CHAPTER 1

Public Finance: Public Finance means how the government gets money and how it spends it. It
studies government income and expenditure for the welfare of people.

Government Functions:

A. Obligatory (Essential) Functions:

• Defense (protecting the country)

• Maintaining law and order (police, courts, etc.)

B. Optional (Welfare) Functions:

• Building roads, bridges, schools, hospitals

• Improving health, education, and environment

Why Public Finance is Needed:

• The government needs money to perform all its duties.

• The money comes from the public through taxes, fees, etc.
• The government must decide:
1. How to collect revenue (income).
2. How to spend money for the maximum benefit of society.

Public Finance vs Private Finance

Topic Public Finance (Government) Private Finance (Person)

1. Income and The government decides spending first and then A person spends according to their
Spending collects money through taxes or loans. income — spends only what they earn.
The government tries to balance its budget every A person has no fixed time to balance
2. Time Period
year. income and spending.
Government finance is open and public (everyone
3. Secrecy Personal finance is private and secret.
can see the budget).
Government can borrow inside the country (from A person can only borrow from others
4. Borrowing
banks/people) and outside (from other countries). (friends, bank, etc.).
5. Income Government gets money from people’s income A person earns money by working or
Source (taxes, duties, etc.). doing business.
6. Printing Government can print paper money through the
A person cannot print money.
Money central bank.
7. Spending Government spends for public welfare (roads, A person spends for personal needs and
Purpose schools, hospitals). happiness.
8. Surplus or It’s okay for the government to spend more than it A person should spend less than they
Deficit earns (deficit) for development. earn (save money).
 Public Finance and the Economic Systems

Meaning of Economic System: An economic system means how a country uses and manages its
resources like land, labor, and capital.

o It decides what to produce, how to produce, and who will get it.
o Different countries have different systems based on their needs and goals.

Types of Economic Systems: There are four main types of economic systems.

a. Traditional Economy

• Oldest and simplest system.

• People follow customs and traditions.
• Work like farming, fishing, hunting.
• Very little use of machines or technology.
• Found mostly in rural and village areas.
• People make only what they need, no extra.

b. Command Economy (Planned Economy)

• Government controls everything in the economy.

• It decides what, how, and for whom to produce.
• Found in communist countries.
• Government owns most industries.
• Changes happen slowly because decisions come from the top.
• Can be inefficient and slow to react.

c. Market Economy (Free Market)

• Based on supply and demand.

• People and businesses make their own decisions.
• Government has little control.
• Prices are decided by the market.
• Encourages competition but creates income inequality.
• The rich get richer, the poor get poorer.

d. Mixed Economy

• Combination of market and command systems.

• Some sectors are private, others are controlled by government.
• Government provides basic services like health, education, and defense.
• Most countries today follow this system.

Type of Economy Who Controls the Economy Example

Traditional Customs and traditions Tribal or rural areas
Command Government North Korea
Market Private individuals United States
Mixed Both government and private sector Bangladesh, India
Public Revenue:

• Government needs money to perform its political, social, and economic duties.
• This money is called public revenue.
• Public revenue comes from taxes, fees, fines, grants, and other sources.

Types of Public Revenue

1. Tax Revenue
2. Non-Tax Revenue

Non-Tax Revenue : Money earned by government from sources other than taxes.

• Main sources:
1. Fees – Charges for services (passport, license, registration).
2. Fines / Penalties – Punishment for breaking rules or laws.
3. Surplus from Public Enterprises – Profits from government-owned companies.
4. Special Assessment / Betterment Levy – Charged on people who benefit from public
projects (e.g., bridge construction).
5. Grants and Gifts – Voluntary contributions from individuals, institutions, or foreign
countries (foreign aid).
6. Deficit Financing – Borrowing to cover the gap when expenditure > revenue (from
domestic/foreign sources or by printing currency).

Tax : A tax is money that everyone must pay to the government. The government uses it to run the
country and help people. Tax payer don’t get something directly back, but they get public services.

• The word tax comes from French “taxe” and Latin “taxare” — it means to charge.
• A tax is money people must pay to the government.
• It is not a punishment, it is a compulsory payment.
• People don’t get anything directly in return for paying taxes.
• The government uses this money for roads, schools, hospitals, and other public needs.
• In Bangladesh, Article 152(1) says tax means any tax, duty, rate, or charge taken by the
government.
• Tax is the main source of income for the government.

Characteristics of Tax

1. Imposed only by the government (Sec 83, Constitution of Bangladesh).

2. Compulsory payment — refusal is punishable.
3. Not a penalty or fine.
4. Involves sacrifice for public welfare.
5. Collected to finance government expenses.
6. No direct benefit to the taxpayer.
7. Main source of revenue for the government.
Purposes or Objectives of Taxation

1. Revenue Collection
o Main source of government income.
o Used to meet public expenses like defense, education, and welfare.
o In Bangladesh, taxes make up about 85% of total revenue.
2. Reduce Inequality
o Helps to reduce income and wealth gaps.
o Rich people are taxed more (progressive tax).
o Poor people benefit through welfare and subsidies.
3. Promote Economic Growth
o Encourages savings and investment.
o Tax money can be used in productive sectors to boost growth.
4. Control Consumption
o High taxes on harmful goods (like alcohol, tobacco) to protect public health.
o Higher taxes on luxury goods to reduce wasteful spending.
5. Protect Local Industries
o Tax incentives for small/local industries.
o Helps them compete with foreign industries.
6. Support Economic Development
o Used to build infrastructure, reduce poverty, and create jobs.
o Helps fund social welfare and development projects.

Canons of Taxation

1. Equality: Tax should be fair — rich pay more, poor pay less.
2. Certainty: Everyone should know how much, when, and how to pay.
3. Economy: Tax collection should cost as little as possible.
4. Convenience: Tax should be easy to pay at the right time.
5. Productivity/Adequacy: Tax must raise enough money for government expenses.
6. Simplicity: Tax rules and system should be easy to understand.
7. Elasticity: Tax rates should be flexible and adjustable when needed.
8. Diversity: Government should collect taxes from many sources, not just one.
9. Expediency: Tax system should match the country’s economic and social needs.
10. Functional Efficiency: Tax system should work well, reduce cheating, and generate enough
revenue.

Characteristics of a Good Tax System (Very Easy Version)

1. Fair: Rich people pay more, poor people pay less.

2. Clear: Everyone knows how much and when to pay.
3. Easy to pay: Tax should not be difficult or complicated.
4. Balanced: Includes both direct (income) and indirect (goods) taxes.
5. Encourages work and savings: Tax should not stop people from working, saving, or investing.
6. Uses money well: Government should use tax money properly for the country.
7. Low cost to collect: Government should spend less to collect more tax.
8. Hard to cheat: People should not be able to avoid paying tax.
9. Benefits society: Tax system should help everyone and improve public welfare.
Tax in Economic Development

1. Resource Allocation: Taxes help move money and resources to important sectors, especially in
poor areas.
2. Government Revenue: Taxes give money for government work and social welfare, so
borrowing is less needed.
3. Encourage Savings & Investment: Taxes can help people and businesses save and invest more.
4. Reduce Inequality: Taxes help make rich and poor more balanced.
5. Economic Growth: Taxes can be used to increase spending in hard times or reduce it in
inflation.
6. Price Stability: Taxes help keep prices steady.
7. Control Mechanism: Taxes reduce harmful or luxury goods use and protect small local
businesses.

Tax Burden

• Tax burden is the amount of tax a person, company, or country pays in a period.
• For a country, it is calculated as total tax collected ÷ national income or GNP × 100.
• Governments design tax policies to who should pay how much tax.

Approaches to Allocate Tax Burden-Ways to Decide Who Pays

1. Expediency Approach:
o Only practical taxes are chosen.
o Must be easy to collect.
o Social or economic goals are not considered.
2. Socio-Political Approach (Wagner):
o Taxes should help society, not just individuals.
o Reduce income inequality.
o Government can control property or inheritance for social good.
3. Benefits Received Approach:
o People pay taxes based on the benefits they get from government services.
o Like a “you get what you pay for” rule.
o Does not focus on fairness or economic growth.
4. Cost-of-Service Approach:
o Citizens pay the exact cost of government services they use.
o Government focuses on recovering costs, not helping poor people.
5. Ability-to-Pay Approach:
o People pay taxes according to how much they can afford.
o Rich pay more, poor pay less.
o This is considered fair and just

Tax Impact

• The immediate burden of tax.

• Falls on the person or company who legally pays the tax first.
• Example: A company paying income tax bears the impact.
Tax Incidence

• The final burden of tax.

• Who ultimately bears the tax, whether or not it was directly levied on them.
• Example: VAT or customs duty—consumers ultimately pay it through higher prices.

Effect of Tax

• Taxes cause responses from taxpayers and the economy.

• Can affect: production, growth, savings, investment, choice of production methods, income
inequality, and regional development.
• Effects can be positive or negative.

Burden of Tax : The harmful effects of a tax, reducing welfare.

Types of Burden:

A. Money Burden (Formal Incidence)

• Loss in disposable income due to tax.

1. Direct money burden: Tax paid directly to authorities.

2. Indirect money burden: Extra expenses caused by the tax.

B. Real Burden (Loss of Welfare)

• Reduction in overall welfare for taxpayers and society.

1. Direct real burden: Welfare loss caused directly by the tax itself.
2. Indirect real burden: Welfare loss due to changes in consumer choices, production,
employment, or total output.

Feature Impact of Tax Incidence of Tax

Meaning Who pays the tax first Who ultimately bears the cost
Who Bears It Initial payer (e.g., manufacturer) Final bearer (e.g., consumer)
Can It Be Shifted? Yes, can pass to others No, cannot be shifted
Example Soda company pays excise duty Consumers pay higher soda price
Direct vs Indirect Tax Same person for direct tax Different person for indirect tax

Feature Incidence of Tax Effect of Tax

Meaning Who finally pays the tax What happens because of the tax
Burden Direct money burden Indirect burden (less spending/saving)
Cause From tax law or shifting From tax itself or shifting of tax
Example You pay income tax You spend less or save less because of tax
TAX SHIFTING

• Meaning: When the person who first pays a tax makes someone else pay it instead.
• Example:
o A manufacturer pays VAT or customs duty.
o They add it to the product price.
o The buyer ends up paying the tax.
• How it happens: By increasing the price of goods or services.

TAX SHIFTING TYPES

1. Single Point vs. Multi-Point

o Single Point: Tax is added once to price → consumer pays.
o Multi-Point: Tax is added many times along the chain → importer → wholesaler →
retailer → consumer.
2. Forward vs. Backward
o Forward Shifting: Tax goes from seller to buyer.
▪ Example: Factory pays tax → increases price → consumer pays.
o Backward Shifting: Tax goes from buyer to seller.
▪ Example: Buyer pays less for product because future taxes reduce price (tax
affects asset value).

Theories of Tax Shifting

1. Concentration Theory
o Tax hits one group only.
o Example: Tax on land → only landlords pay.
o Idea: Government should focus on one main tax.
2. Diffusion Theory
o Tax spreads to everyone.
o Example: Tax is passed through sales → everyone pays a little → cannot tell who paid
finally.
3. Demand & Supply Theory
o Tax moves through price changes.
o If demand is inelastic: Buyer pays more.
o If demand is elastic: Seller pays more.
o Tax is shared between buyer and seller depending on demand & supply.

Classification Based on Number of Taxes

1. Single Tax:
o Only one type of tax in the whole country.
o Example: In old times, people paid poll tax (head tax).
2. Multiple Tax:
o Many different taxes in a country.
o Example: Today, governments collect tax on income, spending, and wealth.
 Classification Based on Impact and Incidence

[Link] Tax

• Paid by the same person on whom it is imposed..

• Cannot be passed to others
• Example: Income tax, land tax.

[Link] Tax

• Tax is first paid by one person but passed to another.

• Usually added to the price of goods/services.
• Example: VAT, customs duty.

Differences Between Direct and Indirect Taxes

Basis Direct Tax Indirect Tax

Taxable Event Based on income or wealth of a person. Based on buying, selling, or making goods/services.

Collected directly from the person who Collected from consumers but paid to government by
Levy & Collection
pays (assessee). seller/dealer.

Burden of Tax Cannot be shifted — payer bears it. Can be shifted — seller passes it to buyer.

After income is earned or assets are

Time of Collection When goods are sold or services are given.
valued.
Classification Based on Structure of Tax Rate

1. Proportional TaxA tax where the rate stays the same for all income levels.
o Same rate for everyone, no matter how much they earn.
o Example: 10% on Tk. 100,000 = Tk. 10,000
10% on Tk. 500,000 = Tk. 50,000
o Income ↑ → Tax ↑ in same ratio.

2. Progressive Tax : A tax where the rate increases as income increases.

o Higher income → higher tax rate.
o Example: Tk. 100,000 → 10%, Tk. 500,000 → 15%
o Rich pay more rate than poor.
o Fair system.

3. Regressive Tax: A tax where the rate decreases as income increases.

o Poor pay more (in proportion) than rich.
o Tax rate decreases as income increases.
o Example: Tk. 100,000 → 15%, Tk. 500,000 → 10%
o Example: Sales tax — both rich and poor pay same, so poor suffer more.

4. Degressive Tax: A tax that is progressive up to a limit, then becomes constant (flat rate).
o Partly progressive, then flat.
o Rate increases slowly up to a limit, then stays the same.
o Example: Low income → 10%, high income → 15% (then fixed).

In Bangladesh, this system is followed

Marginal Tax Rate

Classification Based on Subject Matter of Taxation

1. Personal Tax:
o Based on a person’s ability to pay.
o Example: Income tax.
2. In Rem Tax:
o Based on things or activities.
o Example: Sales tax, wealth tax.

Classification Based on Elasticity of Tax

1. Elastic Tax:
o Tax changes more than income or base.
o Example: When income rises a little, tax revenue rises a lot.
2. Inelastic Tax:
o Tax changes less than income or base.
o Example: Income rises fast, but tax revenue rises slowly.

Classification Based on Tax Base

1. Income Tax: On income of people or firms.

2. Wealth Tax: On assets like land, shares, property.
3. Value Added Tax (VAT): On value added in each production stage.
4. Expenditure Tax: On spending, e.g. purchase or sales tax.

Classification According to Change in Government Revenue

1. Positive Tax: Increases government income.

o Example: Income tax, VAT, wealth tax.
2. Negative Tax: Reduces government income (transfer payments).
o Example: Pension, gratuity.
Classification According to Taxing Authority

1. Central Tax: Collected by central government.

o Example: Income tax, wealth tax.
2. Local Tax (Rate): Collected by local bodies (City Corporation, Union Parishad, etc.).
o Example: Holding tax, municipal tax.

TAX STRUCTURE IN BANGLADESH: The tax structure in the country consists of both direct and
indirect taxes.

1. Two Types of Taxes:

o Direct Taxes: Paid directly by people to the government.
▪ Examples: Income tax, gift tax, land development tax, property tax, registration
fee.
o Indirect Taxes: Paid through goods or services (added to prices).
▪ Examples: VAT, customs duty, excise duty, motor vehicle tax, liquor duty,
electricity duty, travel tax, advertisement tax.
2. Revenue Collection (FY 2021–22):
o Taxes = 88.22% of government revenue.
o NBR taxes = 84.14% of total revenue.

Features of Bangladesh Tax System

[Link] tax system : Bangladesh collects different types of taxes from different sources.

[Link] and stagnant revenue yield relative to GDP

• Tax–GDP ratio is very low.

• In 1973–74 → 5%
• In 2021–22 → 8.70%
• Still lower than other developing countries.

[Link]-ratio of indirect to direct tax revenue

• Most tax comes from indirect taxes (VAT, customs).

• About 66% of revenue is from indirect taxes.

[Link] of Indirect Taxes

• VAT, import duty, supplementary duty give the highest revenue.

• Income tax share is increasing but still lower than indirect taxes.

[Link] administration in Bangladesh

• NBR (National Board of Revenue) collects about 95% of all taxes.

• Government is taking reforms to improve the tax system.
[Link] avoidance behavior of the taxpayers

• Many people and firms avoid tax using loopholes.

• Only 2.3 million taxpayers out of 171 million people (1.35%) pay income tax.

7. Narrow Tax Base

• Small number of people are paying tax.

• Many exemptions reduce collection.
• Agriculture → employs 40% people but pays very little tax.
• Shadow economy ≈ 30% of GDP → no tax collected.

INCOME TAX - CONCEPT AND DEFINITION

• Income tax is the tax that is imposed on the taxable income of a person or entity as per the
provisions of the Income Tax Ordinance, 1984.
• Income tax is a direct and single tax charged on the total income of a person for a
relevant income year.

Characteristics of Income Tax (Easy Version)

1. Direct tax: Paid directly by the person on their income.

2. Law-based: Follows Income Tax Ordinance, 1984.
3. Total income: Charged on all income of a person for the year.
4. Rate fixed by government: Decided by Finance Act; NBR gives extra rules.
5. Single tax: It’s one tax, not many small taxes combined.
6. Annual tax: Collected once a year.
7. Only on income: Taxes on other things are not income tax.

Objectives and Importance of Income Tax

1. Revenue Collection
o Major source of government revenue.
o FY 2022-23: Income tax target Tk 1,21,020 crore (31.2% of total tax revenue).
o Helps meet public expenditure.
2. Redistribution of Income
o Reduces income inequality.
o Rich pay more, benefits go to poorer people through progressive taxation.
3. Increase Savings
o Encourages people to save using tax credit on investments.
4. Increase Capital Investment
o Encourages local and foreign investors.
o Incentives: tax credit, tax holiday, depreciation allowance, other tax benefits.
5. Economic Development
o Revenue used for infrastructure, social programs, poverty reduction.
6. Overall Role
o Income tax is essential for economic growth and development.
o NBR is modernizing to make the system more effective and efficient.
Rights and Obligations of a Taxpayer

1. Professional Assistance
o Taxpayer can get help from tax offices, including forms, brochures, and guidelines.
2. Representation
o Can represent himself or appoint an authorized representative.
3. Access to Records
o Can view his own tax records held by the office.
4. Fair Treatment
o Tax authorities must act impartially, fairly, and professionally.
5. Right to be Heard
o Can be heard before any penalty is imposed.
6. Refund
o Entitled to instant refund when due.
7. Appeals
o Collection cannot be enforced while appeal is pending.
8. Installment Payment
o May pay arrears in installments in certain situations.