taxation principles and theories

Public finance

Tax Principles, Theories and Policies

Public Finance Prof. Rolando C. Rodolfo, A.B. LlB, MPM

(30 MINUTES)

PRE-LECTURE QUIZ

Question

What is taxation?

Why is there a need for taxation?

What is your understanding of the life-blood theory of taxation?

It is the inherent power by which the sovereign state imposes financial burden upon persons and property as a means of raising revenues in order to defray the necessary expenses of the government (Tax Digest by Crescencio Co Untian, 2002). Taxation is the imposition of financial charges or other levies, upon a taxpayer (an individual or legal entity) by a state such that failure to pay is punishable by law.

What is Taxation?

It is a mode by which government make exactions for revenue in order to support their existence and carry out their legitimate objectives (Tax Law and Jurisprudence by Justice Vitug, 2000). It is the most pervasive and the strongest of all the powers of the government. Taxes are the lifeblood of the government, without which, it cannot subsist.

What is Taxation?

What is Taxation?

A means by which governments finance their expenditure by imposing charges on citizens and corporate entities. Governments use taxation to encourage or discourage certain economic decisions. For example, reduction in taxable personal (or household) income by the amount paid as interest on home mortgage loans results in greater construction activity, and generates more jobs.

Taxation according to Colbert:

.

"The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing." (Colbert, 1665) Jean-Baptiste Colbert was the controller general of finance (from 1665) and secretary of state for the navy (from 1668) under King Louis XIV of France. He carried out the program of economic reconstruction that helped make France th dominant power in Europe.

Life blood or necessity theory

The life blood theory constitutes the theory of taxation, which provides that the existence of government is a necessity; that government cannot continue without means to pay its expenses; and that for these means it has a right to compel its citizens and property within its limits to contribute.

In Commissioner v. Algue, the Supreme Court said that taxes are the lifeblood of the government and should be collected without unnecessary hindrance. They are what we pay for a civilized society. Without taxes, the government would be paralyzed for lack of motive power to activate and operate it. The government, for its part, is expected to respond in the form of tangible and intangible benefits intended to improve the lives of the people and enhance their moral and material values.

The first known system of taxation was in Ancient Egypt around 3000 BC - 2800 BC in the first dynasty of the Old Kingdom.

In Biblical times, tax is already prevalent. According to Genesis 47:24:

"But when the crop comes in, give a fifth of it to Pharaoh. The other four-fifths you may keep as seed for the fields and as food for yourselves and your households and your children".

History of Taxation

Earliest taxes in Rome are called as portoria were customs duties on imports and exports

Augustus Caesar introduced the inheritance tax to provide retirement funds for the military. The tax was five percent on all inheritances except gifts to children and spouses .

In England, taxes were first used as emergency measures.

History of Taxation

History of Taxation in the Philippines

The pre-colonial society, being communitarian, did not have taxes.

During the Spanish Period, new income-generating means were introduced by the government such as the : Manila-Acapulco Galleon Trade Polo Y Servicio (Forced Labor) Bandala Encomienda System Tribute


Manila-Acapulco Galleon Trade was the main source of income for the colony during its early years. The Galleon trade brought silver from Nueva Castilla and silk from China by way of Manila.


Polo Y Servicio is the forced labor for 40 days, of men ranging from 16 to 60 years of age who were obligated to give personal services to community projects. One could be exempted from the polo by paying a fee called falla (which was worth one and a half real). Bandala is one of the taxes collected from the Filipinos. It comes from the Tagalog word mandala, which is a round stock of rice stalks to be threshed.


Encomienda are large tracts of land given to a person as reward for a meritorious act. The encomenderos were given full authority to manage the encomienda by collecting tribute from the inhabitants and govern people living on it. Tribute was the residence tax during the Spanish times. It may be paid in cash or kind, partly, or wholly. But in 1884, the tribute was replaced by the cedula personal or personal identity paper, equivalent to the present community tax certificate.


That in the 19th century, the

cedula served as an identification

card that had to be carried at all

times. A person who could not

present his or her cedula to a

guardia civil could then be detained

for being indocumentado.

Andres Bonifacio and other

Katipuneros tore their cedulas in

August 1896, signaling the start of

the Philippine Revolution.

Did you know?

The cdula was imposed by the Americans on January 1, 1940, when Commonwealth Act No. 465 went into effect, mandating the imposition of a base residence tax of fifty centavos and an additional tax of one peso based on factors such as income and real estate holdings. The payment of this tax would merit the issue of a residence certificate. Corporations were also subject to the residence tax.

The Development of the Community Tax

A sample cedula in the 1920s.

Also known as a residence certificate, is a legal identity document in the Philippines.

Issued by cities and municipalities to all persons that have reached the age of majority and upon payment of a community tax, it is considered as a primary form of identification in the Philippines and is one of the closest single documents the Philippines has to a national system of identification, akin to a driver's license and a passport.

What is a cedula?

A person is required to present a cedula when he or she acknowledges a document before a notary public; takes an oath of office upon election or appointment to a government position; receives a license, certificate or permit from a public authority; pays a tax or fee; receives money from a public fund; transacts official business; or receives salary from a person or corporation.

Why is cedula important?

ADAM SMITHS CANONS OF TAXATION

Adam Smith's contribution to this part of economic theory is still regarded as classic. His enunciation of the canons of taxation has hardly been surpassed in clarity and simplicity. His four celebrated canons are as follows:

1. Canon of Equality.

Equality here does not mean that all tax-payers should pay an equal amount. Equality here means equality or justice. It means that the broadest shoulders must bear the heaviest burden.

This canon has given rise to two theories:

(i) Equality of Sacrifice Theory. It means that the burden of taxation

should involve an equal sacrifice for every individual. This equality, however, though good in theory, is difficult to attain in practice. Sacrifice is subjective, something in the mind and feelings of a person. It is difficult to measure. Besides, it has to take into consideration the number of dependents on the earning member in the family and their standard of living.

(ii) The second principle indicating justice is the Ability or Faculty Theory, which holds that the rich should be made to pay something more than proportionate to their income. A man with an income of P125,000 per month will not, other things being equal, feel the same pinch in parting with P15,000 as a man with an income of only P20,000 feels in paying P15,000 because the former's faculty to pay is greater. On this principle is based progression in taxation i.e., increasingly higher rates of taxation as incomes increase. Proportional taxation will not do justice.

2. Canon of Certainty.

The individual should know exactly what, when and how he is to pay a tax. Otherwise, it causes unnecessary suffering. Similarly, the State should also know how much it will receive from a tax.

3. Canon of Convenience

Obviously, there is no sense in fixing a time and method of payment which are not suitable. For example, Land revenue in India is realized after the harvest has been collected. This is the time when the cultivators can conveniently pay.

4. Canon of Economy

This means that the cost of collection should be as small as possible. If the bulk of the tax is spent on its collection, it will take much out of the people's pockets but bring little into the State's pocket. It is not a wise tax.

Taxation has four main purposes or effects: 1. Revenue 2. Redistribution 3. Repricing 4. Representation

The Four Rs of Taxation

Revenue The taxes raise money to spend on armies, roads, schools and hospitals, and on more indirect government functions like market regulation or legal systems.


Redistribution This refers to the transferring wealth from the richer sections of society to poorer sections. Repricing Taxes are levied to address externalities; for example, tobacco is taxed to discourage smoking, and a carbon tax discourages use of carbon-based fuels.


Representation the government is representing the paramount interest of the people in its effort to collect taxes from the populace;

TWO PRINCIPAL APPROACHES TO MODERN TAXATION

Benefit approach principle

Ability-to-pay principle

Benefit Approach Principle

Benefit approach principle is a traditional taxation principle which holds that people benefiting from government spending should be the ones to pay taxes to finance these expenditures, whatever and whichever they may be.

Benefit approach principle is developed by English philosophers Thomas Hobbes (1588-1679) and John Locke (1632-1704), and by Dutch jurist Hugo Grotius(1583-1645).

Under the benefit approach system, individuals pay for each and every one of the government-provided goods and services that they consume. They are not charged any taxes for goods and services they do not benefit from. Therefore, the taxes people pay under the benefit approach principle are in accordance with the benefits they receive.

A practical problem in the benefit approach system is the difficulty of measuring how much benefit an individual actually receives from the government.

The benefit approach principle was refined by Swedish economist Erik Lindahl (1891-1960) in the 20th century.

Ability to Pay Principle

Ability-to-pay principle envisages that taxation should be levied according to an individual's ability to pay; that is, individuals with higher incomes should be charged higher taxes.

Individuals with higher incomes are charged more taxes not because they use more government goods and services but because they have the ability to pay more. The primary indicator of ability to pay is commonly agreed to be income. Ability-to-pay principle is therefore in contrast with the benefit approach principle, which determines the amount of taxes a person should pay by the benefits received in public services. Ability-to-pay principle is based not on the benefits received but on the notion of equal sacrifice. It is considered to be characteristic of a socialist sentiment, and is used in most industrialized economies; but equality of sacrifice, is open to interpretation as it can be easured in absolute, proportional or marginal terms.

The main downside of the ability-to-pay principle is that it diminishes the incentive to work, since a higher portion of the generated income will be collected by the government as taxes.

Ability-to-pay principle was extended by the Swiss philosopher Jean-Jacques Rousseau (1712-1778), the French political economist Jean-Baptiste Say (1767-1832) and the English economist John Stuart Mill(1806-1873).

The main purpose of taxation is to accumulate funds for the functioning of the government machineries. No government in the world can run its administrative office without funds and it has no such system incorporated in itself to generate profit from its functioning. The governments ability to serve the people depends upon the taxes that are collected. Taxes are indispensable in the government operation and without it, the government will be paralyzed.

Why Tax?

Tax law in the Philippines covers national and local taxes. National taxes refer to national internal revenue taxes imposed and collected by the national government through the Bureau of Internal Revenue (BIR) and local taxes refer to those imposed and collected by the local government. The 1987 Philippine Constitution sets limitations on the exercise of the power to tax. The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation. (Article VI, Section 28, Paragraph 1).

The Philippine Tax System

Agencies responsible for Collecting Duties and Taxes Bureau of Internal Revenue

Bureau of Customs

BUREAU OF CUSTOMS

The Bureau of Customs is mainly responsible for collecting duties from importations and exportations. The law governing the operations of the Bureau of Customs is the Tariff and Customs Code of the Philippines. The Current head of the agency is Commissioner John Philip Sevilla.

BUREAU OF INTERNAL REVENUE

The Bureau of Internal Revenue is the primary agency responsible for the collection of taxes. The law governing the Bureau of Internal Revenue is the National Internal Revenue Code of the Philippines. The current head of the agency is Commissioner Kim Henares

Tax evasion happens when

there is fraud through

pretension and the use of other

illegal devices to lessen ones

taxes, there is tax evasion,

under-declaration of income,

and non-declaration of income

and other items subject to tax,

Under-appraisal of goods

subject to tariff , and over-

declaration of deductions

What is Tax Evasion?

The Congress may, by law, authorize the President to fix within specified limits, and subject to such limitations and restrictions as it may impose, tariff rates, import and export quotas, tonnage and wharfage dues, and other duties or imposts within the framework of the national development program of the Government (Article VI, Section 28, Paragraph 2).

The Branches of Government vis--vis the Tax Law

The President shall have the power to veto any particular item or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to which he does not object (Article VI, Section 27, Paragraph 2).

The Supreme Court has the power to: review, revise, reverse, modify, or affirm on appeal or certiorari, as the law or the Rules of Court may provide, final judgments and orders of lower courts in all cases involving the legality of any tax, impost, assessment, or toll, or any penalty imposed in relation thereto (Article VIII, Section 5, Paragraph 2b).

The Branches vis--vis the Tax Law

A) Personal, capitation or poll taxes These are taxes of fixed amount upon

residents or persons of a certain class without regard to their property or business

B) Property taxes 1. Real Property Tax - an annual tax that may

be imposed by a province or city or a municipality on real property such as land, building, machinery and other improvements affixed or attached to real property.

The Forms of Taxes Imposed on Persons and Property

2. Estate Tax (Inheritance Tax) - a tax on the right of transmitting property at the time of death and on the privilege that a person is given in controlling to a certain extent the disposition of his property to take effect upon death.

3. Gift or Donors Tax - a tax on the privilege of transmitting ones property or property rights to another or others without adequate and full valuable consideration.


4. Capital Gains Tax - tax imposed on the sale or exchange of property . Those imposed are presumed to have been realized by the seller for the sale, exchange or other disposition of real property located in the Philippines, classified as capital assets.

C. Income Taxes - Taxes imposed on the income of the taxpayers from whatever sources it is derived. Tax on all yearly profits arising form property, possessions, trades or offices.


D. Excise or License Taxes - Taxes imposed on the privilege, occupation or business not falling within the classification of poll taxes or property taxes. These are imposed on alcohol products; on tobacco products; on petroleum products like lubricating oils, grease, processed gas etc; on mineral products such as coal and coke and quarry resources; on miscellaneous articles such as automobiles.


Under these lies two other taxes: 1.Documentary Stamp Tax - a tax imposed upon documents, instruments, loan agreements and papers and upon acceptance of assignments, sales and transfers of obligation and etc.

2. Value added tax- is imposed on any person who, in the course of trade or business sells, barters, exchanges, leases, goods or properties, renders services, or engages in similar transactions.

The Branches of Government vis--vis the Tax Law

1. Individuals a. Resident Citizen b. Non-resident Citizen c. Resident Aliens d. Non-resident Aliens

2. Corporations a. Domestic Corporations b. Foreign Corporations

3. Estate under judicial settlement

4. Trusts irrevocable both as to the trust property and as to the income.

Who Should Pay Taxes?

The Constitution expressly grants tax exemption on certain entities/institutions such as: 1. Charitable institutions, churches, parsonages or convents appurtenant thereto, mosques, and nonprofit cemeteries and all lands, buildings and improvements actually, directly and exclusively used for religious, charitable or educational purposes (Article VI, Section 28, Paragraph 3).

Who (or What) are those exempted in paying taxes?

Who (or What) are those exempted in paying taxes?

2. Non-stock non-profit educational institutions used actually, directly, and exclusively for educational purposes. (Article XVI, Section 4 (3)).

Exempted to tax as stated in the Article 283 of Rules and Regulations Implementing Local Government Code of 1991 (RA 7160):

Local water districts Cooperatives duly registered under RA 6938, otherwise known as the Cooperative Code of the Philippines Non-stock and non-profit hospitals and educational institutions Printer and/or publisher of books or other reading materials prescribed by DECS (now DepEd) as school texts or references, insofar as receipts from the printing and / or publishing thereof are concerned.

SHIFITNG AND INCIDENCE OF TAXATION

Shifting: The process of transfer of a tax, while its impact lies on the person who pays it at first instance. Or Shifting is the process through which a taxpayer escapes the burden of a tax.

1. Forward shifting: Tax burden from the producer to the consumers in the form of higher price of the commodity. Price serves as the vehicle through which a tax is shifted.

2. Backward shifting: When the imposition of a tax caused a reduction in the prices paid to the factor-owner.

A tax cannot be shifted:

(i) when it is purely personal and

(ii) when it is levied upon economic surplus.

END OF LECTURE

ACTIVITY: BATTLE OF THE BRAINS

Instruction: Group yourselves into two then for each question select a champion that will represent your team. The most number of wins will win the game and will be exempted from the Post lecture Quiz.

EASY ROUND

Question No. 1: Easy Round

It states that taxation should be levied according to an individual's ability to pay; that is, individuals with higher incomes should be charged higher taxes.


It is a traditional taxation principle which holds that people benefiting from government spending should be the ones to pay taxes to finance these expenditures, whatever and whichever they may be.


True or False: Andrew Smith developed the four canons of taxation?

Question No.4 Easy Round

It is an agency responsible for the Collection of Duties.

Question No. 5 Easy Round

It is an annual tax that may be imposed by a province or city or a municipality on real property such as land, building, machinery and other improvements affixed or attached to real property.

Question No. 6 Easy Round

These are taxes imposed on the income of the taxpayers from whatever sources it is derived. Tax on all yearly profits arising form property, possessions, trades or offices.

AVERAGE ROUND

Question No. 1

This happens when there is fraud through

pretension and the use of other illegal devices

to lessen ones taxes, there is tax evasion,

under-declaration of income, and non-

declaration of income and other items subject

to tax, Under-appraisal of goods subject to

tariff , and over-declaration of deductions.

Question No. 2

Give one entity or institution exempted from paying taxes.

DIFFICULT ROUND

Question No. 1: Difficult Round

What is the life-blood or necessity theory?

Who said that "The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing ?

Question No. 2: Difficult Round

Question No. 3 Difficult Round

The process of transfer of a tax, while its impact lies on the person who pays it at first instance. Or it is the process through which a taxpayer escapes the burden of a tax.

taxation principles and theories

Documents

art of taxation

lifeblood theory of

existence of government

known system of taxation

government tax digest

life blood theory

necessity theory

public finance tax principles