1.

Canons of Taxation
A good tax system is one which is designed on the basis of an appropriate set of
principles (rules). The tax system should strike a balance between the interest of the
taxpayer and that of tax authorities. Adam Smith was the first economist to develop a
list of Canons of Taxation. These canons are still regarded as characteristics or features
of a good tax system. Adam Smith gave following four important canons of taxation.

1. Canon of Equity The principle aims at providing economic and social justice to the
people.

According to this principle, every person should pay to the government depending upon
his ability to pay. The rich class people should pay higher taxes to the government,
because without the protection of the government authorities (Police, Defence, etc. )
they could not have earned and enjoyed their income. Adam Smith argued that the
taxes should be proportional to income, i. e. , citizens should pay the taxes in proportion
to the revenue which they respectively enjoy under the protection of the state.

2. Canon of Certainty

According to Adam Smith, the tax which an individual has to pay should be certain, not
arbitrary. The tax payer should know in advance how much tax he has to pay, at what
time he has to pay the tax, and in what form the tax is to be paid to the government. In
other words, every tax should satisfy the canon of certainty. At the same time a good
tax system also ensures that the government is also certain about the amount that will
be collected by way of tax.

3. Canon of Convenience The mode and timing of tax payment should be as far as
possible, convenient to the tax payers.

For example, land revenue is collected at time of harvest income tax is deducted at
source. Convenient tax system will encourage people to pay tax and will increase tax
revenue.

4. Canon of Economy This principle states that there should be economy in tax
administration. The cost of tax collection should be lower than the amount of tax
collected. It may not serve any purpose, if the taxes imposed are widespread but are
difficult to administer. Therefore, it would make no sense to impose certain taxes, if it is
difficult to administer.

Additional Canons of Taxation v Activities and functions of the government have

increased significantly since Adam Smith’s time. Government are expected to maintain
economic stability, full employment, reduce income inequality & promote growth
and development. Tax system should be such that it meets the requirements of growing
state activities. Accordingly, modern economists gave following additional canons of
taxation.

5. Canon of Productivity It is also known as the canon of fiscal adequacy.

According to this principle, the tax system should be able to yield enough revenue for
the treasury and the government should have no need to resort to deficit financing. This
is a good principle to follow in a developing economy.

6. Canon of Elasticity According to this canon, every tax imposed by the government
should be elastic in nature. In other words, the income from tax should be capable of
increasing or decreasing according to the requirement of the country. For example, if
the government needs more income at time of crisis, the tax should be capable of
yielding more income through increase in its rate. .

Canon of Flexibility It should be easily possible for the authorities to revise the tax
structure both with respect to its coverage and rates, to suit the changing requirements
of the economy. With changing time and conditions the tax system needs to be changed
without much difficulty. The tax system must be flexible and not rigid.

8. Canon of Simplicity The tax system should not be complicated. That makes it difficult
to understand and administer and results in problems of interpretation and disputes.

In India, the efforts of the government in recent years have been to make the system
simple.

9. Canon of Diversity This principle states that the government should collect taxes from
different sources rather than concentrating on a single source of tax. It is not advisable
for the government to depend upon a single source of tax, it may result in inequity to the
certain section of the society; uncertainty for the government to raise funds. If the tax
revenue comes from diversified source, then any reduction in tax revenue on account of
any one cause is bound to be small.

From the above discussion, it follows that taxation serves

the following purposes:
(i) To raise revenue for the government

(ii) To redistribute income and wealth from the rich to the poor people

(iii) To protect domestic industries from foreign competition

(iv) To promote social welfare.

Related Articles
Canons of Taxation: Canons of taxation refer to the administrative aspects
of a tax. They relate to the rate, amount, method of levy and collection of a
tax. In other words, the characteristics or qualities which a good tax should
possess are described as canons of taxation.
Canons of Taxation: The taxation is one of the major sources of Government revenue. At the same
time it has got a special role to play in redistribution of income and reduction in inequalities of income
prevailing in the society. To achieve both these objectives, the taxation system should be such that it is
acceptable to general public, fair to all members of society, simple to operate and capable of yielding
the optimum revenue. Adam Smith, the famous eighteenth Century British Economist, was the first to
set forth such maxims in his book {WEALTH OF NATIONS) published in The well-known economist laid
down the four basic canons of taxation on which a good tax system should be based-Various
economists also have suggested different canons of a good tax system.

Adam Smith Canon’s of Taxation

1. The canon of equity/ability

2. The canon of certainty

3. The canon of convenience

4. The canon of economy

1- The Canon of Equity.

According to the first canon, which is also called as canon of ability, all citizens of the nation should

contribute towards expenses of the Government “as nearly as possible in proportion to their
respective

abilities." In other words, the tax system should be such that the citizens are liable to pay taxes as per

individual capacity to pay. The riches are expected to pay more while the poors are expected to pay
less.

The ability-to- pay taxes increases with the rise in income, thus making the higher economic class to

contribute more to the Government revenue. This principle is based on the simple theory that the
ability

to pay taxes increases more than proportionately to the increase in the income because the utility of

money gradually diminishes with every increase in the income.

The canon of ability is also recognized as a canon of equity as it calls for equal tax burden for all
persons
who are similarly situated in the economic income class. The basic principle underlying here is that

“equals should be treated equally”. This principle makes a tax system “fair and just”. Thus, equity

consideration is of overriding importance for any tax system and for any particular tax. Equity level

determines now the tax burden is distributed among the taxpayers. Modern economists, however, did

not agree to this opinion. Instead, they strongly put forth ‘progressive’ tax system which means

increasing rates of taxes with the increase in income i.e., as the income rises, there is a lesser

satisfaction to a person earning it and hence, a greatest part of that rising income should go to the

government. This will enable the government to spend the funds for the welfare of those who are

unable to earn rising income. Considerations of fundamental fairness provide the main rationale for

taxing income taxes. These considerations embrace both of the traditional tax equity criteria:
horizontal

equity, the need for equal treatment of persons with comparable abilities to pay; and vertical equity,
the

need for appropriate differences in the tax treatment of persons with different taxable capacities.

2-The Canon of Certainty:

Like canon of equity, Adam Smith advocated canon of certainty. This canon is meant to protect the

taxpayers from unnecessary harassment by the 'tax officials' the tax which each individual is bound to
by

pay, ought to be certain and not arbitrary. Thus, the amount of tax, the time of payment, the method
of

payment, the place of payment, and the authority to whom the tax is to be paid. Must be clear to the

taxpayer and to other persons- otherwise, the taxpayer shall be at the mercy of the tax administrators

who may increase the tax rate as per their whims and fancies. This may put the public into greater

degree of inconvenience and this may encourage corruption in administration. Certainty about tax

liability helps a taxpayer to affect necessary co-ordination between his income and expenditure with a

view to discharge his tax obligation with planning. In the words of Adam Smith “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 quantity to be paid, ought all to be clear and plain to the contribution and to every

person.” This canon of certainty was mainly advocated to prevent exploitation of taxpayers by the

authorities collecting taxes. If the taxation policies are arbitrary and full of doubts and confusion, the

possibility of harassment to the taxpayer by the collecting authorities by using their power cannot be

ruled out. To avoid such a situation, the taxation policies should be very clear and should create

confidence in the minds of taxpayers that tax being collected from them is just a proper.

3-The Canon Convenience:

The third canon of taxation advocated by Adam Smith is the canon of convenience. In the words of

Adam Smith “every tax ought to be levied at the time, in the manner, it is most likely to be convenient

for the contributor to pay it”. The tax should be levied at such a manner that its payment should cause

least hardship or in-convenience to the taxpayer. For example, when land revenue is collected from a

farmer after harvesting season, it is quite easy for him to pay the tax put if its collected before

harvesting season, it is most trouble-some inconvenient to him. Similarly, sales tax. Excise duty or
taxes

on commodities satisfy the canon of convenience. Income tax also satisfies this canon because the

salaried employees in monthly installments pay it. In short tax system should be such that its

enforcement is certain.

4-The Canon of Economy:

Every tax involves some revenue yield and a corresponding cost of collection. Adam Smith noted,
"Every

tax to be so contrived as both to take out and to keep out of the pockets of the people as little as

possible over and above what it brings into the public treasury of the government."^^The tax system

should be economical to operate and the tax should be such that the cost of its collection should be

minimum. The revenue form tax should be much more than the cost of its collection. Otherwise the

major portion of revenue will be taken away by the cost of its collection. This is particularly important

from the point of view that the costs spent on the collection and nothing to the national output and
resources, which are already in scarcity, should not be wasted. A heavy tax burden also does not
satisfy

the canon of economy. Thus, it is interpreted that if a tax is quite heavy reducing savings of the public,

reducing investments and, thus, the productive capacity, the tax system seems to have failed to satisfy

this canon. The people should not feel that the tax is excessive.

Other Canons of Taxation

5. Canon of Simplicity

6. Canon of Elasticity

7. Canon of Productivity

8. Canon of Co-ordination

9. Canon of Variety 10. Canon of Expediency

In addition to the above basic fundamentals of tax system, given by Adam Smith, some others writers

like Bastable, Shirras, Mrs. Hicks etc. Have added a few more canons of taxation, which are as follows.

5-Canon of Simplicity:

The good tax system should be simplicity so that taxpayers are understood that system and it should
not

be too complicated. That makes it difficult to understand and administer and breeds problems of

interpretation and legal disputed. The tax policy should be simple and to the point. The better tax
policy

is the simple one which requires fewer conditions or assumptions. The canon is meant to prevent

harassment to taxpayers and corruption among the staff of tax administration. The tax system must
be

easy to operate. A sound tax system should be simple and should not be too complex. Simplicity

requires that a tax system not impose under burdens of administration and compliance through

complex and costly rules record- keeping. Administration survey indicates that most taxpayers make

other uses of information gathered to file the State portion of their State tax return.

6-Canon of Elasticity:
The tax system should be adaptable to changing circumstances. It should not be rigid or inelastic. The

tax system is expected to provide built-in devices to facilitate growth and expansion without

dissatisfaction. The tax system should be flexible so that taxes may be increased or decreased as per
the

needs of the government. Thus, income tax rates may be revised upwards or downwards as per the

requirements of the government from time to time. Similarly, the government of India announced rise

in petrol duty in order to cope with the oil crisis in the country. It should be possible for the authorities,

without any delay to revise the tax structure, both with respect to its coverage and rates and to suit
the

changing requirements of the economy and of the treasury.

7-Canon of Productivity:

Productivity has become a key issue with tax planners. Economic growth has come to be firmly linked

with gains in productivity. The canon of productivity requires that the taxes imposed by the State

provide sufficient revenue so that the government may not be required to face financial difficulties.

Thus, a tax system should be capable of providing adequate revenue to the State to enable it to
perform

its function satisfactorily. The tax system should help to increase productivity in the economic sectors.

8-Canon of Co-ordination:

Co-ordination aims at higher efficiency and effectiveness. Co-ordination brings about integration.
Coordination expresses the pnnciple of organization in total, nothing less. Co-ordination is orderly

arrangement of group efforts to provide unity of action in tine pursuit of common purpose. It is
essential

to secure maximum co-ordination between different taxes imposed by different governments. The

Constitution of India provides various guidelines in respect of taxation by various governments in

order

to avoid any conflict or dispute between the Central Government and the State Governments. This

ensures maximum coordination. Any Government should not encroach upon the rights of other

Government In matter of taxation.

9-Canon of variety/Diversity:

Under diversification a multiple tax system is preferable. A government, which adopts variety or

diversity as a growth plan, seeks to enter into new tax system and process. According to this canon, a

multiple tax system should be preferred instead of single tax system. A single tax system is one where

under only one tax be levied upon a person i.e. he is to pay to the State only one tax, thereby the

Government collects all that a person has to pay to the state. This will enable the state to distribute

burden of taxation on every section of the society. Such a system is bound to breed a lot of uncertainty

for the treasury. It is also likely to be inequitable as between different sections of the society. On the

other hand, if the tax revenue comes from diversified sources, then any reduction In tax revenue on

account of any one cause is bound to be very small.

10-Canon of Expediency:

According to this canon, a tax should be such that it requires no justification and it should not be a

subject of any criticism. Thus, it should not be baseless. As far as possible, this canon of expediency

should push its revenue by increasing the existing rates. This canon has got much importance,

particularly In democratic countries.

The above canons are general guidelines, which characterize good tax system. In addition to these

canons, another important element of sound tax system is that it should help the government to check

the inflationary trends. A sound tax system should, therefore, ensure the attainment of equality in

incomes, wealth and opportunities.

1.6. Major Types of Taxes in Ethiopia

The major types of taxes that exist in Ethiopia, their meaning, rates and conditions, as

provided by the Federal Inland Rev

enue Authority, are presented as follows:

1. Value Added Tax (VAT)

This is a sales tax based on the increase in value or price of product at each stage in its
manufacture and distribution. The cost of the tax is added to the final price and is

eventually paid by the consumer.

The rate and impose of VAT:

 The rate of VAT is 15% of the value for every taxable transaction by a registered

person, all imported goods other than an exempt import and an import of services;

 The export of taxable goods or services to the extent provided in regulations for

zero tax rate are:

o The export of goods or services to the extent provided in the regulation;

o The rendering of transportation or other services directly connected with

international transport of goods or passengers, as well as the supply of

55 Ibid

56 Ibid

Page | 34

lubricants and other consumable technical supplies taken on board for

consumption during international flights;

o The supply of gold to the National Bank of Ethiopia; and

o A supply by a registered person to another registered person in a single

transaction of substantially all of the assets of a taxable activity or an

independent functioning part of a taxable activity as a going concern,

provided a notice in writing, signed by the transferor and transferee, is

furnished to the authority within 21 days after the supply takes place and

such notice includes the details of the supply.

2. Excise Tax

This is imposed and payable on selected goods, such as, luxury goods and basic goods
which are demand inelastic. In addition, it is believed that imposing the tax on goods that

are hazardous to health and which are cause to social problems will reduce the

consumption thereof. Excise tax shall be paid on goods mentioned under the sc hedule of

'Excise Tax Proclamation No. 307/2002' (a) when imported and (b) when produced

locally at the rate prescribed in the schedule. Computation of excise tax is applied (a) in

the case of goods produced locally, production cost and (b) in the case of imported goods,

cost, insurance and freight /C.I.F./. Payment of excise tax for locally produced goods is

by the producer and for imported goods by the importer. Time of payment of excise tax

for imported goods is at the time of clearing the goods from the customs area, and for

locally produced goods it is not later than 30 days from the date of production.

3. Turnover Tax

This is an equalisation tax imposed on persons not registered for value-added tax to fulfil

their obligations and also to enhance fairness in commercial relations and to complete the

coverage of the tax system. Administrative feasibility considerations limit the registration

of persons under the value-added tax to those with annual transactions to the total value

exceeding 500,000 Birr.

Rate of turnover tax is 2% on goods sold locally and 10% on others; as provided by the

'Excise Tax Proclamation No. 307/2002'

Page | 35

4. Income Tax

Income taxable under the Ethiopian 'Income Tax Proclamation No. 286/2002' shall

include, but not be limited to:

 Income from employment;

 Income from business activities;

 Income derived by an entertainer, musician, or sports person from his personal

activities;

 Income from entrepreneurial activities carried out by a non-resident through a

permanent establishment in Ethiopia;

 Income from movable property attributable to a permanent establishment in

Ethiopia;

 Income from immovable property and appurtenances thereto, income from

livestock and inventory in agriculture and forestry, and income from usufruct and

other rights deriving from immovable property that is situated in Ethiopia;

 Income from the alienation of property referred to in (e);

 Dividends distributed by a resident company;

 Profit shares paid by a resident registered partnership;

 Interest paid by the national, a regional or local Government or a resident of

Ethiopia, or paid by a non-resident through a permanent establishment that he

maintains in Ethiopia;

 License fees including lease payments, and royalties paid by a resident or paid by

a non-resident through a permanent establishment that he maintains in Ethiopia.

5. Business profit tax

 Taxable business income of bodies is taxable at the rate of 30%

 Taxable business income of other taxpayers shall be taxed in accord with the following
expenses:ance

9.Canon of Expediency:-According to this principle, a tax should be leviedafter considering all

favorable and unfavorablefactors from different angles such as economical,political and social.

10.Canon of Co-ordination:-In a federal set up like Ethiopia, Federal and StateGovernments levy taxes.
So, there should be aproper co-ordination between different taxesimposed by various authorities.

11.Canon of Neutrality:- This principle stresses that the tax system shouldnot have any adverse effect.
That is, it shouldn’tcreate any deflationary or inflationary effects inthe economy.