CHAPTER TWO
• TAX TYPE AND TAX SYSTEMS
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2.1 Tax Type
Common dimensions to classify taxes;
a)Based on impact and incidence of tax
b)Based on tax bases
c)Based on tax determinant
d)Based on number of taxes
e)Based on sources of taxes
TAX IMPACT, SHIFTING AND INCIDENCE
Tax Impact
• It refers to the immediate burden.
• also called legal incidence of a tax.
• Can be shifted.
• It is felt by the person from whom the tax is
originally collected.
Tax Incidence
• It refers to the final or ultimate resting place of the
burden of the tax payment.
• Also called economic incidence of a tax
• Can not be shifted
• Is felt by the person who actually pays the tax.
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Cont’d
Shifting
• It refers to the process by which the burden of a
tax is transferred from one person to another.
• A tax may be shifted either forward or
backward.
Example:
• Forward shift –the importer or producer shift
the tax to wholesaler
• Backward shift – the importer or producer shift
the tax to suppliers
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i) Direct Taxes
Are those taxes whose impact (immediate
burden) & incidence (ultimate burden) fall
on the same person.
They can’t be shifted (passed on) to others.
Are taxes based on income or wealth
(property) of persons.
Some Examples of direct tax includes;
Employment income tax
Business income tax
Rental income tax
Interest income tax
Royalty tax
Capital gain tax
Property tax
Agriculture income tax
Transfer taxes, etc.
ii) Indirect Taxes
Are those taxes whose impact (immediate burden)
& incidence (ultimate burden) fall on different
persons. i.e.,
The impact of the tax falls on the person who pays
it to the government in the first instance but;
The incidence of the tax falls on the person who
finally bears the burden of tax.
E.g. the import duty on vehicles is paid in the first
instance by the importer of cars but ultimately the
importer transfers the burden of this duty (tax) to
the purchaser of the vehicle in the form of price.
The importer includes the import duty paid by
him in the price of car which is charged to the
Indirect taxes can be shifted on to
others so that the burden of the indirect
tax is on ultimate consumers.
Indirect taxes are taxes based on
consumption or expenditure of
persons.
Some Examples include;
Value Added Tax (VAT),
Turnover tax (TOT)
Excise Tax And Custom Duty
b) Based on tax bases
i) Income Taxes: Direct taxes levied on income
of individuals and businesses; such as on
employment income, business income, rental
income, interest income, royalty income, income
from rendering technical services and dividend
income.
ii) Property Taxes: Direct taxes levied on
property of persons or businesses such as on
Wealth, land, estate and inheritance.
iii)Commodity/Expenditure Taxes: Indirect
taxes which are levied on goods and services .
E.g., VAT, TOT, Excise tax, import & export duty
c) Based on tax determinant
This is a classification based on what determines
the tax amount, value or quantity
i) Specific taxes: are taxes which are levied on
goods & services at a fixed amount based on their
weight, size, quantity, or other measurements
other than the values of the goods and services
The value of goods and services is irrelevant to
determine specific taxes.
e.g., if the excise tax on petroleum is br 0.65 per
liter, then 65 cent tax is charged for one liter of
petroleum.
ii) Ad-valorem Taxes:
ad-valorem means according to value
taxes are levied on commodities
according to their value,
Tax is charged according to its value
d) Based on number of taxes
i) Single tax: is a tax that occurs in a system in which
the taxes are levied only on one object, i.e., on one
class of people.
• There is only one tax base
• E.g poll tax or head tax which is imposed on a
person simply because he is there in the society
and not because he has an income or wealth.
ii) Multiple taxes: taxes whose bases are
diversified
Consists many kinds of taxes /both direct &
indirect/
e) Based on sources of taxes
i) Domestic taxes: are related to
transactions executed in the country in
which the tax payer resides.
ii) International taxes: are related to
foreign operations.
2.2 Tax System/Tax Rate Structures
1) Proportional (Flat) Tax System
Is a tax structure that taxes every tax payer
(higher, middle, or lower groups) with the
same flat rate.
Tax rate remains constant as the tax base
increases.
All incomes are taxed at a single uniform
rate.
E.g., 10% tax rate, all taxpayers shall pay
their tax at this rate regardless of the size of
their incomes.
Tax base(Income in Birr) Tax rate (in %)
Over Birr To Birr
0 500 20
501 1500 20
1501 3000 20
3001 5000 20
5001 7500 20
7501 10500 20
2) Progressive (Graduated) Tax Structure
Taxes;
• Higher income groups (richer) more
amounts of tax,
• Middle income groups lower amount of
tax;
• Lower income groups (poorer) are
exempted
If the income of a tax payer increases,
the rate of tax also increases and vice
versa.
Tax base(Income in Birr) Tax rate (in %)
Over Birr To Birr
0 500 10
501 1500 15
1501 3000 20
3001 5000 25
5001 7500 30
7501 10500 35
Graphically, it can be explained as follows:
Tax Rate
(%)
Tax Base - Income (Birr)
Fig. Progressive Tax System
3) Regressive Tax Structure:
Higher income groups (richer) are
taxed at lower rate and the lower
income group pay more amount of tax.
Effective tax rate declines as the value
of the tax base increases.
It is the opposite of the progressive tax.
Tax base(Income in Birr) Tax rate (in %)
Over Birr To Birr
0 500 35
500 1500 30
1500 3000 25
3000 5000 20
5000 7500 15
7500 10500 10
Diagrammatically, it can be explained as follows:
Tax Rate
(%)
Tax Base - Income (Birr)
Fig. Regressive Tax System
4) Digressive (Mild) Tax Structure
Is similar to progressive tax structure, but in
digressive tax the rate of progression is not
in the same proportion as the income.
The Marginal tax rate declines with each
incremental tax base, i.e., the tax rate
increases but at a decreasing rate.
Higher income groups make less sacrifice
than the lower income groups and thus it can
be used as incentive to work, save & invest.
Tax base(Income in Birr) Tax rate (in %)
Over Birr To Birr
0 500 5
500 1500 10
1500 3000 14
3000 5000 17
5000 7500 19
7500 10500 20
Diagrammatically, it can be explained as follows:
Tax Rate
(%)
Tax Base - Income (Birr)
Fig. Digressive Tax System
Effects of Taxation
Taxation might have different effects in
the economy.
It may have a positive or an adverse
effect on:
Production,
Distribution of income, and
Economic stability.
1) Effects of Taxation on Production.
• Taxation adversely affects production in an
economy by reducing the ability& willingness to
save, work and invest.
• When the tax rate increases, taxation reduce both
the ability and willingness to save, work and
invest.
• This in turn will reduce production in the
economy.
• When tax increases, consumption decreases so
that the health and efficiency possessed by the
person is affected.
• This in turn will reduce the ability to work which
directly affect production.
2) Effects of Taxation on Distribution.
• Taxation used in most countries to distribute
fairly the income generated in a country.
• If income generated in a society is not
distributed in a society, it will create
inequality in the distribution of income and
wealth.
• But, taxation minimizes the gap between the
rich and the poor so that it avoids class
conflict between the societies.
3) Effects of Taxation on Stabilization.
• Economic stability may be judged by the
behavior of prices.
• This does not mean that prices should remain
static.
• There should be a normal rise in price
because a normal rise in price is assign of
healthy economy.
• During abnormal price rising (inflation) and
deflation, taxation can be used as a tool to
stabilize the economy.
The End of Chapter 2
Thank You!!!