Public Finance 3

i. Personal income tax

This is a tax that is imposed on incomes of individuals and is usually progressive in nature.

Example pay-As You-Earn (PAYE) for salaries.
In most cases it is paid through check-off system where the employer deducts it from the employee’s salary and remits it to the tax authorities.

ii. Corporation tax

This is tax levied on profits of companies. It is usually proportional in nature.

iii. Stamps duty

This is tax paid in areas such as conveyance of land or securities from one person to another.

iv. Estate (death) duty

This type of tax is imposed on property transferred after the owners’ death.

The tax helps in raising government revenue and also in redistributing income since the inheritor has not worked for it.

v. Wealth tax

This is tax levied on personal wealth beyond a certain limit.

vi. Capital gains tax

This is tax levied on gains realized when a fixed asset is sold at a price higher than the book value.

vii. Capital transfer (gifts) Tax

This is tax imposed on the value of property transferred from one person to another as a gift.

The tax is designed to seal loopholes whereby a wealthy person may try to avoid tax by transferring his/her property to a friend or a
relative as a gift.

This type of tax is progressive in nature. It however does not affect transfers between spouses or to charitable organizations.

Merits/advantages of direct taxes

i. Economical in collection;

Most of direct taxes are collect at source and the cost of collecting them is fairly low.

ii. Tax revenue is certain;

The tax payer knows what and when to pay and the government knows how much tax revenue to expect at what time (can be collected from the annual tax returns in advance).

iii.Equitable /equity;

They facilitate fair distribution in tax contribution as people pay according to the size of their income.

iv.Simplicity /simple to understand;

They are easy and simple to understand by both the tax payer and the collector.

v. Does not affect the price of goods and services;

Direct tax does not cause inflation as it only affects consumer’s disposable incomes and not the prices of goods and services.

vi.Brings redistribution of wealth;

Direct taxes are progressive in nature hence the wealthier members of the society are taxed more than the poorer members of the society.

vii. Civic consciousness;

Tax payers feed the pinch of paying tax and thus take a keen interest in government expenditure.

viii. No leakages;

loss of collected revenue is minimized as the tax is paid directly to the tax authorities and not through middle men.

ix.Desirable;

The tax is desirable because it only affects people who fall within the jurisdiction of income tax and corporation tax.

x. Elastic/flexible;

The tax is flexible in that it can be expanded to cover as many areas as desirable.

It can also be raised or reduced according to the needs of the economy.

Demerits of Direct Tax

i. Encourage avoidance and evasion;

whenever possible people come up with ways of reducing the amount of tax payable by falsifying information or just ignoring payment.

ii. Discriminatory /not imposed on all citizens;

Direct taxes are not paid by all citizens as low income earners who do not fall within the tax brackets are exempted

iii.Discourage investment/deterrent to investment;

Heavy taxation on profits discourage people from investing in risky but profitable businesses

iv.Discourage work/deterrent to work;

High rate of direct tax may deter people from working harder as people may opt for leasure instead of working extra time.

v. Encourage capital flight;

High taxes such as corporate tax make foreigners to withdraw their investments and transfer them to countries with lower taxes.

vi.Unpopularity;

The burden of the tax (incidence and impact) of tax is borne by the tax payer directly and at once. This makes direct taxes very unpopular.

vii. May inconvenience the tax payer;

The tax payer has to comply with complicated formalities relating to sources of income as well as the
expenses incurred while generating it.

This may force the tax-payer to engage the services of tax experts who have to be paid.

viii. Lack of civic awareness;

On tax payers are not interested in scrutinizing government expenditure as they do not feel the pinch of paying tax.

b. Indirect tax

These are taxes in which the impact is on one person and the incidence is partially or wholly on another person.

The tax payer may shift either the whole or part of the tax burden to another person.

Such taxes are usually based on the expenditure on goods and services and include the following:

i. Sales tax:

this is based on the sales made and may be assessed either as a percentage of the sales or a fixed amount e.g. sh.2 per every kilograms
sold. The tax may be collected at one point or various points of sale. In Kenya, sales tax has been replaced by V.A.T

ii. Value Added Tax (V.A.T):

This is the tax that is levied on the value
that a business adds borne by the consumer in the final price.

iii.Export duty:

This is a type of tax that is levied on exports. The objective may either to raise revenue or discourage the exploitation of some
commodities.

iv.Import duty:

This is tax levied on imported products,
For the following reasons.

• Raising government revenue

• Reducing incidences of dumping

• Discouraging consumption of imported goods with a view of boosting local production

• Protecting local industries

v. Excise duty:

This is a type of tax that is imposed on goods that are manufactured and sold within a country.

Its purpose includes:

• Raising revenue for the government

• Discouraging the consumption of some commodities such as beer and cigarettes.

Merits of Indirect Tax

I. Can be used selectively;

It can be used selectively to achieve a given objective e.g. consumption of some commodities.

II. Tax payment is voluntary;

indirect tax is only paid by those who
consume the tax commodities therefore those who do not want to pay the tax would only need to avoid taxed commodities.

III. Difficult to evade;

The tax cannot be evaded because it is part of the price of the commodity. All those who buy the commodity taxed must therefore pay the tax.

IV. Wide coverage/broad based;

The tax is levied on a wide range of
essential commodities thus a high amount of revenue is collected.

V. Stimulate effort;

Indirect taxes if increased increases the prices of goods and services. People who want to maintain the same living standards will therefore have to work harder to be able to buy/affect the same goods and services.

VI. Convenient;

The tax is paid in bits as one buys the goods and services. The tax is also hidden in the price of the commodity and the payer may
not be aware of it.

VII. Flexible;

Flexible; the government can raise or reduce the tax rate to suit the prevailing economic situation in a country.

Demerits of Indirect Taxes

1. END May fuel inflation;

continued increase in indirect taxes may fuel
inflation as it directly increases the prices of goods and services.

2. Less equitable/regressive;

The same amount is charged on both the high and
the low income earners making the tax burden to fall heavily on the low income earners. The low income earners end up paying a larger proportion
of their income as tax.

3. Can be avoided;

Indirect taxes can be avoided by people who do not consume the taxed commodity.

4. Encourages falsification of records;

Traders may falsify their rewards in
order to pay less tax.

5. Lack of civic/contributors awareness;

The tax is hidden in the price of the
commodities therefore the tax payers are not aware that they are contributing anything to the state.

6. Expensive to administer/expensive in collection;

The government must employ many tax inspectors making indirect taxes expensive in collection
and administration.

7. Uncertainty in revenue collection;

The government may not predict the amount of revenue yield as it is not easy to forecast sales and people can also not be forced to buy the taxed commodities.

8. Might interfere with resource allocation;

Indirect taxes increases the prices
of commodities and can therefore force consumers and producers to shift to the consumption and production of commodities that are not taxed.

9. Discourages savings;

Increased expenditure due to increased prices will lead to low saving and hence low investments.

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