From a multi-day seminar for the Joint Finance Commission of the United Republic of Tanzania

1. United Republic of Tanzania
Joint Finance Commission
Tax Policy
Presented by the Asian Institute for Technology
William P. Kittredge, Ph.D.
Visiting Scholar in Residence
DOI: 10.13140/RG.2.1.2947.6720

2. Taxation
 Tax Policy

 Tax Equity

 Equity Analysis

 Tax Incidence

 Distributional Analysis

3. Tax Policy
 When deciding on the best taxes to use, you should think
about which tax (or better a balanced system of taxes) is:
 Fairest – Equity

 Least distortion

 Able to raise sufficient revenue

 Least costly to administer

 Most transparent

 The specific order of these considerations is unimportant
since tax policy is iterative, in part, because tax induced
behavioural changes and, in part, due to exogenous changes
in market conditions.

4. Tax Equity – Adam Smith
 1. The subjects of every state ought to contribute towards
the support of the government, as nearly as possible … in
proportion to the revenue which they respectively enjoy
under the protection of the state.

 2. The tax which each individual is bound to pay ought to
be certain, and not arbitrary. The time of payment, the
manner of payment, the quantity to be paid, ought all to be
clear and plain to the contributor, and to every other
person. Where it is otherwise, every person subject to the
tax is put more or less in the power of the tax-gatherer,
who can either aggravate the tax upon any obnoxious
contributor, or extort, by the terror of such aggravation,
some present or perquisite to himself.

5. Tax Equity – Adam Smith
 3. Every tax ought to be levied at the time, or in the
manner, in which it is most likely to be convenient for the
contributor to pay it.

 4. Every tax ought to be so contrived as both to take out
and keep out of the pockets of the people as little as
possible, over and above what it brings into the public
treasury of the state. (Smith 1776)


6. Tax Equity
 To decide whether a tax is fair, an incidence analysis must
be combined with a value judgement.

 Most people rely on one or both of two well-known
principles:

 The Ability to Pay Principle: People with more to pay taxes
should pay more.

 The Benefit Principle: People who receive more benefits
from the public services funded by a tax should pay more.

 I argue that Smith, quoted above, does not make this
distinction, believing that the 'ability' arises from the
'benefits'.

7. Tax Equity

 Any analysis of tax equity must address two questions,
one positive and one normative.

 The positive question: Who pays the tax?

 The normative question: Is the distribution of the tax
burden fair?

8. Tax Equity: Positive Analysis
 A tax alters real incomes by changing market prices.

 There are mathematical models that estimate the
incidence effects of various taxes.

 However, the real 'test' requires socio-economic research
post-imposition.

9. Tax Equity: Positive Analysis
 Begin with a distinction between legal and economic
incidence:

 Legal incidence: Who is responsible for writing the tax
checks to the government?

 Economic incidence: Whose real income is diminished
because of the tax?

 Legal and economic incidence may not be the same!
 e.g. a sales tax that is imposed on the retailer that is
then passed on to the consumer in addition to the
price of an item

10. Tax Incidence
 Legal incidence does not affect economic incidence

 Economic incidence is determined by supply and demand,
not by institutional arrangements.

 Legal incidence should be selected on administrative
grounds (not based on misperceptions about economic
incidence!)

 Consider Washington State in the USA, a sales tax
dependent state, which has a legal requirement for
payment of sales tax on interstate purchases but fails to
collect very much because of administrative infeasibility of
enforcement.

11. Tax Incidence
 In some cases, the tax burden falls entirely on consumers.

 In other cases, the tax burden falls entirely on firms, although
some consider this a distinction without a difference, arguing
that all costs, including taxes, are ultimately included in the
price.

 Or the burden may be shared.

 Incidence is determined by responsiveness (price elasticity).



12. Tax Incidence
Elasticity Effects

 Economic actors are responsive to price to the extent that
good alternatives exist.

 Consider the 'alternatives' available respectively to the
heavy drinker who regularly travels internationally and
one who does not have regular access to duty free
alcohol

 The market participant with better alternatives escapes more
of the tax.

 If market participant has poor, or no, alternatives, he/she
cannot escape the tax.

13. Distributional Analysis
 The final step in positive analysis of tax equity is to
translate the above incidence analysis into a distributional
impact.

 The supply side may represent rich (corporations) or poor
(low-wage craftspeople)

 The demand side may represent poor (buyers of
necessities) or rich (buyers of fine crafts).

 Tax distribution can be proportional, progressive, or
regressive.


14. References
 Duncombe, W.D., Yinger, J., (2007) “Does School District Consolidation Cut Costs?”
Education Finance and Policy No. 4 pp. 341–75.
 Kittredge, W.P., (2004) Local Government Fiscal Condition Analysis. University of
Georgia Press.
 Musgrave, R.A. (1959) The Theory of Public Finance: A Study in Public Economy New
York: McGraw Hill
 Smith, A (1776) An Inquiry Into the Nature And Causes of the Wealth of Nations.
Chapter II of Book V.