.
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▪ The three major tax bases are related. Consumption is the
portion of income that is not saved, while wealth is the net
value of a person’s stock of accumulated savings or
investments.

▪ Because income is believed to be a good index of the ability

to pay taxes, many economists use this broad economic base
as a benchmark for evaluating the fairness of taxes. The
amount of tax paid is generally computed as a percentage of
annual income.

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4-Main sources of taxes:

1- Income taxes:
▪ An important source of tax revenue, also known as the
personal income tax.
▪ Income taxes are imposed on labor or activities that generate
income, such as wages or salaries.

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2. Capital, Profit and Property tax:
➢ Capital tax: A tax levied on the profit realized when an individual or
corporation sells an asset. (Based on Profit from sale)
➢ Profit tax: is a direct tax imposed on the net income or net profit of
businesses and corporations. (Based on Net earnings)
➢ Property taxes are Annual tax levied on the value of real estate such as
houses. (Based on asset value)

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3. Excise taxes:
• Consumers usually pay a percentage of the sales price as the tax.
• A selective tax imposed on the production, sale, or use of specific goods
(usually harmful, luxury, or non-essential items).
• An excise tax is levied on a specific product, such as alcohol or cigarettes.

4. Payroll Tax:
• A tax an employer withholds or pays on behalf of their employees based on
the wage or salary of the employee (ex. Medicare tax or Unemployment
insurance tax)

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5. Sales Tax:
A tax imposed by the government at the point of sale on retail goods and
services.
Sales tax is based on a percentage of the selling prices of the goods and services
and is set by the state.
Technically, consumers pay sales taxes, but effectively, business pay them since
the tax increases consumers costs and causes them to buy less.

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6. Value-Added Tax:
A national sales tax collected at each stage of production of a good.
The taxing authority often exempts certain necessary living items,
such as food and medicine from the tax.

7- Foreign trade Tax:

Any tax levied by a government on goods, services, or
transactions that cross international borders . This includes import
taxes, export taxes.

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5- Tax rate
The tax rate is the percentage of the tax base that must be paid in the form of taxes.
Examples include sales tax on goods and services, real property tax, short-term
capital gains tax rate and long-term capital gains tax rate.

So, if the tax base equals L.E.100 and the tax rate is 9%, then the tax
will be L.E.9 (=100 × 0.09).
The average tax rate (ATR) is the total amount of taxes collected
divided by the pound value of the taxable base:
ATR = Total Taxes Paid ÷ Value of the Tax Base
The marginal tax rate (MTR) is the additional tax collected on the
additional pound value of the tax base as the tax base increases:
MTR =∆Total Taxes Paid ÷ ∆Value of the Tax Base
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There are three tax rate structures:

1- Proportional taxes (flat-rate tax):

Apply the same tax rate on any income level, or for any size of the tax base.
Example, if Yousif earns 5000 LE and Maha earns 7000 LE per month, and the tax
rate is 10%, then Yousif will pay 500 LE taxes while Maha will pay 700 LE.

proportional taxes is one for which the ATR does not vary with the value of the tax
base. Under proportional taxation, the ATR, but not the amount of tax, is
independent of the size of the base.

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2. Regressive Taxes:

Is inversely proportional to income — the

lower the income, the higher the tax in
relation to income. The ATR declines as the
size of the tax base increases.

More productive individuals would be

rewarded with lower tax rates as they
produced and earned more.

However, the opposition to such a method of

taxation is strong because it violates the
widely held belief that ability to pay increases
with income. 17
3. Progressive Tax:
A progressive tax applies a higher tax rate to higher
incomes.
So, if the tax rate on Ahmed’s annual income of
50,000 LE is 10% and on Margo’s 100,000 LE is
20%, then, Ahmed will pay 5,000 LE taxes while
Margo will pay 20,000 LE taxes.
However, almost all progressive taxes are structured
as a marginal tax, which means that the progressive
tax rate is only applied to that part of the income
which is greater than a certain amount.
The portion of the tax base that is subject to a
particular tax rate, is known as a tax bracket, which
always has lower and upper limits, except for the top
tax bracket, which has no upper limit. 18
Continuing the above example, if the 20% tax
rate is only applied to that portion of the
income between 50,000 and 100,000 LE, then
Margo would pay 5000 LE on the first 50,000
LE of income and 10,000 LE on the 2nd
50,000 LE of income, resulting in a total tax
liability of 15,000 LE.

The ATR increases with the size of the base.

The larger the tax base, the larger the average
tax rate applied.

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6. How should the burden of government finance be distributed?
6-1- The benefit principle
Argues that the means of financing government-supplied goods and services
should be linked to the benefits that citizens receive from government. (
From the point of view of those who favor the benefit approach, fees and
charges are ideal forms of government finance.
Advantage:
Is that it links the cost per unit of government-provided services with the
marginal benefits of those services.
The free-rider problem does not exist.
Disadvantage:
The only way to determine such benefits would be to ask individual citizens how
much extra units of the good or service are worth to them. If individuals know
that their share of the financial burden depends on their declaration of benefits,
they might have little or no incentive to declare their true benefits. 20
6-2-The ability-to-pay principle
Argues that taxes should be distributed according to the capacity of taxpayers to
pay them.
Citizens with greater ability to earn income, should be taxed more heavily than
those with less capacity to earn.

Disadvantage:
The problem of distributing tax shares is viewed as independent of individual
marginal benefits received from government activities.

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7. Tax Evasion and Tax Avoidance:
Tax Evasion: Is noncompliance with the tax laws by not paying taxes
that are due.

The incentives for evasion by individuals depend on the costs and

benefits expected from noncompliance.
The benefits of evasion tend to increase with the amount of tax, or
money in general, saved by not complying with the rules.
The costs of tax evasion vary with the penalties involved and the
probability of being caught by the authorities.

Tax evasion is illegal

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Tax Avoidance is the legal use of tax laws to minimize one's tax
liability.
Taxpayers respond to the changes in prices caused by taxes by
rearranging their personal affairs.
High taxes on labor income might induce workers to refuse overtime
work.
Tax avoidance is not illegal.

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7. Other sources of government finance:

1- Fees and charges, including tolls, and tuition charges at state-run colleges
and universities.
2- Revenues from enterprises operated by governments, such as public
utilities (water, gas, and electricity).
3- Debt finance is the use of borrowed funds to finance government
expenditures.
4- Donations are voluntary contributions to governments from individuals or
organizations.

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Thank You

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