The human was born free and has been free to do business to make a living. However, during this process, society expects compliance with certain standards and regulations to ensure the smooth flow of usual activities and socio-economic norms. The society also expects a certain kickback from the people because of their existence and usage of social space.
Taxation is one of the most prominent examples of these kickbacks.
Understanding Tax Basics
Taxation is one of the social and legal obligations on people executing a profit-making process. However, the money raised through taxes is aimed to be used for public utility services and has been an effective tool to manage the cultural and socio-economic aspects of our community.
Taxes are compulsory. Usually, when money leaves your pocket, you are exchanging it for a specific good or service. However, taxes are unrequited. This means that they are not paid in exchange for a specific public service or sale or purchase of public property. Nonetheless, sometimes there is some kind of connection between the taxes you pay and a particular service you enjoy from the government. For instance, paying road toll levies to help maintain the road network or paying taxes on motor fuel to help finance the construction of new roads or maintenance of old roads.
The Government aims to collect taxes to enhance the socio-cultural and economic environment. This revenue is used to finance public welfare works like schools, colleges, hospitals, construction & infrastructure works, security & defence, and other projects to support life in our region.
Countries around the globe have developed different regulations to collect taxes from individuals and corporations. Applicable Rules and regulations change with the change of country. For instance, tax-related laws in Ghana are different from applicable tax laws in the United States in terms of compliance and practical application.
However, tax is generally calculated on profit, salary, capital gain, interest, dividend, etc. The taxpayer is required to take out a certain percentage from their earnings and submit it to the Government. The amount of tax one pays generally increases with an increase in earnings.
There are different types of taxes: income tax, payroll tax, corporate tax, sales tax, property tax, tariff, estate tax, etc. These taxes can largely be described as being either direct or indirect.
Direct taxes are charged on incomes and profits and paid by an individual or organisation directly to the Government. Its payment can’t be shifted to another person and must be borne by the individual or organisation, e.g. income tax and corporate tax. It’s difficult for the government to collect this unless it’s at the source.
Indirect taxes are levied on products and services and can be transferred to the end-user or consumer. The Government charges these on manufacturers and suppliers for the import, sale and purchase of goods who in turn pass on this cost to the final consumer. An example of this is the Value Added Tax (VAT) and tariffs.
The taxation system varies from nation to nation, and individuals/corporations need to thoroughly understand the taxation system and ensure they comply. From an African perspective, tax is progressive, which means that your tax liability increases with your increase of income.
African Tax History
The roots of taxation in Africa can be traced back to the Colonial days. Time has witnessed different rulers taking the power of tribes and introducing their own governance and tax collection system.
One of the interesting instances from the pages of history is the introduction of the “Hut Tax” that Britain introduced in Africa, derived from its payment on a “per hut basis”. The hut tax was payable in the form of labour, grains, money or stock, and the tax collected was used to manage operational and strategic matters of an empire.
Similarly, a poll tax was introduced by Britain in Africa somewhere in the 19th century where a fixed sum per head was charged from each citizen; it was also called “Head Tax”. This was charged usually on able-bodied men without recourse to their income levels. The purpose of this tax collection kept changing from time to time and included combinations of the following.
- To force people to work hard and lead to higher exports.
- Making financial contributions to support British Army during World War II.
- To support the welfare of colonies and contribute to the process of self-financing.
- To meet public administration costs and finance Government departments.
The poll tax was effective in its conceptual simplicity. However, the problem with this system was the ignorance around the collection and that everyone was required to pay an equal amount irrespective of their earnings level. So there were improvements in the overall system of collection and rules from time to time that has resulted in modern-day taxation.
Advantages of the taxation system
Following are some of the advantages associated with taxation.
- Control of inflation – Higher product demands lead to product shortage and higher price, referred to as demand-pull inflation. Tax implementation can be an effective way to control such a type of inflation. It's due to the fact that adding tax increases product price and discourages people from purchasing by decreasing their purchasing power. Hence, demand is decreased leading to stable pricing.
- Circulate money in the economic system – The government uses the taxes collected to meet public expenses, which boosts money flow in the economic system.
- Income redistribution – The progressive nature of direct taxes aims to charge higher from people who earn more and lower from those who earn less. In this way, it can effectively reduce the gap between the rich and poor classes.
- Collection of Government revenue – The Government needs money to finance the national welfare projects. This is only feasible if the country's people ensure timely payment of taxes.
- Protection for local manufacturers – Usually and ideally, Governments impose higher taxes on the products imported into the country. It gives a competitive edge to the local manufacturers.
Disadvantages of the Taxation System
Following are some of the disadvantages associated with taxation.
- Purchasing power decreases – Implementation of tax leads to higher product prices and lower purchasing power, which might result in low quality of people's lives. This is especially so with indirect taxes which are paid by the rich and poor alike to the same extent.
- Discourages investment – International investors might not be attracted to a regime with higher taxes on income as their main aim for the business is profit-making and higher taxes mean lower profits for them.
- Different people and indifferent taxes – Indirect taxes (taxes collected on the purchase of products) are uniform for everyone, irrespective of their income level. Hence, an increase in indirect taxes might lead to widening the gap between the rich and poor classes of the country. The rich will be able to afford quality products that will simply be out of the reach of the poor.
- Cost of tax collection – Governments have to develop a system and infrastructure to collect taxes, which sometimes incurs higher costs. The fact is that people tend to evade taxes and that can be challenging to control. Tax collection and monitoring is an expensive activity in itself and when it’s inefficient, the government has to spend these same taxes collected to collect more taxes.
Understanding Free Market
A free market is when traders are free to conduct economic activities without the Government’s intervention. The price of goods is merely based on supply and demand because of no Government’s stake in taxes, subsidies, and price regulations. Although, no market in the world is completely free. That is why economists have studied the degree of market freedom and economic well-being and the conclusion was a positive correlation between these concepts.
Still, there is a need to analyse if the free market always brings economic well-being and if a country can survive without a tax collection system. To the extent of well-being, it can be considered to add certain value in the economic system by efficient allocation of resources, setting competitive prices, invention, innovation, better quality product, higher economies of scale, and help reduce domestic monopoly.
Nonetheless, the problem falls in the area of Government interest to finance social projects and ensure the well-being of the society overall; this is not possible without a robust system of tax collection. On the other hand, the supporters of the free-market claim taxes to have a negative impact on economic activities by reducing the individual incentive to work hard and produce more and that the overall national output is expected to decrease with implementing higher taxes in the national economy.
Advantages of free market
Following are some of the advantages of a free market.
- The free market is the market of consumers. It's because market producers have an incentive to produce goods in line with the interest of consumers. Further, consumers have more choices to select the product due to various national and foreign competitors.
- The motivational influence of the free market is strong. A successful entrepreneur is awarded higher profit. So, people are expected to enhance their efforts and achieve profitability.
- The free market is expected to optimize resource allocation; there is constant pressure on producers to control the cost of production and achieve higher profits.
Disadvantages of Free Market
Following are some of the disadvantages of the free market.
- Producers may not meet quality standards on account of pressure to control the cost. Hence, they might compromise on ethical instances of product and quality management. So, Government might need to intervene and control the situation.
- The free market only favours skilled people who can work and generate income. It does not consider certain members of society like children, elders, and unemployed people. On the other hand, the taxation system allocates certain benefits for them.
- Large players can dominate the market and exploit stakeholders in a free market. For instance, they might charge unfairly higher prices from customers and squeeze suppliers because they are free.
Effects of the increased free market on taxation and vice versa
Taxation and free markets are two opposite concepts. The free market is about limited regulation and the will of the market players to direct economic activities. There is no intervention from Government in a free market, which means there is no subsidy/tax. Hence, profit is the only motivational force for the market players to operate.
Free markets separate the Government from the economic activities of a country and lead to limited or no collection of taxes. So, it’s expected to reduce the social influence of the Government in leading and managing its people.
Taxation is about regulation from the Government to collect taxes and ensure the welfare of citizens. This system is designed to financially support society as a whole. The Government collects taxes and finances the projects of social welfare with the money of taxpayers. This system supports all members of society uniformly.
On the other hand, the operational and strategic philosophy of the free market is based on the competence and business acumen of a market player with minimal or no Government interruption at all. So, taxation and a free market are two opposite concepts and the implementation of the free-market approach is expected to let the Government lose grip on socio-economic factors.
Best to have a healthy mix of both? What that means, is an article for another day.
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These are all facts. And this has been an opinion piece.
Have a blessed week!
Dr. Maxwell Ampong is the CEO of Maxwell Investments Group, a leading supplier of impact products & services and ICT worldwide. He is also the Co-Founder of The RIO Corporation, connectors between impoverished communities and impact solutions worldwide. He writes about trending and relevant economic topics, and general perspective pieces.