PRINCIPLES of TAXATION

PRINCIPLES of TAXATION
NADT STUDY MATERIAL ININTERNATIONAL TAXATION PRINCIPLES of TAXATION Induction course for 65rd batch of IRS NADT, Nagpur, Dec’2011 by Dr Vinay Kumar Singh Additional Director (P&R)-II, NATIONAL ACADEMY OF DIRECT TAXES, NAGPUR Dr. Vinay Kumar Singh, Additional Director (Fac), NADT, Nagpur

Principles of taxation
We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes What is a tax ?

Tax is a compulsory charge on resources (usually money) imposed by an authority on people without a quid pro quo exchange of goods/ services. Characteristics of tax Compulsory Charge on resources, usually money Imposed by an ‘authority’ Imposed on people No good or service provided in exchange of tax in a quid pro quo manner Different from a ‘fees’ which is charged in exchange of goods or services provided on a ‘quid pro quo’ basis Why are there taxes ?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes What do we need a tax ?

NEED FOR TAXES Principles of taxation Private individual Vs. Social Institutions Consumption & Production are private activities What is required from social institutions to help these ‘private’ activities ? How can society provide this help ? What are the main social institutions ? Family Tribes, communities Market Government What is the role of market ?

NEED FOR TAXES Principles of taxation The role of Markets Transaction cost of buying & selling Consumption efficiency Markets allow people to buy what they want Allocation of resources for consumption which maximizes welfare Production efficiency Markets allow producers to produce what is ‘in demand’ Efficient production  least wastage; efficient resources in production Markets allow people to ‘privately’ consume and produce goods which allow people to consume what they prefer, within the given resources available Efficient markets maximize social welfare What is the role of Government ?

NEED FOR TAXES Principles of taxation The role of Government 1. Public Goods Not rivaled Not excludable National defense; Law & order (protection of property rights); Regulations Roads, Broadcasting Free-rider problem  need financing from Society-Governments 2. Redistribution of Income Markets do not alter initial endowment Often worsen INEQUITY  Rich have capital  Returns on capital further worsen the difference between rich & poor Why do we need redistribution of income ?

NEED FOR TAXES Principles of taxation The role of Government 3. In case of Market failures Public goods are not provided efficiently by market EXTERNALITIES: Benefit / Harm to society of private actions (consumption / production) Positive Externality : benefit to society Negative Externality : harm / loss to society Monopolies: produce less, charge more, society loses, INEFFICIENT ‘Economy of scale’ industries Information asymmetry: Efficient markets require perfect information Asset Bubbles & Busts How do we finance the Government?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes Can taxes be avoided?

ALTERNATIVES TO TAX Principles of taxation Ways of financing Government TAX Fees & charges e.g. Fees for healthcare, fees for schools, electric / water charges Borrowing DOMESTIC EXTERNAL Aid / donations Business profits (from PSEs) Lease or Sale of assets / Disinvestment Seigniorage (printing of currency) INFLATION TAX Penalties Why taxes ?

ALTERNATIVES TO TAX Principles of taxation Ways of financing Government TAX Fees & charges Borrowing Aid / donations Business profits (from PSEs) Lease or Sale of assets Seigniorage (printing of currency) Penalties PEOPLE NOT READY TO PAY FOR PUBLIC GOODS AVOIDABLE  UNPREDICTABLE AMOUNT DEBT NEEDS TO BE PAID BACK DANGER OF DEBT TRAP UNPREDICTABLE AMOUNT VERY UNPREDICTABLE FIRST NEEDS INVESTMENT; RISK OF LOSSES GOVERNMENT USUALLY NOT GOOD IN DOING BUSINESS NOT SUSTAINABLE IN LONG RUN IF ALL ASSETS ARE SOLD  GOVT WITH NO AUTHORITY PRINTING OF CURRENCY  INRCREASES MONEY SUPPLY  INFLATION  EVERYONE LOSES INFLATION TAX AVOIDABLE  UNPREDICTABLE AMOUNT What about taxes ?

ALTERNATIVES TO TAX Principles of taxation Ways of financing Government TAX Fees & charges Borrowing Aid / donations Business profits (from PSEs) Lease or Sale of assets Seigniorage (printing of currency) Penalties SUSTAINABLE PREDICTABLE ALLOWS AUTONOMY NO OBLIGATION FOR SERVICES OR SUPPLY CREATES NO LIABILITIES (for later generations) NEEDS NO INVESTMENT (by earlier generation) AUTONOMY FROM DONORS’ REQUIREMENTS DOES NOT NEED GOVT TO DO BUSINESS (which it is not good at) DOES NOT REQUIRE ANY SALES OF ASSETS NO INFLATION CAN BE COLLECTED WITHOUT RULE BREAKING LESS ECONOMIC INEFFICIENCY CAN BE MORE EQUITABLE Negative aspect of taxes ?

ALTERNATIVES TO TAX Principles of taxation Ways of financing Government TAX Fees & charges Borrowing Aid / donations Business profits (from PSEs) Lease or Sale of assets Seigniorage (printing of currency) Penalties NO QUID PRO QUO IN RETURN MOST DETESTED USUALLY DISTORTS ECONOMIC BEHAVIOUR can be economically inefficient OFTEN REQUIRES COMPLEX LAWS, RULES & PROCEDURES COMPLIANCE & ADMINISTRATIVE COSTS real burden on the society PROBLEMS: TAX (LEGAL) DISPUTES TAX EVASION TAX AVOIDANCE CORRUPTION SHOULD WE HAVE TAXES ?

ALTERNATIVES TO TAX Principles of taxation Ways of financing Government TAX Fees & charges Borrowing Aid / donations Business profits (from PSEs) Lease or Sale of assets Seigniorage (printing of currency) Penalties REVENUE IS THE BACKBONE OF ADMISTRATION

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes How are taxes designed ?

TAX DESIGN Principles of taxation TAX DESIGN Set of rules on the basis of which a tax is charged from the people RULE BASED TAX Tax imposed by a set of rules Rules avoid arbitrariness in taxation Increase objectivity Make it more predictable Reduce dissatisfaction & disputes Reduce cost of tax collection Allow better planning Limit discretion of tax collector Create TAXPAYER RIGHTS REQUIRE RULES ARBITRARY TAX Tax imposed without any rules Arbitrariness in taxation Increase subjectivity Make it less predictable Increase dissatisfaction & disputes Increase cost of tax collection Planning is very difficult High discretion of tax collector No TAXPAYER RIGHTS Do NOT REQUIRE RULES What kind of rules ?

TAX DESIGN Principles of taxation TAX DESIGN Set of rules on the basis of which a tax is charged from the people Note: Tax design refers to Rules that decide who will pay tax and how much Tax design does not include “procedural rules” which decide the following: -how and when the tax will be paid -to whom -when -what if not paid -who will collect -who will decide if there is a dispute / mistake - what procedure needs to be followed, by whom & how BASIC DESIGN TAX BASE TAX RATE X TAX = SPECIFIC FEATURES ALL OTHER FEATURES THAT AFFECT TAX LIABILITY OF TAXPAYERS EXEMPTIONS OF TAX-BASE DEDUCTIONS FROM TAX LIABILITY DIFFERENTIAL TAX RATES VARIABLE TAX RATES OTHER SPECIAL PROVISIONS What is a tax base?

TAX DESIGN Principles of taxation TAX BASE ELEMENT ON WHICH TAX IS IMPOSED A person is taxed on the basis of presence of the tax base e.g. income, wealth (different from income), property owned, property transacted, livestock, sales, purchases, manufacturing, trade, exports, imports, services, transportation, vehicles, fuel, water, inheritance, interest and expenditure, windows What is a LUMP SUM TAX ?

TAX DESIGN Principles of taxation TAX BASE ELEMENT ON WHICH TAX IS IMPOSED CHARACTERISTICS OF A TAX BASE VARIABLE LINKED WITH ECONOMIC ACTIVITY Consumption of value Production of value Storage / owning of value Transfer of value OBJECTIVE QUANTIFICATION POSSIBLE Why not tax unhappiness, anger, jealousy?

TAX DESIGN Principles of taxation TAX RATE TAX CHARGED ON PER UNIT OF TAX BASE Usually expressed as ‘percentage’ or ‘proportion’ e.g. 20% (one-fifth) or 33.3% (one-third) per annum; Or as amount of tax per unit of tax base, e.g. one ounce of silver for every acre of land Rs for every square feet of commercial property What can be the range of tax rate ?

TAX DESIGN Principles of taxation TAX RATE TAX CHARGED ON PER UNIT OF TAX BASE FIXED RATE – Rate does not change with a change in quality or quantity of tax base VARIABLE RATE – Rate changes with a change in the quantity of tax base PROGRESSIVE: Tax rate increases with increase in quantity of tax base DEGRESSIVE: Tax rate increases with increase in quantity of tax base, but the rate of this “increase” reduces with rise of tax base REGRESSIVE: Tax rate falls with increase in quantity of tax base DIFFERENTIAL RATE – Tax rate changes with quality (characteristics) of tax base e.g. Capital gains, Agricultural income Custom duty of different goods imported What about income-tax rates?

TAX DESIGN Principles of taxation SPECIFIC FEATURES EXEMPTIONS OF TAX-BASE TAX BASE ON WHICH NO TAX IS LEVIED TYPES PERSON SPECIFIC e.g. charitable trust exempted from income-tax ACTIVITY SPECIFIC e.g. income from exports exempt from income-tax QUANTITY SPECIFIC e.g. Income not charged up to a certain limit QUALITY SPECIFIC e.g. Vacant unused land exempt from property tax Any other examples?

TAX DESIGN Principles of taxation SPECIFIC FEATURES DEDUCTIONS FROM TAX LIABILITY REDUCTION OF THE TAX PAYABLE ON THE BASIS OF PRESENCE OR ABSENCE OF SOME OTHER PRE-REQUISITES, WITHOUT AFFECTING THE TAX BASE AND TAX RATE, AS PER PREDEFINED RULES e.g. deductions from income-tax on the basis of savings / medical expenditure / investment in special industry or backward areas / expenditure for research / charitable donations Why is tax design important ?

TAX DESIGN Principles of taxation SIGNIFICANCE OF TAX DESIGN AFFECTS ECONOMIC EFFICIENCY OF TAX Exemptions, deductions, differential tax rates  cause distortion of economic behavior AFFECTS DISTRIBUTION OF TAX BURDEN IN THE SOCIETY Progressive tax  more equitable (rich pay more tax than poor) AFFECTS COSTS OF COMPLIANCE & ADMINISTRATION Simple design  easy to comply & administer  less costs Why do we have complex tax designs?

TAX DESIGN Principles of taxation TAX RATE 30% TAX PAYABLE 20% 10% DEDUCTION FROM TAX LIABILITY INCOME (TAX BASE) QUANTITY BASED EXEMPTION OF TAX BASE QUALITY BASED EXEMPTION OF TAX BASE 1.6 Lac 3 Lac 5 Lac Why do we have complex tax designs?

TAX CLASSIFICATION Principles of taxation Many different ways Benefit based taxation Vs Faculty based taxation Direct Vs Indirect Primary Vs Secondary Tax on person Vs Tax on property Vs Tax on income Tax on value at different times: ‘On acquisition’ Vs ‘for possession’ Vs ‘On consumption’ Proportioned Vs Apportioned Tax on “goods” Vs Tax on “bads” Tax on capital Vs Tax on labour Progressive Vs Digressive Vs Regressive Accounts based taxes Vs Physical verification based taxes What is a DIRECT tax?

TAX CLASSIFICATION Principles of taxation DIRECT TAX Collected from the person who bears its burden (taxpayer pays it from his own resources) Usually Linked with a resource – current or expected More predictable Levied per unit of time EXAMPLES Wealth tax, Income tax, Property tax, Land tax, Corporate tax, Gift tax, Interest tax, Expenditure tax INDIRECT TAX Collected from the person who does not bear its burden (taxpayer collects it from others and pays) Usually Linked with a transaction – as & when it takes place Less predictable Levied per transaction EXAMPLES Sales tax, Central or State Excise, Property transaction tax (Stamp Duty), Value Addition Tax (VAT), Consumption tax What about Inheritance tax?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes What are the economic effects of taxes ?

ECONOMICS OF TAXATION Principles of taxation MARKET DYNAMICS IN A PERFEC T MARKET SOCIAL WELFARE = CS + PS PRICE SUPPLY (MC) CONSUMER SURPLUS MARKET EQUILIBRIUM P PRODUCER SURPLUS DEMAND (MB) Q QUANTITY When is the market perfect ?

ECONOMICS OF TAXATION Principles of taxation MARKET DYNAMICS after a TAX is imposed on transactions SOCIAL WELFARE = CS + PS + REV PRICE SUPPLY AFTER TAX (MC + TAX) SUPPLY (MC) C S After-tax P NEW MARKET EQUILIBRIUM People consume less People produce less Total welfare from private economic activities falls Tax TAX REV DWL P P S ECONOMY SHRINKS DEMAND (MB) Q’ QUANTITY What is ‘DWL’?

ECONOMICS OF TAXATION Principles of taxation MARKET DYNAMICS after a TAX is imposed on transactions DEAD WEIGHT LOSS LOSS OF ECONOMIC ACTIVITY RESULTING FROM THE DISINCENTIVE RESULTING FROM TAX When are the effects of taxes on economy ?

ECONOMICS OF TAXATION Principles of taxation EFFECTS OF TAX ON ECONOMY Tax increase the ‘cost’ of consumption / production Prices rise “TRANSFER” of resources from ‘people’ to ‘government’ Finance Govt. activities  Public goods, Redistribution TAX ‘disincentivize’ economic activities  Dead weight loss What is significance of DWL?

ECONOMICS OF TAXATION Principles of taxation EFFECTS OF TAX ON ECONOMY Dead weight loss is the real “COST” of a tax Other ‘real costs’ of taxes : COST of ADMINISTRATION COST OF COMPLIANCE All taxes lead to some distortion of economic activities, which distorts the market equilibrium, market efficiency and social welfare Should we have taxes?

ECONOMICS OF TAXATION Principles of taxation WHEN TO TAX & HOW MUCH ? TAX is justified if Benefits from tax are more than the costs of tax BENEFITS Public goods / service Social welfare gain from redistribution Gain from modification of behaviour COSTS Dead weight loss Cost of administration Cost of compliance Losses from modification of behaviour Who bears the burden of the tax ?

ECONOMICS OF TAXATION Principles of taxation TAX INCIDENCE - the burden of taxation in a market PRICE SUPPLY AFTER TAX (MC + TAX) SUPPLY (MC) C S PRICE FOR BUYER Tax burden (INCIDENCE) on buyers Tax Tax burden (INCIDENCE) on sellers PRICE FOR SELLER P S DEMAND (MB) Q’ QUANTITY What does this ‘TAX INCIDENCE’ depend upon?

ECONOMICS OF TAXATION Principles of taxation TAX INCIDENCE (BURDEN) ALWAYS FALLS ON THE ‘SURPLUS’ (CS / PS) Flatter (ELASTIC) SUPPLY curve  Less PRODUCER SURPLUS  Less TAX BURDEN ON SELLER PRICE SUPPLY AFTER TAX (MC + TAX) SUPPLY (MC) C S PRICE FOR BUYER Tax burden (INCIDENCE) on buyers Tax Tax burden (INCIDENCE) on sellers PRICE FOR SELLER P S DEMAND (MB) QUANTITY Q’ Flatter (ELASTIC) DEMAND curve  Less CONSUMER SURPLUS  Less TAX BURDEN ON BUYER What about income-tax?

ECONOMICS OF TAXATION Principles of taxation EFFECTS OF INCOME-TAX ON ECONOMY : The usual argument Tax on income reduces incentive to work Work (& income) come at the cost of LEISURE (free time) Everybody would like to have both income & leisure  has to make a choice between the two Principle of diminishing returns: The marginal value of both leisure & income falls with more of it As one works more, the leisure he has reduces & income rises  the marginal value of income falls while marginal value of leisure rises Till the time, marginal value of income is more than the marginal value of leisure, he is willing to work more When the marginal value of income becomes less than marginal value of leisure, he reduces his wok  to a point where marginal value of income EQUALS marginal value of leisure Income-tax reduces the marginal value of income  so the person is likely to work less Any other arguments? What does empirical evidence suggest ?

ECONOMICS OF TAXATION Principles of taxation EFFECTS OF INCOME-TAX ON ECONOMY The usual argument : Tax on income reduces incentive to work Depends upon whether income & leisure are ‘SUBSTITUTES’ or ‘COMPLIMENTS’ If they are substitutes, income-tax will disincentivize work If they are compliments, income-tax can actually make the person work more ( e.g.. Imagine a person with family. Fall in income (by tax) leads to fall in living standard. Instead of living in a smaller flat or shifting children to a cheaper school, the person may prefer to work overtime or take up some extra work) In real life, they are probably partly substitute & partly complements, so effect is mixed Empirical evidence suggests that in real life, income-tax does not change the work supply in case of full time workers, but it reduces the work supply by part time workers ( retired / students / housewives) How?

ECONOMICS OF TAXATION Principles of taxation EFFECT OF INCOME-TAX on willingness of people to work assuming income & work are SUBSTITUTES LEISURE (HOURS) INDIFFERENCE CURVES WORKING HOURS when No Income-tax LOSS OF WORK DUE TO INCOME-TAX BUDGET CONSTRAINT with income-tax BUDGET CONSTRAINT without income-tax INCOME Income-Tax What if they are compliments?

ECONOMICS OF TAXATION Principles of taxation EFFECT OF INCOME-TAX on willingness of people to work assuming income & work are COMPLIMENTS LEISURE (HOURS) INDIFFERENCE CURVES WORKING HOURS when No Income-tax BUDGET CONSTRAINT with income-tax ADDITION OF WORK DUE TO INCOME-TAX BUDGET CONSTRAINT without income-tax INCOME Income-Tax What is LAFFER CURVE?

LAFFER CURVE Principles of taxation EFFECTS OF INCREASING TAX RATE Higher tax rates disincentivize economic activity, leading to shrinking of tax base ( e.g.. Will you do business if tax rate is 96% ? ….remember, government does not share your RISK ) Higher tax rate can lead to : Greater dead weight loss Greater tendency to EVADE TAX Greater costs of admin, compliance BEYOND A POINT, HIGHER TAX RATES LEAD TO LOWER TAX REVENUE REVENUE Max Revenue LAFFER CURVE TAX RATE Revenue maximizing TAX RATE What is our own experience?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX  Economically efficient  Equitable  Neutral  Generates adequate revenue Predictably  Simple to comply and administer -Minimum cost of administration -Minimum cost of compliance Can we achieve all ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX ECONOMICALLY EFFICIENT - A tax is economically efficient when it does not create any disincentives against economic activity by people For a perfectly efficient tax Dead weight loss = zero In case of an economically efficient tax the resources taken up by the government exactly equal the reduction in resources employed for private economic activities There is some economic inefficiency associated with all taxes Which tax is most efficient ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX EQUITABLE - A tax is equitable when it is borne only as per the ability to pay For a perfectly EQUITABLE tax If two persons have different amount of resources, the ‘additional resources’ of the richer will be taxed first, and when they are exhausted, the remaining tax will fall equally on both An equitable tax leads to Redistribution of resources Redistribution of resources creates a disincentive against economic activity Which tax is most equitable ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX NEUTRAL A tax is neutral when the burden of tax on two persons with equal resources is equal, irrespective of their economic activities, and other characteristics (like age, gender, education, race, religion, caste, profession, marital status, place of residence, preferences for consumption, production and wealth) For a perfectly NEUTRAL tax Two persons with equal resources will always be taxed equally irrespective of whatever they are and whatever they may do A neutral tax is usually more economically efficient Very difficult to have a tax that is neutral to economic preferences Can we achieve all ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX ADEQUATE & PREDICTABLE A tax should ideally be able to collect sufficient resources for the Government financing in a predictable manner For an ADEQUATE & PREDICTABLE tax A single tax is sufficient, so multiplicity of taxes and the multiplicity of costs associated with them are avoided. The revenue collected is exactly as predicted A single adequate & predictable tax is always preferable, if other objectives are also fulfilled Every tax can be avoided by modifying economic activities, so a single tax may be less predictable than a combination of taxes Most predictable tax ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX SIMPLE TO COMPLY & ADMINISTER A tax should ideally be simple to comply for the tax payer, simple to administer for the tax administrator, with no difficulties in interpretation and no possibility of legal disputes For an ideally SIMPLE tax Cost of compliance = zero Cost of administration = zero Simple tax requires simple tax design, simple law and simple procedure of reporting Simple tax design may not be economically efficient, equitable, neutral and adequate Which is an ideal tax ?

IDEAL TAX Principles of taxation CHARACTERISTICS OF AN IDEAL TAX No ideal tax Since no single tax achieves the characteristics of an ideal tax alone, so Governments resort to multiple taxes with the aim of Minimizing economic efficiency Achieving more neutrality Achieving Equity Minimizing evasion & ensuring adequacy & predictability of revenue This can increase costs of compliance & administration Which is an ideal tax combination ?

TAX BUOYANCY & ELASTICITY
Principles of taxation TAX BUOYANCY Change in tax revenue in response to one unit change in tax base ( For National statistics, the tax base usually taken is GDP, as a proxy to the economic activity – remember most tax-bases are related to economic activity) Higher Tax Buoyancy (More than 1) Tax Revenue rises faster than the economic growth As economy grows, the Government can expand its activities OR reduce tax rates Low Tax Buoyancy (Less than 1) Tax Revenue rises slower than the economic growth As economy grows, the Government will need to cut down its activities OR increase tax rates (Note : Data for different years should be adjusted for INFLATION ) How do we calculate Tax Buoyancy ?

Principles of taxation TAX BUOYANCY Change in tax revenue in response to one unit change in tax base CALCULATING TAX BUOYANCY : MANY DIFFERENT WAYS Calculate Tax Buoyancy for different years, then take an average Calculate Tax Buoyancy for the duration by using data at the beginning and at the end of that period As (ii) above, but using ‘averaged’ data, e.g.. Use average of first two years , and use average of last two years Using Regression techniques Regress log of Tax Revenue on the year Regress log of Tax Revenue on the log of the Tax Base (GDP) Which method is preferable ?

Principles of taxation TAX ELASTICITY Change in tax revenue in response to one unit change in tax base, that would have happened if there was no change in tax rate and tax design ( ‘Adjusted’ refers to the adjustments in actual tax revenue , to arrive at the tax revenue that would have been there if there were no changes in tax rate and tax design) Tax Elasticity is a more accurate indicator of how tax revenue is responding to the change sin tax base, so more reliable for planning It is a hypothetical concept, requiring adjustments in actual data More difficult to calculate Usually not used for tax revenue arising from multiple taxes What is the use of calculating Buoyancy / Elasticity?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes How are the taxes complied with ?

TAX COMPLIANCE Principles of taxation Compliance with tax laws can be either voluntary or administered VOLUNTARY TAX COMPLIANCE The taxpayer calculates his tax liability himself, pays the tax and informs the Tax Administrator Self assessment  Payment of tax  Reporting (filing of return) ADMINISTERED TAX COMPLIANCE The Tax Administrator calculates the tax liability of the taxpayer and informs him, according to which the taxpayer pays the tax Assessment by Tax Administrator  Informs taxpayer  Taxpayer pays the tax What are the pros & cons of each system ?

TAX COMPLIANCE Principles of taxation VOLUNTARY TAX COMPLIANCE Requires elaborate set of rules that allow objective computation of tax liability Tax Administrator does not look into the tax liability of every taxpayer Needs a credible deterrent to disincentivize tax evasion Lesser cost of compliance and administration ADMINISTERED TAX COMPLIANCE Require less elaborate rules Tax Administrator has to look into the tax liability of each & every taxpayer Need for deterrence is limited Higher costs of compliance and administration Role of Tax administrator ?

TAX COMPLIANCE Principles of taxation VOLUNTARY TAX COMPLIANCE Role of Tax Administrator is to create a system that will: FACILITATE TAX COMPLIANCE Easy to calculate tax Less confusions Simplified procedures for reporting CREATE CREDIBLE DETERRENCE Catch tax evaders Punish them ADMINISTERED TAX COMPLIANCE Role of Tax Administrator is to : EFFICIENT ASSESSMENTS Expedient Accurate Technically sound(in law & accounting) EFFICIENT FOLLOW-UP Expedient communication Monitor tax payments by taxpayers Compare the two systems

TAX COMPLIANCE Principles of taxation VOLUNTARY TAX COMPLIANCE Tax administration needs Strategic efficiency Efficiency of taxpayer services Ability to guide taxpayers Ability of creating a Credible Deterrence Emphasis is more on quality rather than on quantity Costs depend upon the strategy chosen and efficiency of its implementation ADMINISTERED TAX COMPLIANCE Tax administration needs Ability to efficiently assess the tax payable by taxpayer Expedient action and communication High skills in law, accounting Emphasis is more on quantity rather than on quality Costs depend upon number of taxpayers and cost of each assessment Which system do we follow ?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes What is the difference?

TAX AVOIDANCE Vs TAX EVASION
Principles of taxation TAX AVOIDANCE Reducing tax liability by modifying economic or other activities in such a manner that is permitted by law Involves no falsehood Legally permissible e.g.. -Saving in a particular savings scheme -Deriving income from exports -Having a factory in a place where a tax holiday is in operation TAX EVASION Reducing tax liability by reporting or claiming something that is not true, or not reporting something that is true Involves some falsehood or incomplete truth Legally not permitted e.g.. -False accounts / bills -Showing income as loan -Not reporting sales -Falsely claiming exemptions Which one do we target ?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes How to prevent tax evasion?

ECONOMICS OF DETERRENCE
Principles of taxation DETERRENCE Reduced indulgence in particular activities due to perceived likelihood of adverse consequences e.g.. - Late coming is deterred by deduction of C.L. - Crime is deterred by punishment - Jumping into fire is deterred by fear of burning - Errant behaviour is deterred by public criticism How much deterrence ?

Principles of taxation PROBABILITY The statistical likelihood of an event happening Usually described as a ‘fraction of 1’ or ‘percentage’ e.g or 50%; or 10% COST of VOLUNTARY COMPLIANCE FAILURE (CAUGHT) PENALTY COMPLY OR NOT TO COMPLY Probability = p ATTEMPT TO EVADE TAX SUCCESFUL EVASION TAX SAVED COST of NON-COMPLIANCE (ATTEMPTING EVASION) Probability = (1-p) BENEFITS & COSTS ?

Principles of taxation COST {Probability of ‘being caught’ X Penalty} Cost of attempting evasion DETERRENCE if COST > BENEFIT BENEFIT {Probability of ‘not being caught’ X Tax evaded } Cost of voluntary compliance How to increase voluntary compliance ?

Principles of taxation DETERRENCE if COST > BENEFIT COST: {Probability of ‘being caught’ X Penalty} + Cost of attempting evasion BENEFIT: {Probability of ‘not being caught’ X Tax evaded } Cost of voluntary compliance Deterrence can be increased by: Reducing cost of voluntary compliance Increasing cost of tax evasion Increasing probability of catching ‘evaders’ Increasing the Penalty Reducing tax liability What is credible deterrence ?

Principles of taxation CREDIBLE DETERRENCE: General belief in the credibility of deterrence Belief that attempt to evade will lead to penalties, that it is not wise to attempt evasion, that the likelihood of being penalized is dangerously high Note: Probability of being caught is a function of expectations Expectations are based on information available Awareness about Cases of successful non-compliance and evasion lower the expected likelihood of being caught  Weaken the deterrence Awareness about Cases of attempted evasion being caught and penalized increase the expected likelihood of being caught  Strengthen the deterrence Can higher penalties create deterrence?

We will try to cover… Principles of taxation Concept of tax Need for taxes Role of Government : Public goods & Redistribution of income Behaviour modification Alternatives to tax Tax design & classification Economics of taxation Laffer curve Characteristics of an ideal tax Tax elasticity Vs. Tax buoyancy Voluntary compliance Vs. Administered compliance Tax avoidance Vs. Tax evasion Economics of deterrence Globalization & taxes How globalization impacts taxes?

Globalization & Taxes Principles of taxation GLOBALIZATION Increasing mobility of Capital and skills Competitions among nations to attract Capital and skills TAXES play a role : Higher taxes deter Capital and Skills, especially Double taxes Since 1970s, a fall in maximal marginal rates of taxation have been observed in many nations Falling tax rates raised fears of ‘RACE to BOTTOM’ Empirical evidence suggests that while the maximal marginal tax rates have fallen, the total tax revenue collections have NOT fallen, and instead generally risen (Laffer curve effect ?) Customs duties have been affected more Direct Taxes : Problem of double taxation  DOUBLE TAX AVOIDANCE AGREEMENTS Is globalization beneficial ?

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PRINCIPLES of TAXATION

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