Download Assignment No : Two - Information and Communications University

INFORMATION AND COMMUNICATIONS UNIVERSITY
SCHOOL OF HUMANITIES
Course name: Public Finance
An assignment submitted in partial fulfillment of the requirements for
the BA Degree in Public Administration
Assignment No :
Student Name
Two
: Musambo Mutinta Kapapa
Student number: 1406954576
Lecturer’s Name: Mr A. Chisanga
Year
: 2016
QUESTION
Discuss the main ingredients of a sound fiscal policy in relations to
Adam Smith’s Canon of Taxation.
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1.0 INTRODUCTION .................................................................................................................................. 3
1.1 DEFINITION OF KEY TERMS ........................................................................................................ 3
2.1.1 Principle or Canon of Equality......................................................................................................... 4
2.1.2 PRINCIPLE OF CERTAINITY ...................................................................................................... 5
2.1.3 PRINCIPLE OF CONVINENCE .................................................................................................... 6
2.1.4 PRINCIPLE OF ECONOMY .......................................................................................................... 7
3.0 CONCLUSION ....................................................................................................................................... 8
REFERNCES ................................................................................................................................................ 9
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1.0 INTRODUCTION
The significance of fiscal policy especially in developing countries cannot be over emphasized.
This is because fiscal policy determines the level of public revenue and public expenditure while
also directing the measures required to maintain balance between the two. Formulation and
implementation of sound fiscal policy is one of the important functions of government.
Therefore, a sound fiscal policy lays an emphasis on maintaining macroeconomic stability
through harmonizing public expenditure management. Sufficiently, a sound fiscal policy which
is properly synchronized with monetary policy can assist with smooth running of business
cycles, enhance adequate public investment and redistribute income which in turn helps to
nurture economic growth. It is for this reason that fiscal policy is divided into two parts so that
the government can use on that fits a particular situation. This is seen through fiscal policy of
expansion which is used when government spending is increased to increase output and
contraction when government spending is reduced to decrease output. To this effect, this paper
aims to discuss the main ingredients of a sound fiscal policy in relation to Adam Smith’s Canon
of Taxation.
1.1 DEFINITION OF KEY TERMS
FISCAL POLICY: The deliberate action which the government takes in the areas of spending
and levying taxes with the objective of achieving macroeconomic variable.
TAX: A compulsory payment by the tax payers which is used by the government for the benefit
of all citizens. The country uses this revenue to provide economic, social, educational, health and
general administrative services which benefit everyone.
CANONS OF TAXATION: The administrative aspect of tax relating to the rate, amount, method
of levy and collection of a tax in short it is the qualities or attributes of a good tax.
2.0 MAIN BODY
Fiscal policy has been defined as government actions aimed at influencing the direction of the
economy through changes in the level and composition of public expenditure and funding.
Specifically, fiscal policy encompasses government expenditure, taxes and subsides which are
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implemented through the national budget (Nyamongo et al., 2008). Fiscal policy is thus an
instrument that most governments including Zambia use to stabilize the economy. This policy
can be used to reduce inflation, unemployment, improve economic growth or correct trade
balance. The most important source of government revenue is taxes and the act of levying taxes
is called taxation. These taxes are imposed on the income and wealth of persons or corporations
and the rate of taxes vary. A good tax system should adhere to certain principles which become
its characteristics. These principles are important to the creation of tax policies as it is only when
these principles are upheld that effective and efficient taxes are implemented in a manner which
satisfies the stated purposes of a tax system. These principles according to Adam smith are
equality, certainty, convenience and economy. These were formulated to fund the state’s
defense/ justice systems of taxation at that time. Each of these canons will now be discussed in
detail as they are considered to be a starting point for public finance. However, each and every
canon will also be related to the ingredients of a sound fiscal policy. This is because fiscal policy
plays an important role in the economy by delivering on the three principle functions of
government namely, efficient allocation of resources and fair distribution of incomes and
stabilization of economic activity (Nyamongo et al., 2008). The following are thus the principles
or canons of taxation.
2.1.1 Principle or Canon of Equality
This principle stipulates that a tax system should be fair among taxpayers and taxes should be
levied in accordance with one’s ability to pay. To Adam smith, these expenses are similar to
expenses of a mutual private property or an estate. This observation led to the suggestion that
payment should be made in accordance with each person’s income. He further went on to
indicate that the definition of equality is based on ‘ability to pay’ and this issue continues to
trouble economists on how to measure ability to pay, (Alley et al, 2004). Therefore a good tax
should be proportional to income so that the burden of supporting government is in accordance
to benefits received from government. According to Smith (1999) “the subject of every state
ought to contribute towards the support to contribute towards the support of the government, as
nearly as possible, in proportion to their respective abilities; that is in proportion to the revenue
which they respectively enjoy under the protection of the country or state”. This statement
indicates that under the tax system based on equality principle the richer people in society will
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pay more than the poor but smith argued that taxes should be proportional to income. This means
that each person should pay the same rate or percentage of his income as tax. According to
Kayuza (2006) this fairness of a tax system can be achieved through a tax structure consisting of
different tax burden according to chosen criteria in an economy. This has led the modern
economists to deduce that equality or ability to pay differently from Adam smith. Based on the
assumption of diminishing marginal utility of income, they argue that the ability to pay tax
principle calls for progressive tax. This indicates that the rate of tax increases as income
increases and decreases as income decreases.
As this is an administrative principle whose fundamental concept is to bring social equality this
principle demands economic justice in which each person’s contribution to the country or state
should be proportionate to the person’s ability. To this effect, a sound fiscal policy should
possess this attribute as it endeavors to promote even distribution of income within various
classes of societies. Progressive tax has thus become popular tax in most countries as it ensures
equality through redistribution of wealth which is an argument for equality.
2.1.2 PRINCIPLE OF CERTAINITY
It has been said that a good tax system should not only be fair but should be certain. This means
that this system should ensure that taxpayers are clear on their tax compliance obligations, such
as the amount of tax that is payable, the method of payment and the deadline for payment.
According to Smith (1999), “the tax which each individual is bound to pay, ought to be certain
and not arbitrary. The time of payment, the manner of payment, the equality to be paid, ought all
to be clear and plain to the contributor and to every other person”. It therefore suffices to say that
taxation should cover certain aspects of certainty which include:
• Certainty of effective incidence, that is, clearly state who will bear the tax burden
• Certainty of liability which should show the payable amount in a particular period such as a
month, every six months or per year. The tax payers including the exchequer must
unambiguously know.
• Certainty of revenue, meaning that the government should be certain about the estimated
collection of revenue from a given tax levied.
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When these attributes are followed, uncertainty is reduced and cases of corruption are also
reduced. Therefore, while making decisions about the amount of work effort that a person should
put in or invest, he must be well aware of the definite amount of the tax payable to him on his
income. If the payable tax by the interested part is subject to much discretion and arbitraries of
the tax assessment authority, this will weaken the incentive to work or invest more.
On the other hand, clear and certain taxation enables the government to adequately plan
development activities since they can estimate the amount of revenue they receive from taxes. In
the Zambian setup, the government are well aware in advance on the amount taxable to their
income for example in the current budget, all those whose salaries are below K3300 will not be
taxable while those getting above K6000 has been increased for 35% to 37.5%. Government
workers are thus aware and certain that this amount of money will be deducted come month end.
This is one of the canons which is considered as a very important guidance rule when it comes to
formulating the tax laws and procedures in a given country. A good and effective tax system is
required so that the taxpayers feel secure against unpredictable taxes levied on their income or
salaries. A clear and specific law should thus be implemented so that tax payers have little
discretion about how much to assess tax payers for this is a very great and powerful too which is
subject to be abuse.
2.1.3 PRINCIPLE OF CONVINENCE
The emphasis of this principle is on the appropriateness of tax payment. Affirmation to this
statement is made by Smith (1999) that “every tax ought to be levied at the time or in the manner
in which it is most likely to be convenient for the contributor or pay it”. Similarly Bakibinga,
(2003) further states that taxes should be paid at such a time that is convenient to the tax payer.
From both authors, it is clear that payment of taxes should follow suit the way a person receives
his income. To this effect, government must ensure that the tax payer contributes at right time.
The Zambian government and most governments have resorted to tax the income earned at the
point of payment of salaries. Another example is that of VAT, which is deducted at the time of
purchase of goods.
Emphasis is placed on the timing of payment of taxes as if it is not stable and convenient for the
taxpayer; it becomes the government’s loss to trace the tax payers. It thus suffices to say that if
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the methods of paying and the timing of the tax do not suit the taxpayer can lead to evasion. All
in all, this principle is an extension of the canon of certainty.
2.1.4 PRINCIPLE OF ECONOMY
Taxation is one of the major sources of revenue for most countries and it is this revenue that is
spent on public welfare projects which will thus improve the country’s economy.
This principle of economy denotes that the cost of tax collection should be minimum and relative
to the volume of revenue generated in a given country. These cannon entails that the tax structure
should be such that it is economically correct. Confirmation is made by Smith (1999) that “every
tax is to be so contrived as both to take out and keep out of the pockets of the people as little as
possible over and above what it brings into the public treasury of the state”.
Economic growth which means continuing increase on the annual basis in the production of
goods and services or a rise in per income made possible by continuing increase in per capital
productivity can be attained by the administrative cost of collecting the direct taxes. This is
because tax payers directly pay the tax to the country making less wastage of resources and time.
This then satisfies the canon of economy as a large amount of the collection goes directly to the
treasury enabling the government to effectively plan on how to go about implementing
government projects for the welfare of the country and its people. However, if this canon is not
well applied to the extent that the overall cost of collecting taxes is unreasonably high, the
collected amount will not be sufficient in the end. For example, if the government employs
highly salaried employees and absorbs major portion of the yield, the tax will be considered
uneconomical hence the need for the tax collection to be minimal and relative to the volume of
the revenue generated. An ingredient of a sound fiscal policy is to promote economic growth and
development. This is achieved through the steady growth in the national resources and in
national output as well as structural and attitudinal changes in the economy. In order to further
improve the economy of a country, the tax system should be as simple as the progressive and
VAT as it is cost effective. If on the other hand, these taxes are collected using complicated
machinery, this collection process will become costly hence stretching the country’s economy.
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As fiscal policy is used to generate funds, this policy is used to escalate investment in major
sectors of the economy and this helps to reduce recession. Therefore with the investors investing
more in the country, the multiplier effect will help to put back the economy on the right tract thus
reducing borrowing.
3.0 CONCLUSION
A sound fiscal policy has numerous ingredients and those related to Adam Smith’s canon of
taxation concentrate on equality, certainty, convince and economic growth. A sound fiscal policy
will also enhance government expenditure which will in turn influence the economy by
aggregating demand. Furthermore, an increase in government expenditure influences the
accessibility of funds making business of investment more leading to employment of more
citizens. Lastly, with these canons of taxation it is clear that fiscal policy related to these canons
will increase the level of economic and further help to reduce income inequalities through the
canon of fairness and equality which is achieved through progressive tax. Certainty and
convenience will help the investors to invest more and this will in turn promote economic growth
as funds are being reinvested.
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REFERNCES
Adam Smith (1999). The wealth of nations with an introduction and notes by Andrew Skinner.
Penguin books. London New York.
Alley C, Maples A, Polson Higgs and Veal J.(2004). New Zealand Taxation
Bakibinga, D.J (2003). Revenue Law in Uganda. Kampala Professional Book Publishers
Binh Tran-Nam, (2001) “ Use and misuse of tax compliance costs in evaluating the GST. The
Australian Economic Review, vol.34
Chris.E (2003). “Studying the studies: An overview of recent research into taxation operating
costs”, eJournal of Tax Research, vol.1,no.1.
Francois V, Jason.C (2008). Compliance and administrative costs of taxation in Canada, In J.
Clemens (Ed). The impact and costs of taxation in Canada: The case for flat tax reform, Canada.
The Fraser Institute
Kayuza,H.M. (2006). Real property taxation in Tanzania. An investigation on implementation
and rate payer perceptions, Doctoral thesis building and real estate economics royal institute of
technology Stockholm Sweden
National open university of Nigeria (2009). MBA 728: public financial management. NOUN,
Lagos
Nyamongo E.M.,Sichei M.M and Mutai N., (2008). “The Monetary and Fiscal Policy
Interactions in Kenya”. Available online at https://editorialexpress.com/cgi bin/conference/downl
oad.cgi?db-name=IIPF65& paper-id=93
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