Public Finance and

Taxation
BY
REDWAN KELIL
 Basics of Public Finance
1.1. Definition of public finance
1.2. Scope of public finance
1.3. The role of government in the economy
1.4. Public expenditure
1.5. Public revenue
1.6. Public debt
1.7. Public administration
1.8. Fiscal federalism
 Definition of public finance
• Governments, all over the world have started
number of public projects. To provide social
facilities, the government requires adequate
revenue.
• Public Finance, therefore, deals with the income
and expenditure of public authorities.
• Public finance deals with how and through what
different sources the government gets income, how
it spends it and how it controls and administers its
incomes and expenditures.
• It lie on the borderline between Economics and
Politics.
 Scope of Public Finance
The subject matter of the public finance is
classifies under five broad categories.
1. Public Revenue
2. Public Expenditure
3. Public Debt
4. Financial Administration and Control, and
5. Economic Stability and Growth.
 Public Revenue
• This is one of the branches of public finance. It
deals with the various sources from which the
state might derive its income.
• These sources include incomes from taxes,
commercial revenues in the form of prices of
goods and services supplied by public
enterprises, administrative revenues in the
form of fees, fines etc and gifts and grants.
 Public revenue vs Public receipts
• Public revenue includes that income which is
not subject to repayment by the government.
Public receipts include all the income of the
government including public borrowing and
issue of new currency. In this way public
revenue is a part of public receipts.
• Public Receipts = Public revenue + Public
borrowing + issue of new currency
 Basic Categories of Government
Receipt
• Capital Receipts
• Revenue Receipts
 Revenue Receipts
It includes “routine” and “earned” ones
1. Tax-revenue
2. Non-tax revenue.
 Tax-revenue
i. Taxes on income
It covers corporation tax, income tax and similar other
taxes, if any, in force.
ii. Taxes on property and capital transactions
taxes on specific forms of wealth and its transfers such
as estate duty, wealth tax, gift tax, house tax, land
revenue and stamps and registration fees, etc.
iii. Taxes on commodities and services
This section includes taxes on production, sale, purchase,
transport, storage, and consumption of goods and
services.
 Non-tax Revenue Receipt
➢ This category covers the receipts of Currency Notes Press, Mints
and Profit from circulation of small coins.
➢ Interest receipts on loans by the government to other parties,
➢ Dividends and profits from public sector undertaking.
2. Non-tax Revenue Receipt
i. Currency, coinage and mint:
ii. Interest receipts, dividends and profits:
E.g contributions from railways and posts and telecommunications,
iii. Other non–tax revenue:
➢ It covers revenue from various government activities and services
such as from administrative services, public service commission,
police, jails , agricultural and allied services, industry and minerals,
water and power development services, transport and
communications, supplies and disposal, public works, education,
housing, information and publicity, broadcasting, grants-in-aid and
contributions etc.
 Capital Receipts
Capital receipts of the government take money
forms. The most important one comprises of
borrowings which can be classified in terms of
their origin and maturity
• on the basis of origin, public borrowings may be
external (outside the country), or internal (with in
the country).
• In terms of maturity, there may be, ”long term”,
“medium term”, or “short term” loans with
specific demarcation of boundaries for each.
 Public Spending/expenditure
• PE is incurred by public authorities - either for
the satisfaction of collective needs of the
citizens or for promoting their economic and
social welfare. It is incurred by the government
for the attainment of public good.
• Therefore public expenditure, deals with the
expenditure which a government incur for its
own maintenance, the society and the economy
and helping other countries.
 Current and Capital Expenditure
• Technically, in the structure of a budget, most
governments classify public expenditure into
two:

(i) Current expenditure, and

(ii) Capital expenditure
 Objectives of Public Expenditure
• Dr. Dalton divided the aims of public
expenditure into two parts:
(i) Security of life against the external aggression
and internal disorder and injustice.

(ii) Development or up gradation of social life in

the community.
 Canons of Public Expenditure
It used for the fundamental rules or principles governing
the spending policy of the government. According to
Prof. Findley Shirras, the canons are:
• Canon of Benefit
• Canon of Economy
• Canon of sanction
• Canon of Surplus
• Canon of Elasticity
• Canon of Productivity
• Canon of Equity
• Canon of certainty.
 Canons of Public Expenditure
1. Canon of Benefit. Public expenditure should
be so planned and implemented as to bring
about the greatest possible benefit to society.
2. Canon of economy. Public expenditure should
be incurred carefully so that there is no
wastage of funds.
3. Canon of sanction: This cannon suggests that
no public spending should be made without
the approval of proper authority.
 Canons of Public Expenditure
4. Canon of surplus. This canon requires that
expenditure of public authorities should be
kept within the limits of current revenues.
5. Canon of elasticity. Canon of elasticity requires
that the rules of public expenditure should not
be too rigid to achieve the real purpose and
that it should be allowed to vary according to
the needs and circumstances.
 Canons of Public Expenditure
• Canon of Productivity: This canon or principle implies
that the expenditure policy of the Governments
should be such that would encourage production in a
country.
• Canon of Equity: One of the foremost aims of public
expenditure is also to ensure the just and equitable
distribution of is more significant for the countries
where the gap between the highest income and the
lowest income groups is very wide.
• Canon of certainty. This canon requires that public
authorities should clearly know the purpose and
extent of public expenditure. The spending unit should
be certain as to the amount and objective of public
expenditure.
• Canon of Equality: The subjects of every state
ought to contribute towards the support of
the government, as nearly as possible, in
proportion to their respective abilities;
 PUBLIC DEBT
• Public debt is of recent growth and was unheard
of prior to the 18th century. In modern times,
however, borrowing by the States has become a
normal method of government finance.
 Classification of public debt
➢ Source of Borrowing (internal debt and
external debt)
➢ Purpose of the loan (Productive and
unproductive debt)
➢ According to nature (Compulsory and
voluntary debt)
➢ Funded and unfunded debt for (creating a
permanent asset meant to meet current needs)
➢ Time Duration of loan(short, medium, and
long term loan).
 REDEMPTION OF PUBLIC DEBT
• Repudiation of Debt. Repudiation of debt
means simply that the government refuses to
pay the interest as well as the principal.
• Conversion of Loans:-
• Serial Bond Redemption
• Sinking Fund.
 What Is Fiscal Policy?
• FISCAL policy is the use of government spending
and taxation to influence the economy.
Governments typically use fiscal policy to
promote strong and sustainable growth and
reduce poverty.
 Public finance Vs Private finance
Similarities between Public Finance and Private
Finance:
• Satisfaction of Human Wants:
• Balancing of Income and Expenditure:
• Maximum Satisfaction:
• Borrowing a Common Feature:
• Economic Choice a Common Problem:
 Differences between Public Finance
and Private Finance:
1. Adjustment of Income and
Expenditure(investment and financing)
2. Nature of Benefit: (individual and collective)
3. Postponement of Expenditure:
4. Allocation of Resources: (maximum satisfaction
& maximum social welfare)
5. Motive of expenditure: expects return & social
welfare and economic development
6. Influence on expenditure: customs, habits
culture religion & policy
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 2.1. Meaning and Characteristics of
Taxation
• In every country major part of the revenue is raised
through taxation.
• According to Prof. Taylor “Taxes are compulsory
payments to governments without expectations of
direct return or benefit to the tax payer”
• Taxes are payments people are required to pay to
local, state and national governments.
• Taxes are used to pay for services provided by
government:
– Schools
– Police
– Defense
– Etc.
 GENERAL CHARACTERISTICS OF TAX:
• Tax is a Compulsory Contribution:
• Benefit is not the Basic Condition:
• Personal Obligation:
• Common Interest:
• Legal Collection:
• Element of Sacrifice:
• Regular and Periodical Payment:
• No Discrimination:
• Wide Scope:
 Objectives of taxation
• Raising Revenue:
• Tax system reduces inequalities
• Discourage undesirable activities
• Allocate Resources
• Capital Accumulation and saving
• Reduction in Regional Imbalances:
• To protect local industries from foreign
competition
• Creation of Employment Opportunities:
• Encouragement of Exports:
• Enhancement of Standard of Living:
 Principles of taxation
In this sense, his canons of taxation are „classical‟ in sense,
four canons of taxation are:
(i) Canon of equality or equity
(ii) Canon of certainty
(iii) Canon of economy
(iv) Canon of convenience.
• Modern economists have added more in the list of
canons of taxation, these are:
(v) Canon of productivity
(vi) Canon of elasticity
(vii) Canon of simplicity
(viii) Canon of diversity.
 Canon of Equality
• Canon of equality states that the burden of taxation must be
distributed equally or equitably among the taxpayers. However, this
sort of equality robs of justice because not all taxpayers have the same
ability to pay taxes.
• Rich people are capable of paying more taxes than poor people. Thus,
justice demands that a person having greater ability to pay must pay
large taxes
• If everyone is asked to pay taxes according to his ability, then sacrifices
of all taxpayers become equal. This is the essence of canon of
equality (of sacrifice).
• To establish equality in sacrifice, taxes are to be imposed in accordance
with the principle of ability to pay.
• In view of this, canon of equality and canon of ability are the two
sides of the same coin.
 Canon of certainty
• The tax which an individual has to pay should be certain and
not arbitrary.
• According to A. Smith, the time of payment, the manner of
payment, the quantity to be paid, i.e., tax liability, ought all to
be clear and plain to the contributor and to everyone.
• Thus, canon of certainty embraces a lot of things.
• It must be certain to the taxpayer as well as to the tax-levying
authority.
• Not only taxpayers should know when, where and how much
taxes are to be paid. In other words, the certainty of liability
must be known beforehand. Similarly, there must also be
certainty of revenue that the government intends to collect
over the given time period
Canon of Economy andConvenience

Canon of Economy
• This canon implies that the cost of collecting a tax should be
as minimum as possible.
• Any tax that involves high administrative cost and unusual
delay in assessment and high collection of taxes should be
avoided altogether.
Canon of Convenience
• Taxes should be levied and collected in such a manner that it
provides the greatest convenience not only to the taxpayer
but also to the government. Thus, it should be painless and
trouble-free as far as practicable. “Every tax”, stresses A.
Smith: “ought to be levied at time or the manner in which it
is most likely to be convenient for the contributor to pay it.”
 Canon of Productivity and Elasticity
• Canon of Productivity
• According to a well-known classical economist in the field of public finance,
Charles F. Bastable, taxes must be productive or cost-effective. This implies that
the revenue yield from any tax must be a sizable one.
• Further, this canon states that only those taxes should be imposed that do not
hamper productive effort of the community.
• A tax is said to be a productive one only when it acts as an incentive to
production.
• Canon of Elasticity
• Modern economists attach great importance to the canon of elasticity. This
canon implies that a tax should be flexible or elastic in yield.
• It should be levied in such a way that the rate of taxes can be changed
according to exigencies of the situation.
• Whenever the government needs money, it must be able to extract as much
income as possible without generating any harmful consequences through
raising tax rates.
• Income tax satisfies this canon.
 Canon of simplicity
• Every tax must be simple and intelligible to the
people so that the taxpayer is able to calculate it
without taking the help of tax consultants.
• A complex as well as a complicated tax is bound to
yield undesirable side-effects.
• It may encourage taxpayers to evade taxes if the tax
system is found to be complicated.
• A complicated tax system is expensive in the sense
that even the most honest educated taxpayers will
have to seek advice of the tax consultants.
 Canon of diversity
• Taxation must be dynamic. This means that a country‟s tax
structure ought to be dynamic or diverse in nature rather than
having a single or two taxes.
• Diversification in a tax structure will demand involvement of
the majority of the sectors of the population.
• If a single tax system is introduced, only a particular sector
will be asked to pay to the national exchequer leaving a large
number of population untouched.
• Obviously, incidence of such a tax system will be greatest on certain
taxpayers.
• A dynamic or a diversified tax structure will result in the
allocation of burden of taxes.
 Tax systems
Single and Multiple tax systems
• Single tax system is where there is only one tax in place;
• A single tax means only one kind of tax. It does not mean
tax on only one person. On other words, a tax on one thing
i.e. on one class of things or one class of people.
• Against this claim note the following problems:
– identification and choice of an appropriate single tax,
– the adequacy and growth of revenue,
 Major Merit
• Simple:

The greatest merit of a single tax lies in its simplicity.

Since, there is only one tax, it simplifies the work of
the Government. In a single tax system, collection of
revenue would be greatly simplified and it would be
much less costly, if all the taxes are replaced by only
one tax.

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 Major demerit
• Insufficient Revenue:

From the point of view of revenue, the single tax

may not be sufficient for the Government.
The financial needs of the Government are not
fixed and sometimes, the needs of the
Government suddenly increase which cannot be
met by the yield of a single tax.
 Multiple tax system
• A multiple tax system is with several tax structures
being used in the system.
• This means there should be all types of taxes, so that
every class of citizen may be called upon to
contribute something towards the state revenue.

• Any worthwhile tax system in a modern economy is

a multiple tax system.
 Taxation Systems
The ability to pay taxes can be accurately measured
with net income. It may be considered as an
appropriate basis for the allocation of tax burden
between different sections of the society. To
determine the appropriate tax system, various
factors are to be considered.
The tax systems may be summarized as follows:
1. Proportional Tax System.
2. Progressive Tax System.
3. Regressive Tax System.
 TAX AVOIDANCE AND EVASION
• Tax avoidance and evasions constitute a
problem in almost all the countries of the
world.
• Tax avoidance is different from tax evasion,
while evasion is against the law; avoidance is
within the realm of law.
• Suppression of income and & Inflation of
expenditure.
 Causes of Tax Evasion:
• Multiplicity of Tax Laws:
• Complicated Tax Laws:
• High Rates of Taxation:
• Inadequate Information as to Sources of Tax
Revenue:
• Investment in Real Property:
• Ineffective Tax Enforcement:
• Deterioration of Moral Standards:
 Remedies for Tax Evasion:
• Thorough Overhauling of Tax Laws:
• Reduction in Tax Rates:
• Replacement of Sales Tax & Excise Duties
with VAT:
• Maintenance of Proper Accounts:
• Introduction of Expenditure Tax:
• Tightening of Tax Enforcement:
 tax avoidance
• The tax avoidance can be defined as
“escaping from the tax liability by using the
available loop-holes of the tax laws”.
Features of Ethiopian Federal Finance

The functions of budget include the following:

 proper allocation of resources: - to relate expenditure decisions to
specified policy objectives and to existing and future resources;
 to relate all major decisions to the state of the national economy;
 Long term economic growth:- to ensure efficiency and effectiveness
in the implementation of government programs;
 to facilitate legislative control over the various phases of the budgetary process.
 equitable distribution of income and wealth and
 Securing economic stability and full employment.
 Budgeting in Ethiopia
• The government budget represents a plan/forecast by government
of its expenditures and revenues for a specified period.
• Commonly government budget is prepared for a year, known as a
financial year or fiscal year.
• In Ethiopia the fiscal year is from July 7 of this year to July 6 of
the coming year (Hamle 1-Sene 30 in Ethiopian calendar).
• Budgeting involves different tasks on the expenditures and
revenues sides of government finance.
 On the side of expenditure, it deals with the determination of the total
deals with the determination of the total size of the budget (i.e total amount
of money for the year), size of outlays on different functions, and the
magnitude of outlays on various activities;
 On the revenue side, it involves the determination of the size of the overall
revenue and foreign aid.
 The concepts of budgeting in Ethiopia
• Furthermore, budgeting also address the issue of the budget
deficit (i.e. the excess of outlays over domestic revenues), and it‟s
financing.
• Budgeting is not solely a matter of finance in the narrow sense.
Rather it is an important part of government’s general economic
policy.
• Budget is not solely a description of fiscal policies and financial
plans, rather it is a strong instrument in engineering and dynamiting
the economy and its main objectives are to devise tangible directives
and implement the long term, medium term, and annual
administrative and development programs”.
 Budget deficit
• A budget is considered as surplus or deficit according to the position of the
revenue accounts of the government.
 Thus a surplus budget is one in which revenue receipts exceed expenditure charged
to revenue account regardless of the gap in capital accounts; while a deficit budget
is one in which expenditure is greater than current revenue receipts.
Budget deficit is the excess of total expenditure over total revenue of the
government
• The deficit financing denotes the direct addition to gross national
expenditure through budget deficits whether the deficits are on revenue or capital
accounts”.
 It implies that the expenditure of the government over and above the aggregate receipt
of revenue account and capital account is treated as budget deficit of the government.
 Cont’d
 Moreover, if the government borrows from the banks rather than from individuals
the idle funds will be activated and there will be an increase in the total public
expenditure and thus there will automatically be an deficit financing has been
used in a different sense,.
 Here it is used to denote the direct addition to gross national expenditure as a
result of budget deficit.
 Thus deficit financing can be defined as “the financing of a deliberately
created gap between public revenue and public expenditure”.
 The government of Ethiopia has used deficit financing for acquiring funds to
finance economic development.
– When the government cannot raise enough financial resources through
taxation, it finances its developmental expenditure through borrowing from
the market or from other sources.
 Method of deficit finance
• There are four important techniques through which the Government may finance its
budgetary deficits. They are as follows:
A. borrowing from central bank
B. The running down of accumulated cash balances
C. The government may issue new currency
D. Borrowing from market or from external sources.
 Under the first method, government borrows from central bank as per budgetary
policy.
 In the second source, government spends from available cash balance.
 In the third measure, government issues new currency for financing deficit.
 The last method is that government borrows from internal and external sources to
finance its deficit.
 Expenditure assignment
• Fiscal decentralization involves shifting some responsibilities
for expenditures and/or revenues to lower levels of
government.

• One important factor in determining the type of fiscal

decentralization is the extent to which subnational entities are
given autonomy to determine the allocation of their
expenditures. (The other important factor is their ability to
raise revenue.)

• This note outlines principles and best practice and highlights

how country specifics will ultimately be the best determinant
of expenditure assignments.
 Budget preparation in Ethiopia
• Budget types
 Capital Budget
o are incurred on building durable assets, like highways, multipurpose dams,
irrigation projects, buying machinery and equipment.
o They are non-recurring type of expenditures in the form of capital investments.
Such expenditures are expected to improve the productive capacity of the
economy.
 Recurrent budget
o This type of expenditure is of recurring type which is incurred year after year.
o Preparation of the capital budget and recurrent involve seven distinct stages with
some reiteration whenever there is a need.
 budget Administration in Ethiopia
Powers of the Federal Government Organs
1. The MOF is authorized and directed, upon the request of the heads of the concerned Federal Government
organs, to disburse out of the Federal Government revenues and other funds the amounts appropriated
herein for undertakings of their respective organs.
2. The MOF is authorized to allow Federal Government Hospitals, to retain and expend within their total
budgetary appropriations, receipts from the current fiscal year up to an amount not exceeding 50% (Fifty
percent) of their receipt for the previous fiscal year.
3. Public bodies are hereby authorized to record on their appropriate budgetary head, subhead, project, or
program, as the case may be, and undertake all acts necessary for the utilization of any additional loan or aid
in kind and/or cash obtained from foreign or local sources for carrying out capital project or recurrent
programs, and report to the Minister of Finance and Economic Development within one month from the end
of the budget year.
4. The Ethiopian Customs Authority shall assess and record duties and taxes payable on goods imported by
public bodies, purchased with the proceeds of loans, or grants and appropriated from the treasury or acquired
in kind, and allow such goods to enter into the country. The Authority shall notify the assessment, thus
recorded to the public body concerned.
5. If the agreement signed between the consultant and the project executing public body stipulates that the
income tax and the service sales tax payable by the public body, the same shall inform the Federal Inland
Revenue Authority. The federal Inland Revenue authority shall on the basis of information it obtained from
the public body keeps record of such taxes. The authority shall also notify the public body of such record.
 Budget transfer
• Without prejudice to the provisions of Article 17-20 of the Federal
Government of Ethiopia Financial Administration Proclamation No. 57/1996
budget transfer shall be executed as follows:
1. Where a budget is required to finance pending obligations of a project
approved in previous years, such budget shall be allocated in the following
manner:

a. If the budget can be covered by transfer from the capital

budget of the public body, such transfer may be authorized by
the Ministry of finance.
b. If the budget can be covered within the overall capital budget
ceiling by transfer of capital budget of one public body to the
other, such transfer may be authorized by the Council of
Ministers on the basis of the recommendations submitted by
the Ministry of finance.
2. Transfer of recurrent budget from one public body to the other can be made
upon authorization of the Council of Ministers.
 Revenue assignment
• Governments rely on a wide variety of tax
instruments available for their revenue needs, such
as direct, indirect, general, specific, business and
individual taxes.
• The question addressed here is which types of taxes
are most suitable for use by each level of
government.

• In addressing the issue of the allocation of

revenue raising powers, the main question is how
the taxation power is distributed between the tiers
of government in federal system.
 Pattern of revenue sharing
 Ethiopia has chosen the federal structure in which A clear
distinction is made between the federal and region functions and
sources of revenue, but residual powers, belong to the center,
although the states have been assigned certain taxes, which are
levied and collected by them, they also share in the revenue of
certain federal taxes.
 In addition, the regions receive grants-in-aid of their revenue from the federal
government, which further increase the amount of transfers between the two
levels of government.
 The transfer of resources from the central government or Federal
to the states is an essential feature of the present financial system.