EKN 310
Chapter 11 – Introduction to Taxation and Tax
equity
What you must know for this chapter
1. Explain the sources of government revenue
2. Define a tax
3. Understand how tax rates are structured (proportional, progressive,
regressive)
4. Distinguish between diCerent types of taxes
- General vs selective
- Specific vs ad valorem
- Direct vs indirect
5. List the properties of a good tax
6. Explain tax equity (fairness)
7. Explain the diCerence between statutory incidence and economic
incidence of tax.
8. Explain tax shifting using
- Partial equilibrium analysis
- General equilibrium analysis
Introduction
• This chapter focuses on taxation as a source of finance for public
expenditures.
• Government can only spend (on grants, education, healthcare,
infrastructure, public debt, salaries, SOE’s etc) what it first takes in the
form of taxes.
• “what the government gives, it must first take away”
• The tax and transfer system is very powerful
® It can promote economic development, growth, social upliftment
and redistribution
, ® But if poorly designed, it can harm the economy – increase
inequality and destabilize a country.
• Therefore, taxation is:
- Important, because it funds all public activity
- Consequential, because it aCects economic behaviour and
welfare
That is why understanding the technical and economic complexities of taxation
is essential.
Sources of Government Finance
1) Taxes (main source)
o Dominant source of government finance .
o Example: In SA, about 73.3% of government revenue in 2020/2021
came from taxes.
o This shows that most government spending depends heavily on
taxation.
2) Alternative sources of finance (4 other important sources)
User Charges (or benefit taxes)
o These are prices charged for specific public services.
o They function similarly to market prices.
o User charges can only be levied if exclusion is possible, meaning only
those who pay can use the service.
o Examples:
- Toll roads
- University fees
- Public swimming pools
o Economic role: help allocate resources eCiciently, similar to market
pricing.
Administrative Fees
o These are similar to user charges but the benefit received is more defined.
o Examples:
- TV licenses
- Business licenses
, - Driving license
- Parking / speeding fines
o These are generally a small source of revenue.
Borrowing
o Government can borrow from domestic sources (citizens) or from
international lenders.
o Borrowing is typically used to finance capital expenditure (e.g.
infrastructure).
o Should be used for productive investments, not everyday spending.
o Borrowing must be repaid in the future, usually through taxes – therefore
borrowing is eCectively deferred taxation.
Government- induced inflation (or inflation tax)
o If the government finances spending by increasing the money supply
(more money in economy) – it can cause inflation (prices rise)
o Inflation reduces the purchasing power of money.
o Inflation reduces the real value of government debt.
o This eCectively acts as a hidden tax for lenders, because they are repaid in
weaker money.
o Example: if the govt borrows R2000 and inflation is 10%, then in a year’s
time, the real value of the loan will only be R1 800 (R2 000 2 [10/100 x 2
000].
o So, govt still pays the lender back R2000 but that money is weaker can buy
less (reduced value of govt debt).
Definition of Taxes
A tax is defined as:
• A compulsory and legally enforceable transfer of resources from
individuals or firms to government.
Key characteristics:
• Compulsory – people must pay
• No direct link between tax paid and benefits received (you may pay taxes
but not directly benefit from the specific service it funds).
The lack of direct link causes the free-rider problem
Chapter 11 – Introduction to Taxation and Tax
equity
What you must know for this chapter
1. Explain the sources of government revenue
2. Define a tax
3. Understand how tax rates are structured (proportional, progressive,
regressive)
4. Distinguish between diCerent types of taxes
- General vs selective
- Specific vs ad valorem
- Direct vs indirect
5. List the properties of a good tax
6. Explain tax equity (fairness)
7. Explain the diCerence between statutory incidence and economic
incidence of tax.
8. Explain tax shifting using
- Partial equilibrium analysis
- General equilibrium analysis
Introduction
• This chapter focuses on taxation as a source of finance for public
expenditures.
• Government can only spend (on grants, education, healthcare,
infrastructure, public debt, salaries, SOE’s etc) what it first takes in the
form of taxes.
• “what the government gives, it must first take away”
• The tax and transfer system is very powerful
® It can promote economic development, growth, social upliftment
and redistribution
, ® But if poorly designed, it can harm the economy – increase
inequality and destabilize a country.
• Therefore, taxation is:
- Important, because it funds all public activity
- Consequential, because it aCects economic behaviour and
welfare
That is why understanding the technical and economic complexities of taxation
is essential.
Sources of Government Finance
1) Taxes (main source)
o Dominant source of government finance .
o Example: In SA, about 73.3% of government revenue in 2020/2021
came from taxes.
o This shows that most government spending depends heavily on
taxation.
2) Alternative sources of finance (4 other important sources)
User Charges (or benefit taxes)
o These are prices charged for specific public services.
o They function similarly to market prices.
o User charges can only be levied if exclusion is possible, meaning only
those who pay can use the service.
o Examples:
- Toll roads
- University fees
- Public swimming pools
o Economic role: help allocate resources eCiciently, similar to market
pricing.
Administrative Fees
o These are similar to user charges but the benefit received is more defined.
o Examples:
- TV licenses
- Business licenses
, - Driving license
- Parking / speeding fines
o These are generally a small source of revenue.
Borrowing
o Government can borrow from domestic sources (citizens) or from
international lenders.
o Borrowing is typically used to finance capital expenditure (e.g.
infrastructure).
o Should be used for productive investments, not everyday spending.
o Borrowing must be repaid in the future, usually through taxes – therefore
borrowing is eCectively deferred taxation.
Government- induced inflation (or inflation tax)
o If the government finances spending by increasing the money supply
(more money in economy) – it can cause inflation (prices rise)
o Inflation reduces the purchasing power of money.
o Inflation reduces the real value of government debt.
o This eCectively acts as a hidden tax for lenders, because they are repaid in
weaker money.
o Example: if the govt borrows R2000 and inflation is 10%, then in a year’s
time, the real value of the loan will only be R1 800 (R2 000 2 [10/100 x 2
000].
o So, govt still pays the lender back R2000 but that money is weaker can buy
less (reduced value of govt debt).
Definition of Taxes
A tax is defined as:
• A compulsory and legally enforceable transfer of resources from
individuals or firms to government.
Key characteristics:
• Compulsory – people must pay
• No direct link between tax paid and benefits received (you may pay taxes
but not directly benefit from the specific service it funds).
The lack of direct link causes the free-rider problem
