PRINCIPLES of TAXATION by Dr Vinay Kumar Singh Additional Director (P&R)-II, NATIONAL ACADEMY OF DIRECT TAXES, NAGPUR Induction course for 65 rd batch.

PRINCIPLES of

TAXATION

byDr Vinay Kumar Singh

Additional Director (P&R)-II, NATIONAL ACADEMY OF DIRECT TAXES, NAGPUR

Induction course for 65rd batch of IRSNADT, Nagpur, Dec’2011

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 ?

•Concept of tax• Need for taxes



TAXPrinciples of taxation

Why are there taxes ?

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

I. CompulsoryII. Charge on resources, usually moneyIII. Imposed by an ‘authority’IV. Imposed on peopleV. No good or service provided in exchange of tax in

a quid pro quo mannerDifferent from a ‘fees’ which is charged in exchange of goods or services provided on a ‘quid pro quo’ basis


What do we need a tax ?

• Concept of tax

•Need for taxes– Role of Government : Public goods & Redistribution of income– Behaviour modification


NEED FOR TAXESPrinciples of taxation

What is the role of market ?

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 Government ?

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


Why do we need redistribution of income ?

The role of Government1. 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


How do we finance the Government?

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


Can taxes be avoided?




ALTERNATIVES TO TAXPrinciples of taxation

Why taxes ?

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


What about taxes ?

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 GOODSAVOIDABLE UNPREDICTABLE AMOUNT

VERY UNPREDICTABLE

FIRST NEEDS INVESTMENT; RISK OF LOSSESGOVERNMENT USUALLY NOT GOOD IN DOING BUSINESS

DEBT NEEDS TO BE PAID BACKDANGER OF DEBT TRAPUNPREDICTABLE AMOUNT

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


Negative aspect of taxes ?


– TAX

– Fees & charges

– Borrowing– Aid /

donations– Business

profits (from PSEs)



– 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


SHOULD WE HAVE TAXES ?


– TAX

– Fees & charges



profits (from PSEs)



– 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


REVENUE IS THE BACKBONE OF ADMISTRATION


– TAX

– Fees & charges



profits (from PSEs)



– Penalties


How are taxes designed ?



• 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

TAX DESIGNPrinciples of taxation

What kind of rules ?

TAX DESIGNSet of rules on the basis of which a tax is charged from the people

RULE BASED TAXTax imposed by a set of rulesRules avoid arbitrariness in taxationIncrease objectivityMake it more predictableReduce dissatisfaction & disputesReduce cost of tax collectionAllow better planningLimit discretion of tax collectorCreate TAXPAYER RIGHTSREQUIRE RULES

ARBITRARY TAXTax imposed without any rulesArbitrariness in taxationIncrease subjectivityMake it less predictableIncrease dissatisfaction & disputesIncrease cost of tax collectionPlanning is very difficultHigh discretion of tax collectorNo TAXPAYER RIGHTSDo NOT REQUIRE RULES


What is a tax base?

TAX DESIGNSet of rules on the basis of which a

tax is charged from the people

TAX =

ALL OTHER FEATURES THAT AFFECT TAX LIABILITY OF TAXPAYERS

EXEMPTIONS OF TAX-BASEDEDUCTIONS FROM TAX LIABILITYDIFFERENTIAL TAX RATESVARIABLE TAX RATESOTHER SPECIAL PROVISIONS

BASIC DESIGN

SPECIFIC FEATURES

TAX BASE

TAX RATEX

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


What is a LUMP SUM TAX ?

TAX BASEELEMENT ON WHICH TAX IS IMPOSEDA 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


Why not tax unhappiness, anger, jealousy?

TAX BASEELEMENT ON WHICH TAX IS IMPOSED

CHARACTERISTICS OF A TAX BASE

1. VARIABLE2. LINKED WITH ECONOMIC ACTIVITY

Consumption of valueProduction of valueStorage / owning of valueTransfer of value

3. OBJECTIVE QUANTIFICATION POSSIBLE


What can be the range of tax rate ?

TAX RATETAX 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;

Oras amount of tax per unit of tax base,

e.g. one ounce of silver for every acre of landRs. 1000 for every square feet of commercial property


What about income-tax rates?

TAX RATETAX 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 basePROGRESSIVE: Tax rate increases with increase in quantity of tax baseDEGRESSIVE: Tax rate increases with increase in quantity of tax base, but the rate of this “increase” reduces with rise of tax baseREGRESSIVE: 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 incomeCustom duty of different goods imported


Any other examples?

SPECIFIC FEATURES

EXEMPTIONS OF TAX-BASETAX BASE ON WHICH NO TAX IS LEVIED

TYPESPERSON SPECIFICe.g. charitable trust exempted from income-taxACTIVITY SPECIFICe.g. income from exports exempt from income-taxQUANTITY SPECIFICe.g. Income not charged up to a certain limitQUALITY SPECIFICe.g. Vacant unused land exempt from property tax


Why is tax design important ?

SPECIFIC FEATURES

DEDUCTIONS FROM TAX LIABILITYREDUCTION 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 do we have complex tax designs?

SIGNIFICANCE OF TAX DESIGN

AFFECTS ECONOMIC EFFICIENCY OF TAXExemptions, deductions, differential tax rates cause distortion of economic behavior

AFFECTS DISTRIBUTION OF TAX BURDEN IN THE SOCIETYProgressive tax more equitable (rich pay more tax than poor)

AFFECTS COSTS OF COMPLIANCE & ADMINISTRATIONSimple design easy to comply & administer less costs


Why do we have complex tax designs?

INCOME(TAX BASE)

TAX

RA

TE

QUANTITY BASED EXEMPTION OF

TAX BASE

QUALITY BASED EXEMPTION OF TAX BASE

DEDUCTION FROM TAX LIABILITY

30%

20%

10%

TAX PAYABLE

1.6 Lac

3 Lac

5 Lac

TAX CLASSIFICATIONPrinciples of taxation

What is a DIRECT tax?

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

TAX CLASSIFICATIONPrinciples of taxation

What about Inheritance tax?

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

EXAMPLESWealth 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 are the economic effects of taxes ?



• 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

ECONOMICS OF TAXATIONPrinciples of taxation

When is the market perfect ?

QUANTITY

PRIC

E

SUPPLY (MC)

DEMAND (MB)

MARKET EQUILIBRIUM

Q

P

MARKET DYNAMICS IN A PERFEC T MARKET

CONSUMER SURPLUS

PRODUCER SURPLUS

SOCIAL WELFARE = CS + PS


What is ‘DWL’?

QUANTITY

PRIC

E

SUPPLY (MC)

DEMAND (MB)

NEW MARKET EQUILIBRIUM

Q’

P

MARKET DYNAMICS after a TAX is imposed on transactions

After-tax P

SUPPLY AFTER TAX (MC + TAX)

ECONOMY SHRINKS

People consume lessPeople produce lessTotal welfare from private economic activities falls

Tax

C S

P S

TAX REV

SOCIAL WELFARE = CS + PS + REV

DWL


When are the effects of taxes on economy ?

MARKET DYNAMICS after a TAX is imposed on transactions

DEAD WEIGHT LOSS

LOSS OF ECONOMIC ACTIVITY RESULTING FROM THE DISINCENTIVE RESULTING FROM TAX


What is significance of DWL?

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


Should we have taxes?

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


Who bears the burden of the tax ?

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


What does this ‘TAX INCIDENCE’ depend upon?

QUANTITY

PRIC

E

SUPPLY (MC)

DEMAND (MB)

Q’

TAX INCIDENCE - the burden of taxation in a market


Tax

C S

P S

Tax burden (INCIDENCE) on buyers

Tax burden (INCIDENCE) on sellers

PRICE FOR BUYER

PRICE FOR SELLER


What about income-tax?

QUANTITY

PRIC

E

SUPPLY (MC)

DEMAND (MB)

Q’

TAX INCIDENCE (BURDEN) ALWAYS FALLS ON THE ‘SURPLUS’ (CS / PS)


Tax

C S

P S

Tax burden (INCIDENCE) on buyers

Tax burden (INCIDENCE) on sellers

PRICE FOR BUYER

PRICE FOR SELLER

Flatter (ELASTIC) SUPPLY curve Less PRODUCER SURPLUS Less TAX BURDEN ON SELLER

Flatter (ELASTIC) DEMAND curve Less CONSUMER SURPLUS Less TAX BURDEN ON BUYER


Any other arguments? What does empirical evidence suggest ?

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


How?

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 workIf 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)


What if they are compliments?

INCOME

LEIS

URE

(H

OU

RS)

BUDGET CONSTRAINT without income-tax

0

EFFECT OF INCOME-TAX on willingness of people to workassuming income & work are SUBSTITUTES

INDIFFERENCE CURVES

Income-Tax

WORKING HOURS when No Income-tax

LOSS OF WORK DUE TO INCOME-TAX BUDGET CONSTRAINT

with income-tax


What is LAFFER CURVE?

INCOME

LEIS

URE

(H

OU

RS)

BUDGET CONSTRAINT without income-tax

0

EFFECT OF INCOME-TAX on willingness of people to workassuming income & work are COMPLIMENTS

INDIFFERENCE CURVES

Income-Tax

WORKING HOURS when No Income-tax

ADDITION OF WORK DUE TO INCOME-TAX

BUDGET CONSTRAINT with income-tax





• 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

LAFFER CURVEPrinciples of taxation

What is our own experience?

TAX RATE

REVE

NU

E

Max Revenue

0

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 lossGreater tendency to EVADE TAX Greater costs of admin, compliance

LAFFER CURVE

Revenue maximizing TAX RATE

BEYOND A POINT, HIGHER TAX RATES LEAD TO LOWER TAX REVENUE





• 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

IDEAL TAXPrinciples of taxation

Can we achieve all ?

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


Which tax is most efficient ?


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 equitable ?


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


Can we achieve all ?


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 taxTwo 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


Most predictable 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 taxA 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


Which is 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 taxCost of compliance = zeroCost 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 combination ?


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





• 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

TAX BUOYANCY & ELASTICITYPrinciples of taxation

How do we calculate Tax Buoyancy ?

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 )

BaseTax in change %

RevenueTax in change % Buoyancy Tax


Which method is preferable ?

TAX BUOYANCYChange in tax revenue in response to one unit change in tax base

CALCULATING TAX BUOYANCY : MANY DIFFERENT WAYS

(i) Calculate Tax Buoyancy for different years, then take an average(ii) Calculate Tax Buoyancy for the duration by using data at the beginning

and at the end of that period(iii) As (ii) above, but using ‘averaged’ data, e.g.. Use average of first two

years , and use average of last two years (iv) Using Regression techniques

(i) Regress log of Tax Revenue on the year(ii) Regress log of Tax Revenue on the log of the Tax Base (GDP)

BaseTax in change %

RevenueTax in change % Buoyancy Tax


What is the use of calculating Buoyancy / Elasticity?

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 planningIt is a hypothetical concept, requiring adjustments in actual dataMore difficult to calculateUsually not used for tax revenue arising from multiple taxes

BaseTax in change %

RevenueTax in change % Adjusted ElasticityTax


How are the taxes complied with ?



• 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

TAX COMPLIANCEPrinciples of taxation

What are the pros & cons of each system ?

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


Role of Tax administrator ?


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


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


Compare the two systems


Role of Tax Administrator is to create a system that will:

FACILITATE TAX COMPLIANCEEasy to calculate taxLess confusionsSimplified procedures for

reporting

CREATE CREDIBLE DETERRENCE Catch tax evadersPunish them


Role of Tax Administrator is to :

EFFICIENT ASSESSMENTSExpedient AccurateTechnically sound(in law &

accounting)

EFFICIENT FOLLOW-UPExpedient communicationMonitor tax payments by

taxpayers


Which system do we follow ?


Tax administration needs Strategic efficiencyEfficiency of taxpayer servicesAbility to guide taxpayersAbility 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


Tax administration needsAbility to efficiently assess the tax payable by taxpayerExpedient action and communicationHigh skills in law, accounting

Emphasis is more on quantity rather than on quality

Costs depend upon number of taxpayers and cost of each assessment


What is the difference?



• 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

TAX AVOIDANCE Vs TAX EVASIONPrinciples of taxation

Which one do we target ?

TAX AVOIDANCE

Reducing tax liability by modifying economic or other activities in such a manner that is permitted by law

Involves no falsehoodLegally 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 truthLegally not permitted

e.g..-False accounts / bills-Showing income as loan-Not reporting sales-Falsely claiming exemptions


How to prevent tax evasion?



• 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

ECONOMICS OF DETERRENCEPrinciples of taxation

How much deterrence ?

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


BENEFITS & COSTS ?

PROBABILITY The statistical likelihood of an event happeningUsually described as a ‘fraction of 1’ or ‘percentage’

e.g.. 0.5 or 50%; 0.1 or 10%

ATTEMPT TO

EVADE TAX

SUCCESFUL EVASION

FAILURE(CAUGHT)

COST of NON-COMPLIANCE(ATTEMPTING

EVASION)

Probability = p

PENALTY

TAX SAVED

Probability = (1-p)

COST of VOLUNTARY

COMPLIANCE

COMPLY OR NOT TO COMPLY


How to increase voluntary compliance ?

BENEFIT

{Probability of ‘not being caught’ X Tax evaded } + Cost of voluntary compliance

COST

{Probability of ‘being caught’ X Penalty} + Cost of attempting evasion

DETERRENCE if COST > BENEFIT


What is credible deterrence ?

BENEFIT: {Probability of ‘not being caught’ X Tax evaded } + Cost of voluntary compliance

COST: {Probability of ‘being caught’ X Penalty} + Cost of attempting evasion

DETERRENCE if COST > BENEFIT

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


Can higher penalties create deterrence?

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


How globalization impacts taxes?



• 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

Globalization & TaxesPrinciples of taxation

Is globalization beneficial ?

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

Principles of taxation

THANK YOU

PRINCIPLES of TAXATION by Dr Vinay Kumar Singh Additional Director (P&R)-II, NATIONAL ACADEMY OF DIRECT TAXES, NAGPUR Induction course for 65 rd batch.

Documents

characteristics of tax

ideal tax tax elasticity

exchange of tax

tax principles of taxation

taxes principles of

taxes role of government

social welfare slide

production markets