The economic rationale behind taxes, taxation
BY BERHANU LEMMA
Various formalized theories are available in the academic world that explain issues like what taxes are, why they are being collected by the government, how ethical or fair any act of taxing is, who should pay the taxes and in what proportion to one’s income, and so on. These are in lieu of those other kinds of theory that exist side by side—kinds that are much plainer, more anonymous, more familiar and less formal. The most ordinary and least formal is the one often told, by words of mouth, in the typical characteristic of hard humour—one which combines irony with empathy, and sends home so cunningly a clear message to both government and citizens, elite and lay, alike: No one is exempt from taxes and death.
The formal theories of taxation and taxes are said to be so, because they are far more structured and pursued as an area of study in all advanced and some emerging nations. People with vigorous and talented minds and backed by institutional arrangements have made them the focal point of their scholarly lives. Consequently, this involvement of people and the institutionalized support made available for the study and investigation of taxes and taxation, one of the most ancient preoccupations of mankind, have now revolutionized our understanding of them at their very heart, and opened up immense career possibilities for educated citizens.
In Ethiopia, where we still believe that the science and practice of taxation have yet a long way to go before we see the sector as mature as necessary, many young college graduates have landed public and private jobs associated, one way or another, with taxes. The problem here is that, unlike those people in advanced countries, whose awareness has been made possible through a culture of long practice and education, our young people may or may not have had an exposure to the idea of taxes, much less about the practice. One should, however, take solace in the fact that things are changing for the better in this respect, for, as with the staffing of the tax collecting bureaucracy with educated manpower, the government has been trying to increase public awareness. This explains, if partially, why taxation in Ethiopia—though still at its rudimentary level in many developing countries including our own, both as an idea and as a systematized practice—is showing signs of improvement with a comprehensive work going on across various sectors with an end to tap all the revenue generating potentials of the country.
With a history probably as ancient as that of states and governments, taxes certainly make up one of the most fundamental but least discussed issues surrounding our day-to-day lives. They are most fundamental, because, as a portion of the public wisdom—namely “No one can escape from taxes and death”—clearly indicates, paying taxes has been performed for many millennia as one of the essential duties of citizens. This duty is nowadays meticulously sanctioned in written—or even unwritten—constitutions of modern nations. It seems to be unambiguously established that, with respect to paying taxes, there is not such a thing like a choice, for it is logically impossible to make a choice in the absence of a socially all-satisfying counter offer. At least, no government has so far been willing enough to earnestly provide its citizens an alternative in this regard. Customs, in the distant ages, and states’ edicts or constitutions, in later ages, have worked their way toward making this singular character one of the most notable markings for the payment of taxes. People must pay some predetermined amount of money in the form of tax, per a given time period, as long as their incomes fall within one or another range of predetermined taxable amounts—or face the consequences.
One may ask why we do not consider, in our argument, the “consequences” as an alternative to paying taxes. First and foremost, we need to determine what the possible consequences are. Let us describe these consequences here, for our present purpose, into economic, social, cultural, political, legal, and even ethical consequences. There might possibly be others, but the writer believes that those others may be consolidated somehow in the mentioned ones. In addition, for reasons of time and space limitations in this article, we need to restrict our discussion to one of these, for, after all, the idea here is to strike an inspiration for others to follow suit. Thus, let us deal with the economic consequences.
Economic theory has it that society generally consumes two broad categories of goods and services, private and public. Private goods and services are those products which, in a free market economy, private companies can produce and sell in accordance with the free play and dictates of the market forces known as demand and supply. It requires little other effort on the part of producers and/or sellers than the use of prices as a mechanism to exclude anyone and everyone who is unwilling or unable to offer to pay the price set by competition. Prices set thus are ordinarily thought to be the optimum within a given period of time and set of circumstances—by optimum meaning in this case the impossibility of a higher or lower price without dissatisfying the seller or the buyer. Products and services that change hands or, more specifically, ownership with the free, voluntary participation of sellers and buyers are an everyday, household phenomenon, and giving examples as a matter of clarity is hardly necessary. The point we want to make is that, at least, the production and supply of these goods and services are a private matter from a social point of view. And, as the theory goes, unless some arbitrary interference, say, from the government, deters the market forces from playing normally, production and distribution of the private goods and services will go smoothly, and every participant in the market, seller and buyer, will go home satisfied in their own respective ways, i.e., until the next round of a market interaction. In short, expectation of future demand, possibly a greater demand, and higher profit from meeting this demand on the part of producers encourages the production of these private goods and services to happen at an ongoing basis and a greater level.
In contrast, public goods possess an entirely different—more precisely, unique—nature. They are called public goods, because their production or consumption or both have a public or collective nature, and assigning a certain portion to a certain consumer based on the ability or willingness to pay some specific price is somehow complex and even technically difficult. Their unique quality arises out of the fact that these goods or services manifest a number of properties not shared by their counterparts, private goods and services. First, their production—and, in many cases, also their distribution—generally involve a very high expenditure for the setting up of the necessary organizational and infrastructural requirements which private investors are not willing or able to fulfil. That is, because of the high initial expenditures—possibly coupled with the socially affordable low prices—associated with some goods and services, issues such as payback or capital recovery period, being very long, scare away private investors. One example that illustrates these conditions is the establishment, if not the running, of a railway transport system. Our country has a first-hand experience about how intractably difficult it is to own, run and maintain such a system in a poor economy, let alone to initiate a new one from scratch. The initial outlay, especially, is so huge and the capital recovery period so long that railway projects have historically been carried out by governments, because even very rich individuals or companies are not attracted by them.
The thing about such goods and services we call public gets even more complicated when we introduce a two other problems, indivisibility and the free-rider issue. The idea of indivisibility builds on the fact that public goods and services are generally too bulky in nature, produced and made available for use only in large sizes whereby dividing them into bits and pieces so that people can purchase them according to their respective needs and abilities to pay is difficult or entirely impossible. To cite an example, security against military threat being in continuous demand as a service by citizens, one should imagine how a private company—assuming that there is such a private company equipped militarily to deter foreign aggression or internal terrorist attack—can produce and distribute it to consumers in accordance with the amount individual buyers are subscribing and willing to pay for. For instance, can any organization sell such security, say, at a thousand birr per piece to a person even if he or she is willing to pay for it? It is simply an impossible situation, and, as a result, private investors lack the temptation to invest in undertakings like these. One has to be careful, however, not to confuse this example with the kinds of security service some private companies are rendering to private consumers, i.e., in the form of security guard or escort services.
Similarly, the free-rider concept establishes another of the central problems in the allocation of resources through the agency of the market system. Human beings are by nature averse to incurring costs, avoiding, if they can, the pain of giving up money or something equally valuable in return for what they take from others. Economics recognizes this free-rider mentality as a natural—and possibly rational—human disposition which is based on an optimizing instinct. This writer believes that some of us hardly possess the moral high-ground to condemn this temperament as an abnormal tendency, because, however cultivated we can be in other ways, this nature of ours is likely to mastermind our decisions from time to time or as occasions for it arise. The key issue here is that, even when there is a private organization willing to take risk, produce and supply some of the goods or services which we have said require a huge outlay or take a long time to recover investment money at a certain amount of payment, some people may choose to use the product or service but escape the payment. Such incident introduces a case in which the exclusion principle on which the pricing or market mechanism is set to operate fails to apply, calling for an intervention, necessarily the intervention of the government.
How do these issues merge with the subject we set out to discuss, namely the issue of taxation and taxes? Well, as we mentioned immediately above, the need for government intervention partially comes to the provision of those goods and services which private companies cannot supply for the stated nature of either the goods and services or mankind. In fact, this role of the government is one of the few reasons that made relevant the existence of any government. This being as it is, such intervention requires expenditure, and expenditure presupposes the collection of income or revenue whereby the place and significance of taxes become self-evident.
The formal theories of taxation and taxes are said to be so, because they are far more structured and pursued as an area of study in all advanced and some emerging nations. People with vigorous and talented minds and backed by institutional arrangements have made them the focal point of their scholarly lives. Consequently, this involvement of people and the institutionalized support made available for the study and investigation of taxes and taxation, one of the most ancient preoccupations of mankind, have now revolutionized our understanding of them at their very heart, and opened up immense career possibilities for educated citizens.
In Ethiopia, where we still believe that the science and practice of taxation have yet a long way to go before we see the sector as mature as necessary, many young college graduates have landed public and private jobs associated, one way or another, with taxes. The problem here is that, unlike those people in advanced countries, whose awareness has been made possible through a culture of long practice and education, our young people may or may not have had an exposure to the idea of taxes, much less about the practice. One should, however, take solace in the fact that things are changing for the better in this respect, for, as with the staffing of the tax collecting bureaucracy with educated manpower, the government has been trying to increase public awareness. This explains, if partially, why taxation in Ethiopia—though still at its rudimentary level in many developing countries including our own, both as an idea and as a systematized practice—is showing signs of improvement with a comprehensive work going on across various sectors with an end to tap all the revenue generating potentials of the country.
With a history probably as ancient as that of states and governments, taxes certainly make up one of the most fundamental but least discussed issues surrounding our day-to-day lives. They are most fundamental, because, as a portion of the public wisdom—namely “No one can escape from taxes and death”—clearly indicates, paying taxes has been performed for many millennia as one of the essential duties of citizens. This duty is nowadays meticulously sanctioned in written—or even unwritten—constitutions of modern nations. It seems to be unambiguously established that, with respect to paying taxes, there is not such a thing like a choice, for it is logically impossible to make a choice in the absence of a socially all-satisfying counter offer. At least, no government has so far been willing enough to earnestly provide its citizens an alternative in this regard. Customs, in the distant ages, and states’ edicts or constitutions, in later ages, have worked their way toward making this singular character one of the most notable markings for the payment of taxes. People must pay some predetermined amount of money in the form of tax, per a given time period, as long as their incomes fall within one or another range of predetermined taxable amounts—or face the consequences.
One may ask why we do not consider, in our argument, the “consequences” as an alternative to paying taxes. First and foremost, we need to determine what the possible consequences are. Let us describe these consequences here, for our present purpose, into economic, social, cultural, political, legal, and even ethical consequences. There might possibly be others, but the writer believes that those others may be consolidated somehow in the mentioned ones. In addition, for reasons of time and space limitations in this article, we need to restrict our discussion to one of these, for, after all, the idea here is to strike an inspiration for others to follow suit. Thus, let us deal with the economic consequences.
Economic theory has it that society generally consumes two broad categories of goods and services, private and public. Private goods and services are those products which, in a free market economy, private companies can produce and sell in accordance with the free play and dictates of the market forces known as demand and supply. It requires little other effort on the part of producers and/or sellers than the use of prices as a mechanism to exclude anyone and everyone who is unwilling or unable to offer to pay the price set by competition. Prices set thus are ordinarily thought to be the optimum within a given period of time and set of circumstances—by optimum meaning in this case the impossibility of a higher or lower price without dissatisfying the seller or the buyer. Products and services that change hands or, more specifically, ownership with the free, voluntary participation of sellers and buyers are an everyday, household phenomenon, and giving examples as a matter of clarity is hardly necessary. The point we want to make is that, at least, the production and supply of these goods and services are a private matter from a social point of view. And, as the theory goes, unless some arbitrary interference, say, from the government, deters the market forces from playing normally, production and distribution of the private goods and services will go smoothly, and every participant in the market, seller and buyer, will go home satisfied in their own respective ways, i.e., until the next round of a market interaction. In short, expectation of future demand, possibly a greater demand, and higher profit from meeting this demand on the part of producers encourages the production of these private goods and services to happen at an ongoing basis and a greater level.
In contrast, public goods possess an entirely different—more precisely, unique—nature. They are called public goods, because their production or consumption or both have a public or collective nature, and assigning a certain portion to a certain consumer based on the ability or willingness to pay some specific price is somehow complex and even technically difficult. Their unique quality arises out of the fact that these goods or services manifest a number of properties not shared by their counterparts, private goods and services. First, their production—and, in many cases, also their distribution—generally involve a very high expenditure for the setting up of the necessary organizational and infrastructural requirements which private investors are not willing or able to fulfil. That is, because of the high initial expenditures—possibly coupled with the socially affordable low prices—associated with some goods and services, issues such as payback or capital recovery period, being very long, scare away private investors. One example that illustrates these conditions is the establishment, if not the running, of a railway transport system. Our country has a first-hand experience about how intractably difficult it is to own, run and maintain such a system in a poor economy, let alone to initiate a new one from scratch. The initial outlay, especially, is so huge and the capital recovery period so long that railway projects have historically been carried out by governments, because even very rich individuals or companies are not attracted by them.
The thing about such goods and services we call public gets even more complicated when we introduce a two other problems, indivisibility and the free-rider issue. The idea of indivisibility builds on the fact that public goods and services are generally too bulky in nature, produced and made available for use only in large sizes whereby dividing them into bits and pieces so that people can purchase them according to their respective needs and abilities to pay is difficult or entirely impossible. To cite an example, security against military threat being in continuous demand as a service by citizens, one should imagine how a private company—assuming that there is such a private company equipped militarily to deter foreign aggression or internal terrorist attack—can produce and distribute it to consumers in accordance with the amount individual buyers are subscribing and willing to pay for. For instance, can any organization sell such security, say, at a thousand birr per piece to a person even if he or she is willing to pay for it? It is simply an impossible situation, and, as a result, private investors lack the temptation to invest in undertakings like these. One has to be careful, however, not to confuse this example with the kinds of security service some private companies are rendering to private consumers, i.e., in the form of security guard or escort services.
Similarly, the free-rider concept establishes another of the central problems in the allocation of resources through the agency of the market system. Human beings are by nature averse to incurring costs, avoiding, if they can, the pain of giving up money or something equally valuable in return for what they take from others. Economics recognizes this free-rider mentality as a natural—and possibly rational—human disposition which is based on an optimizing instinct. This writer believes that some of us hardly possess the moral high-ground to condemn this temperament as an abnormal tendency, because, however cultivated we can be in other ways, this nature of ours is likely to mastermind our decisions from time to time or as occasions for it arise. The key issue here is that, even when there is a private organization willing to take risk, produce and supply some of the goods or services which we have said require a huge outlay or take a long time to recover investment money at a certain amount of payment, some people may choose to use the product or service but escape the payment. Such incident introduces a case in which the exclusion principle on which the pricing or market mechanism is set to operate fails to apply, calling for an intervention, necessarily the intervention of the government.
How do these issues merge with the subject we set out to discuss, namely the issue of taxation and taxes? Well, as we mentioned immediately above, the need for government intervention partially comes to the provision of those goods and services which private companies cannot supply for the stated nature of either the goods and services or mankind. In fact, this role of the government is one of the few reasons that made relevant the existence of any government. This being as it is, such intervention requires expenditure, and expenditure presupposes the collection of income or revenue whereby the place and significance of taxes become self-evident.
source The Ethiopian Herald, September 23
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