FUNCTIONS OF TAX

Taxes may either be imposed on:

• Income (i.e. employment, business and investment incomes)

• Capital or
• Expenditure

It is within these three areas that one ascertains the functions of tax.
 Tax may be said to perform the following functions:

a. Raising revenue for government budget financing. It is by all standards

the means by which governments obtain resources with which they
operate and function.

b. Tax may also function as an economic stabilizer. For instance reduction

of corporate taxes in times of high unemployment to increase business
earnings so as to encourage reinvestment and expansion to create jobs,
thereby reducing unemployment.

c. Taxes serve to curtail consumption and free resources for capital

formation especially during inflation and serves as a deflationary tool to
reduce purchasing power to reduce high circulation of money.
d. Reallocating resources for investments regarded as having little
beneficial results for those of greater benefits for growth. This is done
through tax incentives. Thus if corporate tax is reduced from 20% to 10%
for tyre manufacturing companies in Domeabra where there is
availability of raw materials i.e. rubber, whilst those in Accra remain
25%, it is expected that such companies will relocate and invest in the
low tax community of Domeabra. This can be intra and international.

e. Taxes provide flow of funds to government to facilitate transfers and

redistribution of resources. Voltaire in 1764 opined that “The art of
taxation by government consists in taking as much money as possible
from one part of the citizenry to the other.”

f. Taxes provide incentives to alter economic behaviour in such a way as to

facilitate economic growth by discouraging production and consumption
of certain products, thereby providing added incentives to save and to
ensure private sector capital formation.
g. Theoretically taxes reduce economic inequalities to ensure equal
redistribution of wealth. Thus where high income earners pay higher
taxes than low income earners the income gap is bridged. Those with
high income pay more and such taxes are used to provide goods and
services which is enjoyed by the low income earner and thus ensuring
redistribution of the wealth.

h. Taxes function to control aspects of an economy in ensuring an effective

balance of payment regime by discouraging imports and encouraging
exports as more exports increase a country’s earning power as against
more imports.

i. In terms of taxation of natural resources such as petroleum, it is the

means by which rewards between the resource owner and for that
matter the State and the investor or IOCs in case of petroleum
exploitation is measured and apportioned.
j. It also serves as a tool to encourage more investments and control the
pace of exploration and exploitation, control and reduce the rate of
depletion of the resources in such sectors by way of petroleum tax
incentives such as research and development incentives and
accelerated or delayed depreciation of capital cost by way of capital
allowances.

k. Taxes also function as a tool for controlling adverse environmental

impact issues through the use of tax instruments such as green taxes on
CO2 emissions to mitigate and prevent environmental pollution and
global warming. Conversely granting of fiscal incentives like Carbon
credit may also encourage the protection of the environment. E.g.
planting of trees by a company
 Attributes of a Good Tax System and Rules of Equity

• For taxation to be effective the particular tax system or regime must possess
certain attributes.

• Economic theorists such as Sir Adam Smith in his book ‘Wealth of Nations’
has espoused certain undisputed attributes of any good and effective tax
system.
• According to him “the subjects of every State ought to contribute to the
support of government nearly as possible in proportion to their respective
abilities i.e. in proportion to the revenue which they respectively enjoy in the
protection of the State.’’

• These attributes are equity, neutrality, certainty, convenience, efficiency in

administration and collection, and stability among others.
• The ultimate desire for effectiveness however seems to be fairness in the
tax system.
 Equity Rules in Taxation

• Any good tax system is measured on some rules of equity. By this we mean every
citizen should be made to pay his fair share of tax and this calls for an equitable
distribution of the burden. Every tax system must thus be equitable and therefore
equity in tax simply means that the tax burden must be equitable and every one
must be made to pay his fair share.

- Thus those with broader purse must be made to bear a higher and bigger burden.
- Taxation must be on the basis of ability to pay according to the resources available
to a particular person.

- The higher the resources a person possesses the higher in terms of proportion
should be his contribution.

- Tax payers of equal capacity or abilities should pay equal amount of taxes while tax
payers of unequal abilities and capacities should pay unequal amount of taxes.
• The Equity principle is assessed in two senses that is the ‘horizontal’ and
‘vertical’ sense.
- Horizontal Equity: The concept of horizontal equity assumes that those, be
it individuals or corporate, with equal abilities to pay should pay the same
amount, thus equity is equality or equality is equity. Thus the marginal
utility of the income schedule of such taxpayers must be the same. If A and
B both unmarried earn GHC12,000.00 a month without any other inflows of
economic resources, the two shall pay an equal amount of tax identical to
their marital status and salaries.

- Vertical Equity: The concept of vertical equity requires that tax payers be it
individuals or corporate bodies with greater ability to pay should pay more.
A progressive tax system fits this criteria. It involves a kind of fair rate
structure calculated based on the different levels of income. Thus if A
receives GHC12, 000.00 and B receives GHC10,000.00 then A should by this
principle pay more tax than B.
 Neutrality

• It connotes the extent to which a tax distorts the workings of market mechanisms in
the economy.

- The concept of neutrality assumes that taxes should cause minimal distortions in the
economy. It should minimize the adverse effect and interference with economic
decisions.

- It therefore determines whether the tax system interferes with investment decisions
in a manner that it causes a deviation from its social optimum and effect.

• A good tax should thus be neutral with a minimal excess burden, that is, the total loss
of welfare and the economic cost of tax should be such that economic decisions are
not distorted.

• In the private sector taxes should intervene to correct inefficiencies in that sector and
not otherwise.
 Certainty

• This attribute implies that taxes should be certain in that citizens must know and be
clear in their minds what and how much tax they will pay.

• This concept also connotes non-arbitrariness in that Tax authorities should have no
discretion so far as tax demands are concerned.

- The tax payer must be able to determine his or her tax liability with a degree of
certainty and accuracy. There must be no ambiguity in the mind of the tax payer.
- In Russell v. Scott [1948] AC 422 Lord Simmonds observed that ‘the subject is not
taxed unless the words of the taxing statute unambiguously impose the tax on him’.

- Tax authorities should not be left alone to demand how much tax they can demand.

- Further when, how and the place of payment of tax must be known to the tax payer
and the administrator.
 Convenience

• This attribute requires that a good tax system should be convenient for the
state to administer and for the tax payer to pay.

- It must be easy for tax payers to comply with the tax laws.

- The time and manner a tax is imposed and the mode of collection must be
conducive for the tax payer to pay and for the administrator to collect.

- The tax payer must be willing to routinely comply with the payment without
the mode of collection necessarily intruding his privacy nor unnecessarily
incurring costs in the payment. PAYE is an example of a convenient tax
system.

- Decentralization of the tax administrative system connotes convenience

 Stability

• By stability a good tax system must not be subject to rampant changes or be

unpredictable as this may affect developmental projects.

• Stability also relates to the extent the tax is predictable and reliable in terms of
government revenue, that is, the government should be able to know how much
revenue will be collected by it and when and should not be dependent on the
volatility of prices.
• A good tax system must facilitate the use of fiscal policy for stabilization and
economic growth objectives.
- A tax system must be stable to engender the confidence of investors in
government where for instance in the extraction industries long term
investments is the norm.
 Thus a tax subject to constant tinkering tends to increase political risk and reduce
investor confidence.
 Stable government revenue will impact on expenditure forecasting and
budgeting.
 Efficiency and Economy
• This attribute is about cost effectiveness and efficiency in the administration of the tax
system. The effectiveness of a tax system thus deals with issues of enforcement,
monitoring and cost of administration and complying with payment of tax.

• Transparency issues also underline this attribute. How transparent a tax is by way of
how government obtains revenue may also impact on its efficiency.

- An ideally effective tax system must be inexpensive to administer and must be levied
on a well-defined tax base that is easy to collect.

- The cost of administration should be low and the tax imposed must be compliance
inspired.
- It must be easier for tax payers to judge the consequences of their failure to pay.
- Issues of evasion and moonlighting are critical areas to determine whether the tax
system is effective. Moonlighting is earning and paying tax on one source of income
but then undertaking a second job and declaring no tax on that one.
 Simplicity and Clarity
• A good tax system ought to be intelligibly simple, plain and clear to make it more
effective to administer. It should not be difficult to understand neither must is it be
complicated on issues of interpretation.
 Elasticity and Flexibility.
• By this attribute a good tax system must be flexible and be able to adjust itself
automatically to the community’s wealth and other tax variables without any
adverse effect on investment and the tax payer.
 Productivity and Risk Sharing

• A good tax system must be productive and have an element of risk sharing
especially in the case of resource exploitation.

- Whilst a good tax system must produce a high net yield of revenue it must also not
be too high to destroy the very source of the revenue.
- The aim is for the yield to be enough to avoid deficit financing.
• In terms of risk sharing, risk is the variation in the investor’s expected returns.
Thus the investor’s attitude does not only depend on the level of tax but on
the extent to which the government shares in the projected risks.

• A good tax system must share risk. Tax can increase the risk of a project, by
means of additional fiscal risk and this can discourage investments.

 It is therefore said by a French Finance Minister Jean- Baptiste Colbert that

“the art of taxation consists in so plucking the goose so as to obtain the
largest amount of feathers with the least possible hissing’’ but ‘it is also
important not to frighten away the geese so that they lay no eggs, golden or
otherwise, let alone present themselves for plucking.’’