Taxation is used to finance government expenditure. It represents a transfer of income from individuals, groups and organizations to the government.
Taxes may be classified under various headings, the commonest distinction being “direct” and “indirect” taxation . Anyone paying direct tax (income tax) cannot shift this liability onto others. Taxes on goods, on the other hand are traditionally regarded as “indirect”. Corporation and individual income taxes are direct; value-added taxes, sales taxes, and import or excise duties are indirect taxes.
Income tax is usually collected at source. Employers compute, deduct and remit the tax to be paid on their employees’earnings.
Corporation tax, a tax on the income of companies which are distinct legal entities, is a major source of fiscal revenue. The net income of a corporation constitutes the tax base, irrespective of whether such net trading profits are paid as dividends or kept as reserves. Corporation income taxes vary among the countries. Less developed countries usually have lower corporation tax rates in order to attract foreign investment.
Sales taxes and excise duties are the best known examples of indirect taxes. The distinction between excise duties and sales taxes is based on the scope of coverage. Excise duties are levied on particular commodities, e.g. tobacco, petrol, while sales taxes apply to a broad range of goods and services. Sales taxes are charged on top of excise duties, wherever the latter apply, so that anyone buying cigarettes or petrol will, in effect, not only pay excise duties but also a sales tax on top.
The best known kind of sales tax, value added tax (VAT) has won recognition in the European Common Market. This is a national sales tax levied at each stage of production or at the sale of consumer goods. The tax is assessed in proportion to the value added during that stage. Generally, manufactiring goods, such as plant and equipment, have been exempted from this tax. In most cases, food items also have been exempted. Here is an example of how VAT works. A tree owner who sells part of a tree to a lumber mill for $1 must set aside ten cents VAT to pay to the government. The lumber mill processes the tree into building material and sells the wood for $3 to a lumber wholwsaler. The mill adds $2 in value and thus sets aside 10 per cent of the added value, or twenty cents, to pay to the government. And so the VAT continues until the final sale.
The VAT system offers advantages, such as rebates on exports. Profitable and unprofitable firms are taxed alike, as there is no possibility of tax deductions to determine taxable income. A badly run company is, therefore forced to improve or go out of business. Further, VAT is easy to calculate and collect. But VAT is often accused of having contributed to seriuos inflation in countries where it was introduced.