CHAPTER 3: PUBLIC REVENUE

3.1 Definition and Sources of Public Revenue

3. 1.1 Definition of Public Revenue
Like any other economic unit, a government needs funds to finance its activities. Such funds are
raised from various sources. It is difficult to give a complete list of all the sources of public
receipts. However, the important ones include taxes, income from currency, market borrowings,
sale of public assets, income from public undertakings, fees, fines, gifts and donations, etc.

Public revenue can be defined in broad and narrow sense. In the wider sense, it includes all the
income and receipts, which the Government happens to get during any period of time. Public
income/revenue includes income from taxes, prices of goods and services supplied by public
enterprises, revenue from administrative activities, such as fees, fines, etc., and gifts and grants,
while public receipts include all the incomes of the government which may be received during a
given period of time.

Public revenue includes receipts from all sources. Public revenue is a narrower concept and
excludes public borrowings, income from the sale of public assets, and receipts from the use of
printing currency.

The receipts further divided in to “revenue” and “capital” categories. Revenue receipts include
routine and earned ones. For this reason, they do not include borrowing and recovery loans from
other parties, but they do include tax receipts, donations, grants, fees, and fines etc. Capital
receipts, on the other hand, cover those items, which are basically of non-repetitive and non-
routine variety and change government’s financial liabilities/assets.

3.1.2 Sources of Public Revenues

Government has played an important role in the socio economic development of society. Social
development may be in the form of raising the level of living and social welfare in the form of
providing social amenities to the people. Social amenities are in the form of education, health
and sanitation, utilities like electric supply, water supply etc, and recreation facilities.

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The process of socio-economic development requiring huge expenditure cannot be carried unless
the government has the persistent source of income. Every government has two important
sources of revenue. These are:
(a) Tax sources, and
(b) Non-tax sources.

a) Tax Revenue
Tax revenue is one of the most important sources of government revenue. Taxes are compulsory
payments to government without expectation of direct return or benefit to tax payers. It imposes
a personal obligation on the taxpayer. Taxes received from the taxpayers, may not be incurred
for their benefit alone.
Taxation is the powerful instrument in the hands of the government for transferring purchasing
power from individuals to government.
Every Government imposes two kinds of taxes:
(1) Direct taxes, and
(2) Indirect taxes
A tax, in the modern times, therefore is a compulsory levy and those who are taxed have to pay
the sums irrespective of corresponding return of services or goods by the government. It is not a
price paid by the tax-payer for any definite service rendered or a commodity supplied by the
government. The tax-payers do get many benefits from the government but no tax-payer has a
right to any benefit from the public expenditure on the ground that he is paying a tax. The
benefits of public expenditure may go to anyone irrespective of the taxes paid. Therefore, we
may say that taxes are compulsory payments to government without expectation of direct return
or benefit to the tax-payer.

b) Non-tax Revenue
This includes the revenue from government or public undertakings, revenue from social services
like education and hospitals, and revenue from loans or debt service. Generally, non-tax revenue
consists of:
i) interest receipts

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Interest receipts, dividend and profits comprises, apart from interest receipts on loans by the
Government to other parties, dividends and profits from public sector undertakings run by or as
government departments including other income generating departments. Examples are
contributions from Ethiopian Airlines, Telecommunication, and profits of National Bank of
Ethiopia transferred to the Government.

ii) dividends and profits

iii) fiscal services and others.

3.2 Characteristics of Tax

(1) Tax is a Compulsory Contribution
A tax is a compulsory payment from the person to the Government without expectation of any
direct return. Every person has to pay direct as well as indirect taxes. As it is a compulsory
contribution, no one can refuse to pay a tax on the ground that he or she does not get any benefit
from certain public services the government provides.
(2) The Assessee will be required to pay Tax if is due from him
No one can be forced by any authority to pay tax, if it is not due from him. Suppose, if there is a
tax on liquor, the state can force an individual to pay the tax only when he drinks liquor. But, if
he does not drink liquor, he cannot be forced to pay the tax on liquor. Similarly, if an
individual’s income is below the exemption limit, he cannot be forced to pay tax on income. For
example individuals earning monthly salary below birr 150 cannot be forced to pay tax on
income.
(3) Taxes are levied by the Government
No one has the right to impose taxes. Only the government has the right to impose taxes and to
collect tax proceeds from the people.
(4) Common Benefits to All
The tax, so collected by the Government, is spent for the common benefit of all the people. In
other words, when the government collects a tax, its proceeds are spent to extend common
benefits to all the people. The Government incurs expenditure on the defense of the country, on
maintenance of law and order, provision of social services such as education, health etc. Such
benefits are given to all the people- whether they are tax-payers or non-taxpayers. These benefits
satisfy social wants. But the Government also spends on subsidies to satisfy merit wants of poor
people.

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(5) No Direct Benefit
In the modern times, there is no direct relationship between the payment of tax and direct
benefits. In other words, there is absence of any benefit for taxes paid to the Governmental
authorities. The government compulsorily collects all types of taxes and does not give any direct
benefit to tax-payers for taxes paid. For example, when taxable income is earned by an
individual or a corporation, he or it simply pays the tax amount at the specified rate cannot
demand any benefit against such payment.
(6) Certain Taxes Levied for Specific Objectives
Though taxes are imposed for collecting revenue for the government to meet expenditure on
social wants and merit wants, certain taxes are imposed to achieve specific objectives. For
example, heavy taxes are imposed on luxury goods to reduce their consumption so that resources
are directed to the production of essential goods, such as cheaper variety of cloth, less costly
goods of mass consumption, etc. Thus, taxes are levied not only to earn revenue but also for
diversion of resources or saving foreign exchange. Certain taxes are imposed to reduce
inequalities of income and wealth.
(7) Attitude of the Tax-Payers
The attitude of the tax-payers is an important variable determining the contents of a good tax
system. It may be assumed that each tax-payer would like to be exempted from taxpaying, while
he would not mind if other bears that burden. In any case, he would want his share to be within
the general level of tax burden being borne by others. In other words, it is essential that a good
tax system should appear equitable to the tax-payers. Similarly, overall burden of the tax system
is of equal importance. The attitudes of the tax-payers in this regard are influenced by a host of
other factors like the political situation such as war or peace, natural calamities like floods and
droughts, economic situations like prosperity or depression and so on.
(8) Good tax system should be in harmony with national objectives
A good tax system should run in harmony with important national objectives and if possible
should assist the society in achieving them. It should try to accommodate the attitude and
problems of tax-payers and should also take into consideration the goals of social and economic
justice. It should also yield adequate revenue for the treasury and should be flexible enough to
move with the changing requirements of the State and the economy.
(9) Tax-system recognizes basic rights of tax-payers

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A good tax system recognizes the basic rights of the tax-payers. The tax-payer is expected to pay
his taxes but not undergo harassment. In other words, the tax law should be simple in language
and the tax liability should be determined with certainty. The mode and timings of payment
should be convenient to the tax-payer. At the same time, a tax system should be equitable
between tax-payers. It should be progressive and burden of taxation should be equitable on all
the tax-payers.

3.3 Objectives of Taxation

Initially, governments impose taxes for three basic purposes: to cover the cost of administration,
maintaining law and order in the country and for defense. But now government’s expenditure
pattern changed and gives service to the public more than these three basic purpose and it restore
social justice in the society by providing social services such as public health, employment,
pension, housing, sanitation and other public services. Therefore, governments need much
amount of revenue than before. To generate more revenue a government imposes taxes on
various types. In general objective of taxations are:
1. Raising revenue: to render various economic and social activities, a government needs
large amount of revenue and to meet this government imposes various types of taxes.
2. Removal of inequalities in income and wealth: government adopts progressive tax
system and stressed on canon of equality to remove inequalities in income and wealth of
the people.
3. Ensuring economic stability: taxation affects the general level of consumption and
production. Hence, it can be used as effective tool for achieving economic stability.
Governments use taxation to control inflation and deflation
4. Reduction in regional imbalances: If there is regional imbalance with in the country,
governments can use taxation to remove such imbalance by tax exemptions and tax
concessions to investors who made investment in under developed regions.
5. Capital accumulation
Tax concession or tax rebates given for savings or investment in provident funds, life
insurance, investment in shares and debentures lead to large amount of capital
accumulation, which is essential for the promotion of industrial development.
6. Creation of employment opportunities

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 Governments might minimize unemployment in the country by giving tax concession or
exemptions to small entrepreneurs and labor intensive industries.
7. Preventing harmful consumptions
Government can reduce harmful things on the society by levying heavy excise tax on
cigarettes, alcohols and other products, which worsen people’s health.
8. Beneficial diversion of resources
Governments impose heavy tax on non- essential and luxury goods to discourage
producers of such goods and give tax rate reduction or exemption on most essential
goods. This diverts produce’s attention and enables the country utilize to utilize the
limited resources for production of essential goods only.
9. Encouragement of exports
Governments enhance foreign exchange requirement through export-oriented strategy.
These provide a certain tax exemption for those exporters and encourage them with
arranging a free trade zones and by making a bilateral and multilateral agreement
10. Enhancement of standard of living
The government also increases the living standard of people by giving tax concessions to
certain essential goods.

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The base, buoyancy and Elasticity of a tax
3.6.1 The base of tax
The base of a tax is the legal description of the object with reference to which the
tax applies. Every tax has a base. For example, the base of income-tax is the
money income of assessee; the base of an exercise duty is the volume of
production or packing or processing of a specific good-within the enterprise, the
base of customs duty is the value of import or export of goods. The base of each
tax has to be defined legally for the purpose of determining the tax liability of an
individual tax-payer. Each tax payer is considered a legal entity for this purpose.
Accordingly, an individual legal entity may be subjected to more than one tax.
Every tax base may have a time-dimension also. For instance, income-tax is
usually on annual basis.

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With the passage of time, a tax base under consideration may grow or may shrink.
This will depend on the volume, transaction or the policy of the government. For
example as production of excisable goods increases, the base of excise duties
would be termed to have grown. If new items are brought within the purview of
excise taxation, we shall say that the coverage of excise taxation have extended
and the base of excise taxation has been widened, if the production of new items
covered under excise duties increases.
3.6.2 Buoyancy of a Tax
Buoyancy of a tax indicates the factors responsible for an increase in the yield of
a tax-over time. If a tax revenue increase with the growth of its base, but without
an upward revision of the tax rates (without an increase in the rate of tax), then
the tax is said to be buoyant. It has an inherent tendency to yield more tax revenue
with the growth of the base. For example, if 10% increase in sales tax collection is
Public Finance and Taxation-
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Mekelle University, Faculty of Business Economics
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owing to 10% increase if the volume of sales and not due to an increase in tax
rates, it is termed as the measure of buoyancy i.e. 10% buoyancy.
Similarly, if yield from income-tax increases as national income increases with
given rates of income-tax, it would be termed a buoyant tax. Another example is
that of excise duties. Excise duties are imposed on production of specified goods.
If new items are not brought under these duties and the rates of existing duties
remain unchanged, but the revenue from excise duties increases with an increase
in the production of excisable items, we have a case of buoyancy of excise duties.
3.6.2 Elasticity of a Tax
Elasticity tax is related to the rate of tax and yield of a tax. If the yield of a tax
increases or decreases owing to reduction or increase in tax rates, we call it
elasticity of a tax. The yield of a tax may also go up on account of extension of its
coverage or a revision of its rates. Such a characteristic of a tax is referred to as its
elasticity. In other words, the elasticity of a tax refers to the steps taken by
authorities in increasing its yield through an extension of its coverage or revision
of its rates.
3.5 Principles of Taxation
A tax system (that is, the set of all taxes) for achieving certain objectives chooses and adheres to
certain principles which are termed its characteristics. A good tax system therefore, is one of
which designed on the basis of an appropriate set of principles, such as equality and certainty.
Mostly, however, objectives of taxation conflict with each other and a compromise is
needed .therefore, usually economists select some important objectives and work out the
corresponding principles which the tax system should adhere to. The first set of such principles
was enunciated by Adam smith (which he called Cannons of Taxation)

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Canons of Taxation
The four canons of taxation as prescribed by Adam Smith are the following:
(1) Canon of Equality
This canon proclaims that a good tax is that which is based on the principle of equality. In
other words subjects of every state ought to contribute towards the support of the
government, as nearly as possible, in proportion of their respective abilities, that is, in
proportion to the reserve which they respectively enjoy under the protection of the State.
It implies what the income which a person enjoys under the protection of the State,
should be taxed on the proportional rate of taxation. But modern economists do not agree
with Adam Smith. They advocate progressive taxation to observe the canon of equality.
In other words, they advocate progression should be the basis for imposing taxes.
(2) Canon of Certainty
This canon is meant to protect the tax payers from unnecessary harassment by the ‘tax
officials’. It implies that the tax-payer should be well informed about the time, amount
and the method of tax payment. According to Adam Smith, “the tax, which each
individual is bound to pay, ought to be certain and not arbitrary. The time of payment, the
manner of payment, the quantity to be paid, ought all to be clear and plain to the
contributor and to every other person.” Adam Smith was also of the view that the
government must also be certain of the amount which it derives from a particular tax.
Thus this canon is equally important both for the individual and the state.
(3) Canon of Convenience
The third canon of Adam Smith is that of convenience. According to Adam Smith, “every
tax ought to be so levied at the time or in the manner in which it is most likely to be
convenient for the contributor to pay it.” In other words, taxes should be imposed in such
a manner and at the time which is most convenient for the tax-payer, i.e., the best time for
the collection of land revenue is the time of harvest. Similarly, taxes on rent of houses
should be collected when it is most convenient for the contributor to pay.
(4) Canon of Economy
The fourth canon is the canon of economy. This canon implies that the administrative
cost of tax collection should be minimum, i.e., the difference between the money, which

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 comes out of the pockets of people and that which is deposited in the public treasury,
should be as small as possible. Administrative cost of tax collection should be minimum
because levying of a tax may require a great number of officers, whose salaries may eat
up the greater part of the produce of the tax, and whose pre-requisites may impose
another additional tax upon the people. Hence, the administrative cost should be
minimum.
In addition to the above four canons given by Adam smith, the following other canons
have been advanced by Basable and other economists
(5) Canon of Productivity
The canon of productivity advocated by Bastable implies that taxes should be productive.
The productivity of a tax may be observed in two ways. In the first place, a tax should
yield a satisfactory amount for the maintenance of a government. In other words, the tax
should be such that it procures a considerable amount of revenue for the expenditure of
the government, Secondly, the taxes should not obstruct and discourage production in the
short as well as in the long run.
(6) Canon of Elasticity
Bastable also laid stress on the principle of elasticity. The canon of elasticity implies that
yields of taxes should be increased or decreased according to the needs of the
government. The government may need funds to face natural calamities and other
unforeseen contingencies. It may need funds to finance a war or for development
purposes. The government resources can be raised quickly only when the system is
elastic.
(7) Canon of Diversity
The canon of diversity put forward by Bastable implies that the tax system should be
diverse in nature. In other words, in a tax system, there should be all types of taxes so that
everyone may be called upon to contribute something towards the revenues of the state.
Thus, the governments should adopt multiple tax system.
(8) Canon of Simplicity
The canon of simplicity implies that a tax should easily be understood by the tax-payer,
i.e., its nature, its aims, time of payment, method and basis of estimation should be easily
followed by each tax-payer. In other words, the tax imposed on the tax-payers should be

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 so simple that they are able to guess easily the aim of its imposition and they are not
confronted with accounting, administrative or any other difficulties.
(9) Canon of Expediency
This canon implies that the possibilities of imposing a tax should be taken into account
from different angles, i.e. its reaction upon the tax- payers. Sometimes it is seen that tax
may be desirable and may be productive and may have most of the characteristics of a
good tax, yet the government may not find it expedient to impose it, for example,
progressive agricultural income tax, but it has not been imposed. So far in the manner it
should have been imposed.

3.6 Types of Taxes

Taxes can be classified based on incident/ direct Vs indirect taxes/, degree of progression/
proportional, progressive, and regressive taxation/, or tax base/ single Vs multiple taxation

3.6.1 Direct Vs Indirect Taxes

Economists usually classify taxes into direct taxes and indirect taxes based on whether the
incidence can be shifted to others or not.

a) Direct Taxes
Direct taxes are those taxes which are paid entirely by those persons on whom they are imposed.
In other words, the immediate money burden is upon the man who pays the tax to the authority.
Direct taxes are those which cannot be shifted to others. Thus, if a tax is intended to be paid by
the persons on whom it is imposed, it is a direct tax.
Some economists define direct taxes as those taxes which are based on the receipts of income.
Thus, income taxes, tax on profits, capital gains tax, property or wealth tax are direct taxes.

A tax system is composed of both direct and indirect taxes. Since effects of direct and indirect
taxes on production, distribution and consumption are separate and distinct, it is necessary to
examine their merits and demerits.

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Merits of Direct Taxes:
1. Equitable: direct taxes such as income tax, taxes on property, capital gains tax, etc. are just
and equitable because they are based on the principle of progression. Direct taxes are taxed
according to the “ability-to-pay” of the taxpayers. Ability to pay is interpreted as the money
income of the assessee. It means any person having a flow of income is expected to pay tax.
Taxes at high rate are paid by the richer section of the society and lower are paid by the
poorer section of the society.
2. Certainty: direct taxes satisfy the canon of certainty. Direct taxes involve certainty about the
rates of taxes, such as income tax, which are widely publicized. In other words, the taxpayer
is certain as to how much he/she is expected to pay, and similarly the State is certain as too
how much it has to receive income from direct taxes. There is also certainty about the time of
payment and manner of payment. Therefore, taxpayers can plan their own budgets and other
economic activities in advance because they know with certainty their tax liabilities.
3. Reduce Inequalities: As stated above, direct taxes are progressive in nature, and therefore,
rich people are subjected to higher rates of taxation, while poor people are exempted from
direct tax obligations. Rates of taxes increase as the levels of income of persons rise. As they
fall heavily on the rich, they take away a large part of their income by way of income and
property taxes. So, the revenue so collected is used for providing social amenities like food,
clothing and housing facilities to the poor people. The real income of the poor rises and that
of the rich falls. Hence, direct taxes help to reduce inequalities in incomes and wealth.
4. Elasticity: direct taxes also satisfy the cannon of elasticity. Elasticity in direct taxes implies
that more revenue is collected by the Government by simply raising the rates of taxation. In
other words, revenue of the Government may be increased by increasing the incomes of the
people. Therefore, the income of the Government from direct taxes may increase with the
increase in the income of the people.
5. Civic Consciousness: Direct taxes inculcate the spirit of civic responsibility amongst the
taxpayers. Since direct taxes are certain, the taxpayers feel the pinch of such payment and
are, therefore, alert and take keen interest in the method of public expenditure, whether the
revenue raised is properly utilized or not. In other words, people try to be vigilant about how
much tax revenue is being raised by the Government and to what uses it is being put.

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 Taxpayers become conscious of their rights and obligations. In a democratic country, this
civic consciousness checks the wastage in the public expenditure.
6. Adverse Effects of Direct Taxes can be Avoided: one of the merits of direct taxes is that there
can be modified in time to avoid their adverse effects on willingness and ability to work, save
and invest. In other words, reasonable rates of income tax, property tax etc. may avoid
adverse effects of direct taxes on taxpayers. Exemption and concessions may also avoid their
adverse effects on production.

Demerits of Direct Taxes

Direct taxes are not free from certain disadvantages. Thus, they are criticized on the following
grounds:

1. Unpopular: direct taxes are unpopular because they are required to be paid in one lump sum
which is inconvenient to the taxpayer. Direct taxes are generally not shifted. Therefore, they
are painful to the taxpayer. Hence, such taxes are unpopular and are generally opposed by the
taxpayers, as they have to be borne by the assessees themselves.
2. Inconvenience: Direct taxes are inconvenient in nature, because a taxpayer has to submit a
statement of his/her total income along with the source of income from which it is derived.
Moreover, direct taxes are paid in lump sum which causes inconvenience to the taxpayers.
Hence, these taxes are said to be inconvenient to the taxpayers.
3. Possibility of Evasion: A direct tax is said to be a tax on honesty, but it can be evaded
through fraudulent practices. As stated above, direct taxes are certain and taxpayers know the
rate of tax they have to pay. Therefore, awareness of tax liability tempts the taxpayer to
evade tax. It is a fact that the people in the higher income groups do not reveal their full
income. They do not hesitate to fill up false returns, concealing a considerable part of their
incomes. Black money is generated on a large scale and a parallel economy is established
which is injurious to economic development. Hence, it is found that direct tax can wholly or
partly be evaded, if the taxpayer decides to become dishonest.
4. Arbitrary: Direct taxes are found to be arbitrary because there is no logical or scientific
principle to determine the degree of progression in taxation. Rates of income tax and other

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 direct taxes are determined according to the whims of taxation authorities. They are likely to
underestimate or overestimate the taxable capacity of the people.
5. Adverse effects of Direct Taxes on will to work and Save: Will of the people to work depends
on the nature of tax. Certain taxes by nature like, excess profit tax etc. do not have any bad
effect on the will of the people to work and in turns save. Conversely, if the higher taxes are
imposed on the income of the assessees, the will of the people to work hard and save may
adversely be affected. This may prove to be injurious to the economy.

b) Indirect Taxes
Indirect taxes are imposed when the income is spent i.e., on goods purchased. In a sense, indirect
taxes are taxes on expenditure. It can be shifted or passed on to other persons. Indirect taxes are
taxes on commodities. These are custom duties, excise duties, sales tax etc. Thus, if it is intended
that the amount of tax should be collected from other persons by those on whom it is imposed,
such a tax is an indirect tax.

Merits of Indirect Taxes

In direct taxes have the following merits:
1. Convenience: Indirect taxes are convenient to pay. They are paid in small amounts instead of
in one lump sum. They are generally included in the price of a commodity and hence the
burden of these taxes is not felt very much by the taxpayers. They are also convenient from
the point of view of the Government also. These are collected only when the income of the
person is spent, and spending is spread over a long time. Thus, indirect taxes are convenient
and less unpopular.
2. No Evasion: There is always a tendency to avoid or evade taxes. Indirect taxes are generally
difficult to be evaded as they are included in the price of a commodity. A person can evade
an indirect tax only if he decides not to purchase the taxed commodity.
3. Elastic: Indirect taxes can be elastic, i.e., the revenue from indirect taxes can be increased.
Revenue may be increased if the tax is imposed on those articles, the demand for which is
inelastic. In other words, if taxes are imposed on articles of common consumption, revenue
may be increased.

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4. Wide Coverage: Through indirect taxes, every member of the community can be taxed, so
that everyone may provide something to the Government to finance the services of public
utilities. In other words, through indirect taxes, everyone contributes towards social benefits.
5. Can be Progressive: Indirect taxes can be made progressive by imposing heavy taxes on
luxuries and exempting articles of common consumption from the tax net.
6. Economy: Indirect taxes, such as sales tax, are collected by trades, manufacturers and sellers
from individual buyers and then paid in lump sum to the tax authorities. Thus, there is
economy in the collection of indirect taxes.

Demerits of Indirect Taxes

1. Regressive: Indirect taxes are regressive in nature, as they fall more heavily upon the poor
than upon the rich. The Government in order to increase its revenues imposes heavy taxes on
the articles of common consumption, the demand for which is inelastic. The real burden on
the poor is more, since their incomes are low.
2. Administrative Cost: The administrative cost of collection of such taxes is generally heavy as
they have to be collected from large number of people in small amounts. It is necessary to
check records of manufacturers and sellers as well as to prevent smuggling of goods. Large
number of inspectors has to be maintained. Thus, the cost of collection tends to be very high
in the case of indirect taxes.
3. Discourage Savings: Indirect taxes discourage savings because they are included in the price
of a commodity and people have to spend more on essential commodities. Hence, they
discourage savings.
4. Uncertainty: The income from indirect taxes is said to be uncertain, because the taxing
authority cannot accurately estimate the total yield from different taxes on account of the fact
that the demand for different goods is influenced by so many factors like elasticity of
demand. If the demand for these is elastic, the income may be less and vice-versa.
5. No civic Consciousness: Indirect taxes are collected through middlemen like traders, and
hence they have no direct impact. Unlike direct taxes, indirect taxes are collected in small
amounts; hence, they are not felt very much by the taxpayer and do not arouse civic
consciousness.

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6. Adverse Effects on Efficiency: When indirect taxes, such as excise duties and sales tax, are
levied on essential goods, their consumption by workers is reduced and so too their
efficiency. Therefore, productivity of workers is reduced.
7. Creation on Inflation: Another major evil of indirect tax is that these taxes generate inflation
in the economy. Prices of taxed goods keep on rising without any reduction in the purchasing
power in the economy.
Price inflation caused by indirect taxes increases the cost of inputs and outputs. Increase in
production costs pushes the price of goods further, which in turn, increases the wages of the
workers. This hampers both the welfare of the people and economic growth. Thus, cost-push
inflation results from indirect taxes.

It is therefore concluded that both direct and indirect types of taxes have their own merits and
none can be regarded as inferior to the other. Both are mutually complimentary to each other.
Therefore, both types must be appropriately adjusted in a rational tax system.

3.6.2 Proportional, Progressive, and Regressive Taxation

A tax system is called progressive when the tax liability increases with increase in income. To
put differently, in a progressive tax, the tax rates increases with increase in tax base. A tax
system is said to be proportional when a tax rates remains constant in response to increase in tax
base. On the other hand, a tax system is regressive when the tax rate reduces with increase in tax
base. In other words, a tax system is regressive when the tax rates reduce with increase in tax
base.

a) Proportional Taxation
A tax is called proportional, if all the taxpayers pay the same proportion of their income
(property) as tax

Arguments in Favor of Proportional Taxation

i) Relative Position not affected: According to the classical economists, the objective of
taxation should not be to alter the relative poison of the taxpayers. Hence, they

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 advocated proportional taxation, as it does not affect the relative position of the
taxpayers- as percentage of tax is the same on all the taxpayers.
ii) Simple & uniform tax rates: Taxes rates are the same both for the rich and for the
poor. Since the tax rate is uniform for all the taxpayers, taxation is not very much
opposed by them. Taxpayers do not feel the pinch of paying proportional taxes.
iii) Certainty: Proportional taxation satisfies the canon of certainty. As the tax rates are
the same for all the taxpayers, the amount of proportional taxes can be estimated and
calculated easily by the Government. Therefore, proportional taxation also satisfies
the canon of simplicity and has been regarded as better than progressive taxation.
iv) Willingness to work and save not affected: The Proportional taxation has been
supported on the ground that the willingness to work more and save more of the
taxpayers is not adversely affected by the proportional taxation because the rate of
taxes remains constant. Therefore, they are generally not opposed by the taxpayers.
v) Equitable: Proportional taxes are just and equitable because the money burden
increases in the same proportion as the income increases. Therefore, the taxpayers do
not feel the pinch of paying proportional taxes

Objection against Proportional Taxation

On the other hand, the supporters of progressive taxation and the critics of proportional taxation
argue that this taxation has a number of shortcomings
i. Not just and equitable: A system of proportional, according to some critics, is not just and
equitable. According to them, proportional taxation would not lead to equitable and just
distribution of the burden of taxation, as it falls more heavily on small incomes than high
incomes. Hence, the sacrifice involved in paying of a tax, proportion to the income, is greater
for the poor than for the rich as the marginal utility is greater for the poor than for the rich.
Justice requires that the sacrifice made by each taxpaying should be equal. Therefore, the rich
should be taxed at higher rate than the poor.
ii. Inadequate resources: A system of proportional taxation means that the tax rates for the rich
and the poor are the same. Hence, the state cannot obtain from the richer section of the
society as much as they can give. Therefore, in modern times, with the increasing financial

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 needs of the government, such a system may fail to provide adequate resources to the
government.
iii. Inelastic: The proportional tax system cannot be elastic. In other words, revenue from
proportional tax system cannot be increased as the financial needs of a government are not
fixed; they may change from time to time and is often required to have more funds. In
proportional tax-system, the burden of taxes falls more heavily on the poor than on the rich,
as the rates of taxes are the same. If the tax rate for the smaller income group is already
heavy and that it cannot be increased. This implies that the tax rate for higher income groups
cannot also be raised, as under the proportional tax system all should be taxed at the same
rate. Hence, the Government may not be able to increase its revenue in times of emergency.
Therefore, the system is not elastic
Hence, the proportional tax system suffers from the effect if there is inequitable distribution of
the burden of taxation, lack of elasticity and inadequacy of funds for the increasing needs of the
modern Government.

b) Progressive Taxation
A tax is said to be progressive, if larger the taxpayer’s income (property), the greater is the
proportion that he pays as tax. A sharply progressive tax system tends to reduce inequalities in
the distribution of income and wealth and, shaper the progression, the stronger is the tendency to
reduce inequalities.

Arguments in Favor of Progressive Taxation

The principle of progression in taxation has been accepted. This principle has been favored by
different writers on a number of grounds, some of which are as follows;

1. Just and equitable: Progressive taxation is just and equitable on the ground that it secures
equality in sacrifice. In other words, under the system of progressive taxation inequalities
would be reduced because a higher proportion of the income and wealth of the rich would be
taken away by way of taxes than that of poor. Hence, a sharply progressive tax system tends
to reduce inequalities in the distribution of income and wealth and, the sharper the
progression, the stronger is the tendency to reduce inequalities. Obviously, progressive

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 taxation is desirable in order to bring about a more equitable distribution of wealth as it is
based on the principle of ability to pay.
2. Reduces inequalities: Progressive taxation reduces inequalities of income and wealth by
taking away the excessive capacity to pay. In a progressive tax system, rich are subjected to
higher rates of taxation and poor are either subjected to lower of taxation or exempted from
tax obligations.
3. Economical: Progressive taxes have also been justified on the ground that they are
economical, as the cost of collection does not rise with the increase in the rates of taxes.
4. Elastic: Progressive taxes are elastic in nature. Revenue from progressive taxes can be
increased by increasing the rates of taxes i.e. the public revenue can be increased at any time
by increasing the rates of taxes and vice-versa
5. Curbs Inflationary trends: Progressive taxation may be helpful in curbing the inflationary
trends as it reduces consumption demand and the resources thus mobilized may be directed
towards productive investment which may increase the supply of commodities. Hence,
inflationary trend may be curbed; growth and economic stability may be achieved.

Objections against Progressive Taxation

The following objections have been advanced against the policy of progressive taxation
1. Arbitrary: Progressive taxation is arbitrary. It is not bound by rules. In other words, there are
no guiding principles according to which tax rates are determined. The Government, in order
to increase its revenue, arbitrarily increases the rates of taxes and vice-versa.
2. Discourages capital formation: Progressive taxation may adversely affect production and
discourage the growth of industry. This may hamper the formation of capital and the growth
of industry.”
3. Encourage Evasion: Progressive taxation also encourages evasion. As rich are subjected to
higher rates of taxation, assessees submit false returns of their income and wealth. Hence, in
case of progressive taxation, the motives for evasion would be stronger and the means of
prevention is less effective than in case of a proportional tax. However, this objection may be
removed through efficient and strong tax collection machinery.

c) Regressive Taxation

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A regressive tax is a tax which takes a larger percentage of income from people whose income is
low. Often it is a fixed tax – every person has to pay the same amount of money, such as a poll
tax. A poll tax is a fixed tax for each person: since each person pays the same amount of money,
it is a lower proportion for people with higher incomes. A regressive taxes fall more heavily on
the poor section of the community, than on the richer section. Thus, it violates the principle of
equity and social justice.

3.6.3 Single Vs Multiple Taxation

a) Single Tax System
A single tax means only one kind of tax. It does not mean tax on only one person. On other
words, a tax on one thing i.e. on one class of things or one class of people. It can be
proportional, progressive or regressive.

Merits of a Single Tax

i. Simple: The greatest merit of a single tax lies in its simplicity. Since, there is only one
tax, it simplifies the work of the Government. A multiple tax system complicates the
work of the Government. A multiple tax system complicates the work in every respect in
collecting revenue and its effect on production and distribution. Thus, in a single tax
system, collection of revenue would be greatly simplified and it would be much less
costly, if all the taxes are replaced by only one tax.
ii. Equitable: single tax like income tax is just and equitable because it is based on the
principle of equity in taxation. Higher taxes are imposed on the income of the rich and
lower taxes are imposed on the income of the rich and lower taxes are imposed on the
income of the poor. Income below the exemption limit is exempted from taxation.

Demerits of a Single tax

i. Insufficient Revenue: From the point of view of revenue, the single tax may not be
sufficient for the Government. The financial needs of the Government are not fixed and
sometimes, the needs of the Government suddenly increase which cannot be met by the

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 yield of a single tax. The yield of a single tax does not increase as rapidly as the yield
from the multiple tax system.
ii. Regressive: Single tax is opposed on the ground that, it is regressive in nature as it cannot
be imposed in proportion to the ability to pay of the taxpayer. For instance, if a tax is
imposed on houses, land, or any other such things, it is difficult to make its burden on
everybody in proportion to his/her ability. Here, it has been pointed out that, if the tax is
on income, it can be made very equitable. However, income tax can be evaded especially
by rich people and hence tax may not achieve the objective of equitable distribution of
income and ability to pay.

a) Multiple Tax System

Multiple taxations laid great stress on the diversity of taxation. This means there should be all
types of taxes, direct and indirect, so that every class of citizen may be called upon to contribute
something towards the state revenue. Hence, a multiple tax system is preferable to a single tax
system, but too great a multiplicity is not desirable, as it may go against the canon of economy
and productivity.

Merits of Multiple Taxations

Following arguments have been advanced in favor of multiple taxations
i. Just and Equitable: Multiple taxes are just and equitable because they are based on the
principle of ability to pay. All the taxpayers pay taxes according to their money income.
Rich pay taxes at high rates and poor are exempted from taxation. The burden of taxation
is equitably distributed on all the sections of a society. In other words, the sacrifice of the
society is equal.

ii. No Evasion: Multiple taxes cannot easily be evaded. If a person evades a tax on one
account, he pays the tax on another account because of the multiplicity of taxes. Direct
taxes like income tax can be evaded but it is not possible to evade consumption taxation
because the tax is included in the price of a commodity. Hence, tax evasion is not easy
under multiple tax system.

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 iii. Sufficient Revenue: As a number of taxes are imposed in a multiple tax systems,
therefore all the people pay, more or less, all the taxes. Hence, the Government is able to
collect sufficient revenue to meet the growing needs of the society.

iv. Wide Coverage: Through multiple taxes, every member of the community can be taxed
so that everyone may provide something to the Government to finance the services of
public utilities. In other words, through multiple taxes, everyone contributes towards
social benefits. Therefore, by adopting multiple tax system, the tax structure becomes
broad based covering almost every sector and person in the country.
v. Satisfies all the Canons: Multiple tax system satisfies most of the canons of taxation such
as equity, diversity, productivity, flexibility etc

Demerits of Multiple Taxation

i. Unpopular: Multiple tax system is unpopular amongst the taxpayers as it is composed of all
types of taxes, direct taxes as well as indirect taxes. Direct taxes are generally not shiftable;
therefore, they are painful to the taxpayer. On the other hand, indirect taxes are included in
the price of a commodity; therefore, they cannot be evaded. Hence, multiple tax system is
unpopular and opposed by the taxpayers.
ii. Inconvenient: Too much multiplicity of taxes, may lead to inconvenience to both the taxing
authority and the taxpayer as well as to the general public.
iii. Affects Economy and Productivity: Excessive taxation in the name of multiple taxation must
be avoided, for though, multiple tax system is generally preferable to a single tax system, too
much multiplicity is not desirable, since it may sacrifice the canon of economy, productivity
and convenience.
iv. Administrative Cost: The administrative cost of collection of such taxes is generally heavy as
they have to be collected from large number of people. It is necessary to check records of
manufacturers and sellers as well as to prevent smuggling of goods. Large numbers of
officers have to be appointed to collect revenue. Salaries have to be given to the officers.
Salaries of the officers eat up the greater part of the product of tax. The Government has to
impose additional taxes on the people.

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3.7 Public Debt
3.7.1 Definition of Public Debt
Public borrowing or public debt is a debt or loan taken by the Government from its own people
as well as from foreign countries or both. Borrowing may be short term as well as long term. The
Government may borrow from banks, business organizations, business houses, individuals and
foreign countries. Public debt refers to “Obligations of Governments, particularly those
evidenced by securities to pay certain sums to the holders at some future date”. Government
needs to borrow when current revenue falls short of public expenditure since current public
revenue is usually insufficient to meet the current and development expenditure of the modern
Government. The Government has no alternative except to borrow money.

The instruments of public borrowings are in the form of various types of Government bonds and
securities. A Government bond or a Government security paper is a form of a written promise to
pay, made by the Government to the lender of the capital. The proceeds from public borrowings
constitute the revenue of a capital nature, while the provision for their repayment, and servicing
should be regarded as an expenditure of a capital nature in any budget. The payment of interest
on loans borrowed is, however, a charge on the revenue account of the budget.
3.7.2 Sources of Public Debt
Every Government has two major sources of borrowing: internal, and External.
1. Internal Sources
Internally, the government can borrow from individuals, financial institutions, commercial
banks, non-banking institutions and central banks.

 Borrowing from Individuals: public debt borrowed from individuals is in the form of
bonds, debentures or loans. They carried fixed rate of interest and are repayable on the
due dates by the Government to the individuals from whom it borrows.
 Borrowing from Commercial Banks: Public debts are also raised by the Government
from commercial banks in the form of loans. Commercial banks can subscribe to
Government loans through creation of credit.

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  Borrowing from Non-banking financial Institutions: Public debt is also raised by the
Government from non-banking financial institutions such as insurance companies, trusts,
mutual saving banks etc. in the form of Government bonds.
 Borrowing from Central Banks: Central Bank of a country is also an important
subscriber to the government loans. Central Banks purchases bonds of both the central
Government as well as State Government.

Increasing need of government for funds cannot be fully met by taxation alone in under
developed and developing countries due to limited scope of taxation. Government therefore has
to resort to alternate sources. Rising of debt is one such source. Debt, though involves
withdrawal of resources by curtailing private consumption, has certain advantages. Transfer of
funds from public to government is voluntary. Loans do not reduce the wealth of the lenders.
Debt raised for productive purpose will not be a burden on the economy.

There are many objectives of creation of public debt. Debt may be raised to meet the normal
current expenditure, exigencies like war, finance productive government enterprise, finance
public social welfare and economic development.

Capital receipts mainly consist of market borrowings, small savings and external loans,
disinvestments of PSUs and recoveries of loans.

2. External Sources
To finance various services, the Government also resorts to external borrowings. External
sources of borrowings include foreign individuals and foreign banks, international institutions
and foreign Governments. International financial institutions which lend money are International
Monetary Fund i.e. IMF, World Bank, African Development Bank/ADB/, Agricultural
Development and Asian Development Bank etc. Public debt is also raised by the Government
from external sources for overcoming temporary balance of payment difficulties and for
development purposes.

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In under developed and developing countries, internal sources are limited. Under developed and
developing countries, therefore, go for external debt. The transfer of capital at international level
may take the form of:
i) Financial aid through grants and loans
ii) Commodity aid
iii) Technical assistance

External debt is an immediate source of funds for development. However, such debt has
following drawbacks.
i) Political subordination
ii) Other obligation
iii) Excess supply of goods and services in debtor country
However, such external inflows help to achieve faster growth.

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