Image Size Effect (N)

Taxes are classified in various ways by various authors. Abdulrazaq¹¹⁸ classified taxes into two broad categories, namely Direct and Indirect taxes. This is also same as the learned author, Umenweke¹¹⁹ who went further to classify taxes by adding Proportional, Progressive and Regressive taxes. Most authors have generally towed this path in the classification of taxes. In this research work, taxes are generally classified into Direct and Indirect taxes as well as Progressive, Proportional and Regressive taxes.

115FIRS, www.Firsveb.tariatech.com.ng/../Tax%20circulars%20document%20library/Assessment accessed on 25^th October, 2014.

116 Ibid.

117 O U Bassey, op cit, P. 28.

118 M T Abdulrazaq op cit P. 5.

119 M N Umenweke op cit P. 25.

42 A) Direct and Indirect Taxes

The distinction between direct and indirect taxes which has generally been approved by authors was that given by Mill. According to Mill¹²⁰:-

A direct tax is one which is demanded from the very person who, it is intended or desired, should pay it. Indirect taxes are those, which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of the other; such as the excise or customs. The Producer or Importer of a commodity is called upon to pay a tax on it not with the intention to levy a particular contribution upon him, but a tax through him the consumers of the commodity, from whom it is supposed that he will recover the amount by means of an advance in price.

As the name implies, direct taxes are paid directly by the taxpayer on whom it is levied. There is a direct relationship between the tax authority and the taxpayer since the tax authority has to assess and collect the tax from the taxpayer.¹²¹ The incidence of tax is of vital essence in classifying tax into direct or indirect taxes. A direct tax, is one which is demanded from the very persons who it is intended or desired should pay it.¹²² In other words, the incidence of tax is borne entirely by the entity that pays it, and cannot be passed on to another entity. In direct taxes, the formal and economic incidences are essentially the same, i.e. the taxpayers are not able to pass the burden to someone else.

A direct tax cannot be shifted by the taxpayer to someone else. In this sense, indirect taxes such as a Sales Tax or Value Added Tax (VAT) are imposed only if and when a taxable transaction occurs. People have the freedom to engage in or refrain from such transaction.

Therefore, direct tax is imposed upon a person, typically in an unconditional manner, such as

120 J S Mill, Principles of Political Economy with some of their Applications to Social Philosophy (7th edn, London: Longmans, Green, Reader & Dyer, 1871) Book V, Chap.3.

121 O U Bassey op cit, P. 10.

122 I A Ayua, The Nigerian Tax Law (Ibadan: Spectum Publication, 1996) P. 12.

43

on a person‘s income or property which is one that cannot be shifted by the taxpayer to someone else, where as an indirect tax can be.

Tax rate doesn‘t remain the same in case of direct tax. Each individual who is liable to pay tax has to pay as per his income or revenue.¹²³

Indirect Tax on the other hand is a type of tax whose impact passes on the other person. In this taxation system, the person who is selling the goods or product initially bears the burden of payment but the ultimate economic burden of tax is then shifted to the consumer by adding the paid amount of tax in the price of product. Indirect tax is the major source of government revenue in almost all the countries of the world. It is based on the principle of equity;¹²⁴ a person who will purchase or spend more will pay high. It is equally applied on the whole society whether rich or poor.

An Indirect tax such as Value Added Tax (VAT) is collected by an intermediary from the person who bears the ultimate economic burden of tax (such as the consumer). The intermediary later files a tax return and forward the tax proceeds to government with the return. In this sense, the term indirect tax is contrasted with a direct tax, which is collected directly by government for the persons (legal or natural) on whom it is imposed.

Again, it is noteworthy that an indirect tax may increase the price of a good to raise the price of the product for the consumers.¹²⁵ Example would be liquor and petroleum products. Another example is an excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately, the manufacturer transfers the burden of this duty to the buyer of the car in the form of a higher price. Thus as stated earlier, an indirect is one that can be shifted or passed on. The degree to which the burden of a tax is shifted determines whether

123Difference Between, Difference between Direct Tax and Indirect Tax, www.differencebtw.com/difference-between-direct-tax-and-Indirect-tax/ accessed on 7th September, 2014.

124 As already discussed under the principles of tax/characteristics of a good tax system in this dissertation.

125 As already discussed under impacts, incidences and effects of taxation in this dissertation.

44

a tax is primarily direct or primarily indirect. This is a function of the relative elasticity of the supply and demand of the goods or services being taxed. Under this definition, even income taxes may be indirect.¹²⁶

Indirect taxation is policy commonly used to generate tax revenue. It is so called as it is paid indirectly by the final consumer of goods and services while paying for the purchase of goods or for enjoying services. It is broadly based since it is applied to everyone in the society whether rich or poor. Since the cost of the tax does not vary according to income, indirect taxes are fixed. However, indirect taxation can be viewed as having the effect of a regressive tax as it imposes a greater burden (relative to resources) on the poor than on the rich, as both the rich and poor pay the same tax amount for consumption of a certain quantity of a specific good. The taxpayer who pays the tax does not bear the burden of tax; the burden is shifted to the ultimate consumers. In the case of a direct tax, the taxpayer has to bear the burden of tax personally. In the case of indirect tax, the taxpayer and the tax bearer are not the same person.¹²⁷

Indirect taxes are essentially fees that are levied equally upon taxpayers, no matter their income. As such, they are regressive taxes. For example, the import duty on a television imported from Japan will be the same amount, no matter what the income of the consumer purchasing the television is.¹²⁸

There are some other classifications of taxes as stated earlier under this head; first of all, we have Proportional Tax. A tax is proportional when the tax paid by each taxpayer takes a constant proportion of income and so can be said to be a neutral tax.¹²⁹ It is tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or

126 National Federation of Independent Business v Sebelins (2012), 567 U.S, 41.

127 United States v Connor, 898.F.2d 942, 90-1 U.S Tax Case (CCH) Para. 50, 166 (3^rd.Cir.1990).

128D Siegel, Indirect tax, www.Investopedia.com/terms/i/Indirecttax.Gsp accessed on 7th September, 2014;

The VAT rate in Nigeria is 5 percent. Some supplies may be zero rated or completely exempt.

129 M. T. Abdulrazaq op cit, P. 4.

45

decreases. The amount of the tax is in proportion to the amount subject to taxation.

Proportional describes a distribution effect on income or expenditure, referring to the way the rate remains consistent (does not progress from ‗low to high‘ or ‗high to low‘ as income or consumption changes), where the marginal tax rate is equal to the average tax rate.¹³⁰

It can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Proportional taxes maintain equal tax incidence regardless of the ability-to-pay and do not shift the incidence disproportionately to those with a higher or lower economic well-being.¹³¹ An example of proportional tax in Nigeria is the Companies Income Tax which is levied at the rate of 30 kobo for every naira on a company‘s profits.¹³²

Progressive Tax on the other hand, is one in which the rate of tax increases as the income of the taxpayer increases. In other words, the higher the income, the higher the rate of tax.¹³³ A progressive tax is a tax in which the tax rate increases as the taxable amount increases. The term ‗progressive‘ refers to the way the tax rate progresses from low to high, with the result that a taxpayer‘s average tax rate is less than the person‘s marginal tax rate.¹³⁴ Progressive tax is imposed in an attempt to reduce the tax incidence of people with a lower ability to pay; as such taxes shift the incidence increasingly to those with higher ability-to-pay.

The term is frequently applied in reference to personal income taxes, in which people with lower income pay a lower percentage of that income in tax than do those with higher

130 D M Hyman, Public Finance: A Contemporary Application of Theory to Policy (3^rd edn, Chicago, IL:

Dryden Press, 1990) P. 5.

131 S James, A Dictionary of Taxation (Northampton, MA: Edgar Elgar Publishing Limited, 1998) P. 115.

132 CITA op.cit, S.40(1).

133 O U Bassey op cit, P.13.

134 D. M. Hyman op cit P. 10.

46

income. It can also apply to adjustments of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects e.g. property tax.¹³⁵

Progressive taxation is often suggested as a way to mitigate the societal ills associated with higher income inequality, as the tax structure reduces inequality,¹³⁶ but economists disagree on the tax policy‘s economic and long-term effects. Progressive taxation has also been positively associated with happiness, the subjective well-being of nations and citizens satisfaction with public goods, such as education and transportation.¹³⁷

Most systems around the world contain progressive aspects. That is when taxable income falls within a particular tax bracket; the individual pays the listed percentage of tax on each amount that falls within that monetary range. The personal income tax in Nigeria is an example of a progressive tax system. In Nigeria, there are six income tax bracket (income after adjustments, deductions and exemptions) ranging from 7% minimum tax rate to 24%

maximum tax rate.¹³⁸

However, the progressive nature of PITA in Nigeria is doubtful. A relevant issue to how a particular tax regime could be evaluated as progressive is the minimum of income that is completely shielded from tax. In discussing the origin of advocacy for exemption for tax purposes, Hagopian¹³⁹ notes that it arises to protect the part of income that is required to meet subsistence or ensure survival. In Australia, for example, the non taxable minimum income is the same irrespective of the marginal tax rate bracket of the taxpayers which is 0% effective

135 D B Suits, ‗Measurement of Tax Progressivity‘ (1977) American Economics Review 67(4), 747.

136 P Moyes, ‗A note on minimally progressive taxation and absolute income inequality‘ (1988) Social Choice and Welfare, Vol. 5, Numbers 2-3, 227.

137 O Shigehiro et al, ‗Progressive Taxation and the Subjective Well Being of Nations‘ (2011) Psychological Science 23(i), 86.

138 PITA op.cit, Sixth Schedule, S.3.

139 K Hagopian, ‗The Inequality of the Progressive Income Tax‘ (2011) Policy Review, 3.

47

up to $18,200¹⁴⁰. The rationale behind this equal amount exempted from tax for all individuals is underpinned by the notion of shielding of income necessary for subsistence from tax. The assessment of progressive tax cannot necessarily be restricted to marginal tax rates but extended to include the non-taxable income minimum for such tax in order to satisfy income redistribution policy objective.¹⁴¹

In Nigeria, the current minimum tax is 1% of gross income, which arises when after tax assessment, the taxpayer has no taxable income or the taxable income will generate tax liability that is less than 1% of gross income. Indigent taxpayers thus endure double chastening for being precarious, firstly, they might not be able to use up all the reliefs and exemptions under the Act which of course lapses in that year of assessment. Secondly, they are obliged to pay tax on their insufficient income even when it is obvious that such income is below the minimum for meeting subsistence in the present day Nigeria. The inconsistency of the present non-taxable threshold which obviously benefits the rich more than the poor further suggests how non-progressive the Nigerian PITA is. For example, a taxpayer on annual income of N120, 000.00 is expected to pay N1, 200.00 as tax even though the individual is entitled to an abandoned unused up consolidated relief allowance of N220, 000.00.

In conclusion, it is generally believed that the PITA is progressive however it has no tax threshold and it is riddled with a myriad of inconsistencies which benefit the high income groups more than the low income earners which suggests that income tax progressivity in Nigeria that meets the canon of equality and simplicity is in doubt which obviously hinders voluntary tax compliance in Nigerian tax administration.

140Australian Taxation Office, Individual Income Tax Rates, http://www.ato.gov.au accessed on 30^th September, 2014.

141 O Egbon and C O Mgbame, What Is Progressive About Nigerian Personal Income Tax? (2015) JORIND, 13.

48

Regressive Tax on the other hand is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. This is a tax whose structure is such that the revenue yield becomes smaller as the value of the property taxed increases.¹⁴² It is a tax structured so that the effective tax rate decreases as the tax base increase. With this type of tax, the percentage of income paid in taxes decrease as the taxpayer‘s income increases.¹⁴³ A flat tax (such as the typical Sales Tax) is usually considered regressive despite its constant rate because it is more burdensome for low-income taxpayers than high-income taxpayers. A growing exemption also produces a regressive tax effect.¹⁴⁴ In terms of individual income and wealth, a regressive tax imposes a greater burden on the poor than on the rich. There is an inverse relationship between the tax rate and the taxpayer‘s ability to pay, as measured by assets, consumption, or income. These taxes tend to reduce the tax burden of the people with a higher ability to pay, as they shift the relative burden increasingly to those with a lower ability to pay.

The opposite of a regressive tax is a progressive tax, in which the average tax rate increases as the amount subject to taxation increases. The regressive tax is against the canons of or principles of a good tax system which primarily is against the principle of equality. Few people would consider a tax system to be fair if the poorer you are, the more of your income you pay in tax. But that is exactly what regressive taxes do. They require the middle and the low income earners to pay a much greater share of their incomes in taxes than the wealthy.

As stated earlier, the sales tax is a regressive tax. This is because sales taxes are levied at a flat rate, and because low-income taxpayers spend more of their income on items subject to the sales tax than do wealthier taxpayers, sales taxes inevitably takes a larger share of

142 M N Umenweke op cit , P. 26.

143 B A Garner,op cit , P. 1687.

144 Ibid.

49

income from low and middle-income taxpayers than they take from the wealthy.¹⁴⁵ Excise taxes on cigarettes, gasoline and alcohol are also quite regressive, and property taxes are generally somewhat regressive.

So the question that readily springs up is what is the best tax system in a Self Assessment Regime like Nigeria? This question has no straightforward answer because some believe that a proportional or ‗flat‘ tax structure is fair. They argue that if everyone pays the same share of income in taxes, then everyone is treated equitably.¹⁴⁶ But this view ignores the fact that taking the same share of income from the middle or low income earners as from a rich taxpayer has vastly different consequences for each. Low-income earners must spend most (or all) of their income just to achieve the most basic level of comfort. Even the middle income earners spend most of what they earn to sustain only a modest standard of living. A tax on these taxpayers can cut directly on their ability to make ends meet. In contrast, the same tax will hardly affect the life style of the wealthiest families at all.

Progressive taxes are therefore the fairest taxes. Personal income taxes are the only major tax that can easily be designed to be progressive. Low income taxpayers can be exempted entirely as already suggested earlier when discussing progressive taxes and tax rates can be regulated with higher tax rates applying to higher income levels, so that the middle income and the rich income earners pay taxes fairly related to what they can afford.