CHAPTER FOUR

PUBLIC REVENUE

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 INTRODUCTION
 The necessity of public revenue is due to the necessity of public
112
expenditure.
 As the government has to perform certain functions for the
welfare of the public and these functions are not performed free of
cost, they involve expenditure.
 State provides social goods and services such as defense, health
services, education, streetlight, highways and other infrastructures.
 To finance them it needs income.
 Thus, the amount of public revenue to be raised is a function of
necessity of public expenditure.
 The government can collect revenue from different sources .
 Income of government is called public revenue.
 Of various sources of government revenue taxation is the most
important one.
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 Meaning and Source of Public Revenue
 In its wider sense, P.R. incorporates all receipts and incomes that a
114 public authority may get during any period of time irrespective of

their sources and nature and is called public receipt.

 Generally government sources of revenue are divided into tax
revenue and non-tax revenue
 Tax revenue - In every country, the largest part of public revenue is
raised through taxation and mainly it incorporates the following
three sections.
1. Taxes on income and expenditure- it deals with taxes that are
imposed on receipts and expenditures such as corporation tax,
income tax, expenditure tax, interest tax and other similar taxes.
2. Taxes on property and capital transaction- this part includes
taxes imposed on specific form of wealth and its transfer.
Example, estate duty, wealth tax, gift tax, house tax, etc.
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 Contd…………………
3) Taxes on commodities and services -it is concerned on taxes
116 levied on production, sale, purchase, transport, storage and
consumption of goods and services.
 Non-tax revenue: Public revenues received through administration,
commercial enterprise, gifts and grants are non-tax revenue of the
government.
a) Administrative revenue- public authorities can get income in the
form of: fees, fines and penalties, and special assessments.
b) Profits of state enterprise - these are important sources of
revenue these days, owing to the expansion to public sector. These
revenues are received in the form of prices paid for government
produced goods and services.
c) Grants and Gifts- they cover very small part of public revenue. Usually
patriotic people or institutions may provide gifts to the state. They are
voluntary contributions that are beneficial particularly during wartime
and emergency.
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  Local governments obtain grants from state government and state
government from the center. It is said to be grants - in - aid.
117
 When one country’s government makes grants to another country's

government, it is referred to as foreign aid.

d) Borrowings- It has many forms. But the most important are fresh
borrowings that can be categorized according to their origin and
maturity.
i. In terms of their origin: public borrowing may be external or
internal.
ii. In terms of their maturity: public borrowing may be long
term, medium term and short term
Note. Income and profit from creation of currency by government
that is greater than its face value of currency over its cost of creation are
also incorporated into category of non-tax revenue.

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 Tax Revenue
 Fund raised through various taxes is referred to as tax revenue.
 Taxes may be imposed on person's income or wealth, they may be direct
119
or indirect and they may be different rates and nature.
The main characteristics of a tax are as follows:
1) tax is compulsory payment to be paid by citizens who are supposed to be
liable to pay it. Therefore, anyone who wants to refuse to pay tax will be
punished.
2) There is no direct quid pro quo between the taxpayer and public
authority. This means taxpayer may not receive benefit proportional to
tax that he has paid. (Quid pro quo means something given or taken as
equivalent to another.)
3) tax is imposed to meet public spending incurred by government in the
general interest of the nation. It is payment for indirect service to be
provided by the government to community as whole.
4) tax is not a price paid by the taxpayer for any definite service rendered or
commodity offered by government.
5) tax is payable regularly and periodically as determined by tax authority.
For instance, income taxes are usually paid annually.
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 The Base of Tax
 The tax collecting authority has legally described the object on
which the tax is imposed.
 The base of each tax has to be defined legally and quantified for
purpose of determining the tax liability for an individual tax payer.
 Each taxpayer is considered as legal entity for this purpose.
 According to the different tax base, individual taxpayer may be
subjected to more than one tax.

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 Buoyancy of Tax

123 The growth of tax base increases tax revenue.
 This rise in tax revenue is termed as buoyancy of tax.
 A buoyant tax has inherent tendency to yield more tax revenue with
growth of its base.
Objectives/purposes of taxation
 Objectives of tax system in economy are mainly connected with:-
a) overall economic and non-economic policies of government

b) non-tax components of its fiscal policy

c) Institutional and other situations faced by the economy.

 Objectives of tax system differ significantly between developed

countries and underdeveloped countries

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 Contd……………….
 The main problem affecting the developed countries is instability of
125 income and employment.
 Therefore, they design their tax system to solve this problem.
 Unlike advanced nations primary objective of taxation in
underdeveloped countries is not related to instability of income
and employment
 Rather these countries, like Ethiopia, have been affected by several
problems that are related with:-
 Economic growth
 Poverty
 Inequality
 Health
 Chronic unemployment
 Regional disparities etc.
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 Canons of Taxation
 By cannon of taxation we mean those characteristics, which good tax
127 should, posses.

 Canons of taxation are concerned with the rate, amount and method of

levy and collection of a tax.

 The first set of principles developed by Adam Smith is referred to as
canons of taxation.
 These are: Canon of equality, Canon of certainty, Canon of
convenience, Canon of economy
a) Canon of Equality: It explains that taxation must be distributed
equally in relation to the ability of the taxpayer.
 It requires that the rich should pay more taxes and the poor should bear
lesser burden.
 However, if we interpret this principle with regard to disutility which
taxpayers sacrifice by paying taxes, tax should impose equal marginal
disutility up on every taxpayer.
 This situation results in two possibilities of imposing a tax.
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 Contd……………….
 On one hand, if the marginal utility of income is constant, the rich as
129 well as the poor people should pay a given percentage of their

income in the form of tax.

 On other hand, if we agree that marginal utility of income decreases,
equality can be approved when rich pay larger proportion of his
income as taxes and poor pay smaller proportion of his income in
form of taxes (i.e. tax should be progressive).
 However, it is obvious that the marginal utility of income goes on
diminishing with the increase in its stock and hence the rich person
feels less disutility or sacrifice in paying taxes than the poor person
paying at the same rate.
 Therefore, if the canon of equality to be properly observed, the
progressive taxes must be advocated.

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 Contd…………………
b) Canon of certainty- it indicates that taxation has to include element
131 of certainty to prevent taxpayer from unnecessary harassment by
tax-officials. Adam Smith said that the tax that is paid by each
individual should be certain and not arbitrary. This means time of
payment, manner of payment and the person to whom the tax is
to be paid, amount to be paid should be clear to contributor and
every person
c) Canon of Convenience- According to this canon tax should be
collected in away that are convenient for taxpayer as far as possible.
For instance, it is convenient to collect a tax from salaried
employees at the time of paying salaries.
d) Canon of Economy: It is clear that government has incurred costs
to collect taxes. Consequently, this principle suggests that the cost
of collecting taxes should be as minimum as possible.

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 Contd………………..
 However, in view of developments in economic philosophy,
133 economists have added a few more canons.

 These are:

1) Canon of elasticity

2) Canon of productivity

3) Canon of Simplicity

4) Canon of diversity
1) Canon of elasticity- it states that taxation should be elastic in
nature for the purpose of collecting more tax when income of the
people increases.
 This means, it should be possible for the authorities to revise the tax
structure both with respect to coverage and rates to fit the
changing requirement of the economy and the treasury.

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2) Canon of productivity- it indicates that the tax system should be
able to generate enough revenue for the treasury. And the
government should have no need to resort to deficit financing and
135
taxes should be levied that they do not obstruct and discourage
production.
3) Canon of simplicity- it suggests that tax system should not be too
complex and beyond understanding of layman. Rather, it should
be as simple as possible. So that tax payer should not be confronted
with accounting, administrative and other difficulties.
4) Canon of diversity - it implies that taxes should be imposed on
diverse sources because having single tax system may be risky and
inequitable. However, too much multiplicity of taxes should be
avoided because it leads to unnecessary cost of collection and
violates canon of economy.

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 Features of Good/Sound Tax System

138
A good tax system is one which:-
a) fulfills most of canons of taxation

b) yield sufficient revenue

c) causes minimum aggregate sacrifice to people

d) Least obstructs incentives for production.

 Thus for such good tax system to exist, the following principles
must be observed:
1) It should ensure maximum social advantage–effect on
production and distribution of wealth in society should be
considered.
2) It ought to cause minimum aggregate sacrifice, i.e., tax burden
should be imposed according to ability to pay tax.

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 Contd………………..
3) It should have built in flexibility, so that changes are possible
140
according to changing condition of dynamic economy.
4) It ought to be balanced one. This means it should not contain just,
progressive, regressive or proportional tax only, but
combination of all taxes. Because all type of taxes has its own
merits and demerits
5) It should be multiple, but greater multiplicity is not necessary.
6) There should be simplicity,
7) It should not hamper development of trade and industry otherwise
it ought to support economic development of country.

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 Theories of Taxation
 Economists focus on issue of tax burden and justice for equity in its
144 distribution.

 Accordingly tax burden can be classified as:

1. Money burden of taxation: amount of money income transferred
from people to government by way of various taxes.
2. Real burden of taxation: refers to volume of goods and services
transferred from payers to government or value of money raised by
government.
 Equity on taxation refers to fairness or justice in distribution of tax burden.
 There are two classes of equity
1. Horizontal equity: implies that people in equal economic
circumstance should pay equal amount of taxes.
2. Vertical equity: people who are in different economic situation should
be treated differently. Rich people should pay more taxes than others.

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 Theories of equitable distribution of tax burden
1. Socio-economic Theory
145
 Every economic problem should be looked at its social and
political context
 The main objective of taxation is realizing socio-economic
stabilization through reducing:-
a) income inequality

b) unemployment

c) cyclical fluctuation

 Therefore, this principle emphasizes on that the poor, religious,

educational, and charity organization should be free from tax
 Because imposing tax on them may lead to social instability

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 Contd……………….
2. Cost of Service Theory (supply side)
147The cost incurred by the government in providing public goods
and services would be regarded as the basis of taxation.
 Thus, citizens should pay tax as per cost of public goods enjoyed.

 In other words, government is just like producer of social goods

and services, and taxes are the price for those goods
 Weakness
 Estimating cost of social goods and services offered to each
individual is difficult
 It violates property of tax. Tax is not price.

 It does not consider the essence of welfare.

 If cost is base of taxation, government cannot provide free

education and medical care to poor.
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 Contd……………….
3. Benefit- Received Theory (demand side)
149
 Burden of taxes should be divided among taxpayers in relation to
benefits enjoyed from government.
 This means those who get more benefit from public goods should
pay more taxes than others.
 Weakness
 Measuring benefits received by individual from public goods is
difficult. Benefit is ultimately subjective. It results in injustice.
 This principle recommends imposing more tax on poor because
they get more benefit from social goods and services.
 It does not address main objective of taxation, i.e. reducing
income disparity.

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 Contd………………..
4. The ability to pay principle Theory
 Burden of taxation should be distributed among members of
society according to principle of justice and equity.
 This means that tax should be imposed on taxpayer based on their
relative ability to pay.
 There are two indices for measuring ability to pay:-

a) Objective Index of Measuring Ability to pay- it considers money

value of taxable capacity of each taxpayer rather than their
psychology of sacrifice and feelings
 The indices used to measure ability to pay are:-

i. Property (houses, farms, factories, equipment’s etc. )

ii. Consumption expenditure
iii. Income etc.
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 Contd………………..
b) Subjective Index of Measuring Ability to pay:
153
 Taxpayers suffers sacrifice by paying tax.
 It supposes that taxation does not make taxpayer feel better
by idea that he/she is contributing to welfare of society.
 Tax liability of taxpayers should be related to equal sacrifice
principle. There are three alternative ways of interpreting equal
sacrifice
i. Equal absolute sacrifice - tax imposed on higher income
individual should cause him to lose amount of satisfaction
(utility) equal to that sacrificed by lower income tax payer. In
other words, higher income people should pay more tax than the
other.

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 Contd………………...
ii. Equal proportional sacrifice - loss of utility (satisfaction) in tax
155 payment should be proportional to total income of each taxpayer.
iii. Equal marginal sacrifice or least aggregate sacrifice- marginal
utility of income sacrificed by all taxpayers should be same
 Marginal utility of income for higher income people is low and
marginal utility of income for lower income people is high.
 Therefore, rich should pay more tax than poor.

 Out of these three versions, equal marginal sacrifice is considered as

best and generally accepted principle of taxation by modern
economists.

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 Taxable Capacities
 Economists have defined taxable capacity as ability of people to pay tax
without adversely affecting or worsening their standard of living and
157
efficiency i.e. it is maximum capacity of community to bear tax without
much hardship.
 Taxation beyond taxable capacity is over-taxation. It results in
economic as well as political instability.
 Taxable capacity can be seen in two ways

1. Absolute taxable capacity- amount of money or proportion of income

that can be taken away by government from people in form of taxes
without producing unfavorable effects.
 It represents maximum amount of tax that can be collected from
individuals of particular country.
 In long period, it is bound to change through growth in savings,
investment, economic growth, changes in production pattern etc.
 Therefore, determination of absolute taxable capacity is almost
impossible.
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 Contd………………..
2. Relative taxable capacity- In relative sense, reference is to
159 proportion in which two or more nations or group of persons or
states in country contribute towards common expenditure through
taxation.
 It is possible to determine in advance proportion in which two or
more communities should contribute in order to meet some common
expenditure in accordance with their respective abilities to pay.
 Richer community shall be called up on to bear greater share of
such common expenditure
 Concept of relative taxable capacity is more useful in federal
economy like Ethiopia, where different states are required to
contribute towards common expenditure.
 In other words relative taxable capacity is capacity of community
to contribute to some expenditure in relation to capacities of
other
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communities.
 Factors Determining Taxable Capacity
 size of National Income
162  distribution of income
 Size and rate of population growth
 Pattern of Taxation
 Stability of income
 Nature of public expenditure
 Psychology of taxpayers
 Standard of living of people
 Administrative efficiency
 Economic Situations
 Political conditions

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 Important Terminologies
1) Tax rate is per-unit amount of tax or percentage rate at which
economic activity is taxed.
2) Tax incidence relates to the way burden of tax is distributed
among economic units (consumers, producers, employees,
employers). It points out who is legally responsible for paying
the tax.
3) Impact of tax is tax’s first point of contact with the taxpayers. It is
felt by those who bear the first statutory responsibility of paying
it to the government
4) Effect of a tax refers to responses from taxpayers and the
economy to the imposition and collection of taxes. Such
responses can be of great variety and influence the working of the
economy in terms of production, growth, saving, investment,
inequality etc.
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 Classification of Taxes
1. Direct taxes impose the burden or impact and incidence on the
same person who earns the income. They are computed based on
the ability of the taxpayer to pay, which means that the higher the
person’s capability of paying, the higher the taxes
a) Income tax: the type of tax that governments impose on income
generated by individuals and businesses within their jurisdiction.
b) Transfer tax: the most common form of transfer tax is levied on
real estate. Such a tax is levied on the taxable portion of the
property of a deceased individual including trusts and financial
accounts.
c) Property tax: this tax is charged on properties such as land and
building and is used for maintaining public service.
d) Capital gains tax: this tax is charged when an individual sells
assets such as stocks, real estate, or a business. This kind of tax is
computed by acquisition amount and the selling amount.
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 Cont’d
2. Indirect taxes impose the impact (immediate burden)
and incidence (ultimate burden) on different persons.
 Sales tax and consumption taxes like Value Added Tax &
Excise tax

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 Tax System and Structure in Ethiopia
 Ethiopia introduced the concept of income taxation in 1944 when
the Emperor issued a decree requiring all peasants to pay one-tenth
of their agricultural products to tax officials.
 Since then, the tax regimes have changed with associated changes
in governments.
 Currently, the government agency which is responsible for tax
collection is the federal Ministry of Revenues and custom authority.
 Types of Tax and Tax Accounting in Ethiopia
 According to the Tax Proclamation No. 286/2002 and Regulations
No. 78/2002 of Ethiopia, there are four schedules of income in
addition to exempt income. They are:
a) Schedule A: Income from employment.
b) Schedule B: Income from rental of buildings.
c) Schedule C: Income from business.
d) Schedule D: Other income.
e) Schedule E: Exempt income.
Schedule A: income from employment is taxed at rates ranging from 10
to 35%.
 Employment income tax is withheld by employers and is a final tax.
 That mean employees earning income exclusively from employment
are not required to declare income to tax authorities
 Cont’d
 Employment income includes the following earnings:
a) salary, wages, allowance, bonus, commission, gratuity, or
other remuneration received by employee in respect of past,
current, or future employment.
b) the value of fringe benefits received by employee in respect of
past, current, or future employment
c) An amount received by employee on termination of
employment, whether paid voluntarily, under agreement, or
because of legal proceedings, including any compensation for
redundancy or loss of employment, or a golden handshake
payment.
Cont’d
 Cont’d
Schedule B: rental income tax is imposed for each tax year on a
person renting out a building or buildings who has taxable income for
the year. The taxable income tax of a taxpayer for a tax year is the
gross amount of income derived by the taxpayer from the rental of a
building or buildings for the year reduced by the total amount of
deductions allowed to the taxpayer for the year
Schedule C: provides for the taxation of income earned from
businesses. Business income tax is imposed for each tax year. The
taxable income for a tax year is the total business income reduced
by the total deductions allowed to the taxpayer for the year.
 Cont’d
Schedule D: includes other income such as income from royalties,
income paid for services rendered outside of Ethiopia, income
from games, dividends, income from casual rental of property,
interest income, specified non-business capital gains.
Schedule E: refers to exempt income. A list of exempted income
items includes the cost of medical treatment of employees,
hardship allowance, salary paid to domestic servants,
maintenance, or child support payments, travelling expenses paid
to employees recruited from elsewhere than the place of
employment, pension contribution, and payments made to a
person as compensation.
Value added tax (VAT): is a tax levied on the value added at
different stages. It is a sales tax that is administered in a different
form. It is an indirect tax. Ethiopia introduced the VAT Act on 1
January, 2003 with the standard rate of 15% which is applied on every
taxable transaction by a registered person.
 Cont’d
 Turnover tax (TOT): this is an equalization tax that is imposed on
persons not registered for value-added tax to fulfil their
obligations and to enhance fairness in commercial relations and
to complete the coverage of the tax system.
 Excise tax: this is imposed and payable on selected goods such as,
luxury items and basic goods which are demand inelastic. In
addition, it is believed that imposing the tax on goods that are
hazardous to health and which cause social problems will reduce
the consumption.
 Surtax: it is an additional 10% tax that is applicable on imported
goods except for fertilizers, petroleum and lubricants, motor
vehicles for freight, passengers and special purpose motor
vehicles, aircraft, spacecraft, and parts thereof, and capital
(investment) goods.
 Cont’d
 Pension contribution: the contributions payable to the Private
Organizations Pension Fund shall, based on the employee’s
salary, be by the employer (11%) and by the employee (7%).
 Withholding Tax all bodies and specified sole proprietor
businesses are required to deduct withholding tax on domestic
transactions at a rate of 2% of the value of the transaction and
remit to the tax authority monthly.
 Stamp Duty is another form of taxation basically imposed on the
services given to individuals through affixing seals. Stamp is an
official mark or seal placed on a document specially to indicate that
a requirement tax has been paid.
 Cont’d
Customs Duty: is imposed on imported or exported goods.
This is the best instrument to prevent or reduce importation of
goods. It serves as trade barrier. Whenever a state needs to ban or
reduce importations to her territory, it can impose high rate in
some goods (excise taxation) it might reach a rate of 100% or
above
 Problems Associated with Taxation in Ethiopia
 The major criticisms of tax systems around the world have focused
on the complexity of their administration and the difficulty for
taxpayers to understand and comply with it. Both problems
cause taxpayers to incur costs to correctly calculate their tax
liability. This may encourage the growth of unreported
transactions in the underground economy (tax evasion) and the
growth of demand for tax shelters (tax avoidance)
 Tax avoidance refers to arranging one’s affairs so as to minimize
the tax burden. It entails taking full advantage of the provisions of
the tax code or schedule to reduce one’s tax obligations. An
example is a reduction of one’s tax burden through exemptions,
deductions or incentives approved in the tax schedule.
 Cont’d
 Tax evasion is falsifying information on a tax return in order to
reduce one’s tax liability or even not filing at all (failing to pay
legally due taxes) which is illegal. Tax evasion is rooted in
underground economic activities that exist for, at least, two reasons:
(a) because certain activities are illegal and individuals do not want
records of those activities having taken place, and (b) because high
marginal tax rates give people an incentive to obtain income
without reporting it.
 Other problems which tax administrations face, both in Ethiopia
and elsewhere, are a steadily growing workload, the complexity
of fiscal legislation, the attitude of taxpayers and the degree of
non-compliance, the need to improve customer service, the need
to reduce costs of tax assessment and collection, and the need
for efficient and effective management.
 Questions

164

1. What are the major source o f revenue of the government?

2. What are the qualities of good tax system? Explain the canons
of taxation.
3. What are the main principles of taxation?
4. Distinguish between direct and indirect taxation.
5. Explain the concept of equity in taxation.

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