JARUS ON SUNDAY: TAXATION FOR DUMMIES 1

Last week I justified why basic knowledge of taxation by everyone is key to the attainment of issues-based political participation and knowledge-driven society.

Tax has been defined as a compulsory levy imposed by government on individuals and businesses to generate funds to finance its activities, among other objectives. The need for taxation is pretty obvious – not all goods or services can be provided by private persons (natural and corporate). If you use your money to provide road for instance, you cannot stop me from using it. So there is no incentive for you to provide roads.

Therefore, the constituted authority is in better position to provide the road, which will be available to all of us. But you and I need to contribute to fund the road construction. Hence, imposition of compulsory tax by the government. You can own your TV, your car, your house and prevent third party from using them, but not your road. There is no incentive for you to provide your road because you can’t solely enjoy the benefit, even if you solely bear the cost. This kind of good is called public good – good that cannot be consumed to the preclusion of others and which logic calls for provision by government.

You can also think of services which are too critical to be left in the hands of private entities. Classic examples are defence and law. Defence of a country’s territory or making of law cannot be privately sourced. They have to be fully and solely controlled by government. All of us benefit from a secured and orderly country, but individual benefit cannot be quantified. Hence the need for all of us to contribute to the funding of these services, which is achieved through taxation. These are the traditional reasons why taxation is necessary.

But taxation is actually not a modern phenomenon. It is as old as organized society itself. In Islamic tradition, there is what is called zakat, which is a form of taxation. It is 2.5% of annual taxable wealth. In Christianity there is tithe at 10%. Traditional African societies have various forms of taxation. There is esusu in Igboland, there are owo ori and isakole in Yorubaland and other forms of traditional tax system. It should be noted that the famous Aba women riot of 1929 was triggered by the inclusion of women in tax net by the colonial government, as against existing traditional practice. So taxation has evolved over time.

Naturally, man doesn’t want to pay tax. That is why enforcing compliance is not an easy task. Yet in advanced societies, the fact that there is no way you can play around it, makes voluntary compliance very high. But in our own societies, two factors make the compliance situation more severe. One, a lot of people know they can get away with it. Two, experience with successive thieving governments has disillusioned the citizenry and they see their taxes as going to end up in private coffers, hence disincentivization of compliance.

There are various forms of taxes. We shall be touching each of them briefly in the course of these series. Taxes can be classified into different categories, depending on the classification criteria. If we want to talk of shiftability of burden, we shall be having direct and indirect taxes. If we are looking at tax base, we shall be having income tax, consumption tax and capital tax. When we look at tax system, we shall have progressive, proportional and regressive tax system.

Direct taxes are taxes whose burden cannot be passed on, while indirect taxes are those whose burden can easily be transferred. Income taxes are examples of direct taxes, because you can hardly pass on the burden. The PAYE deducted from your monthly pay is an income tax – personal income tax. You can’t pass on the burden.

The companies income tax companies pay is also a direct tax, although, strictly speaking, it can be passed on. It is only a matter of working back your model and building the tax into your selling price – raising the price and passing on, or at least sharing, the burden to the purchasers of your product, especially if your product has low elasticity (i.e people can hardly run away from it). Value Added Tax is an indirect tax in that you can only pass on the tax suffered to the next node in the chain of supply until it gets to final consumer who, not purchasing for resale or value adding, will not have anyone else to transfer the burden to, and ultimately bears the burden.

Tax base refers to the object being taxed. Is it the income or capital or consumption? You are liable to income tax if you earn income, except if exempted. When you consume, you are liable to consumption tax, notably VAT, except if the good or service is exempt. When you sell an asset, which is not what you normally do (i.e you are ordinarily not in business to sell that kind of asset), and you make a net gain (after removal of purchase price, improvement costs and costs incidental to sale of that asset), you are liable to Capital Gains Tax.

Progressive tax system relatively takes more from the high income earner and less from low income earner. The reverse is regressive system. Where there is a constant rate, it is proportional. Nigeria’s PAYE system is progressive. The rates range from 7-24%, depending on income band. We shall discuss that in details in this column in subsequent parts of these series.

See you again next Sunday, by God’s grace.