Chapter 12

Income taxation

Learning outcomes

• Define the comprehensive income tax base• Discuss the international principles of taxing income• Discuss the reasons why the personal income tax

base differs from the comprehensive income tax base• Explain what a progressive personal income tax is

and how progressiveness is achieved• Discuss the economic effects of personal income tax• Explain why companies are taxed separately• Define the company tax base• Describe the classical and fully integrated company

tax systems.

Learning outcomes (continued)

• Describe company tax in South Africa• Explain the efficiency of company tax• Discuss the importance of company tax in the

investment decision• Discuss the merits of tax incentives for investment• Explain the equity implications of company tax• Discuss the arguments for and against capital gains

taxation• Explain a flat rate income tax• Explain the dual income tax.

The comprehensive income tax base

Three bases• Income• Wealth• ConsumptionIncome• Y = C + S• Anything that makes consumption possible• Recorded as accrued, not when realised.

International taxation

2 principles• Residence of taxpayer

– Country where person lives receives tax

• Source of income– Country where income is generated receives tax

Issues facing developing countries• Source basis resembles benefit principle• Tax system should not influence locational decisions.

The personal income tax base

• Gross income• Exempt income• Net income• Taxable income• Tax expenditures

– Exclusions– Exemptions– Deductions– Rebates/credits.

Calculating personal tax liabilityTOTAL (COMPREHENSIVE) INCOME

minus Exclusions (eg imputed rent & unrealised capital gains)

GROSS (CASH) INCOMEminus Exemptions (eg tax-free portion of interest)

NET INCOMEminus Deductions (eg contributions to medical scheme)

TAXABLE INCOMETax according to tables

GROSS TAX LIABILITYminus Rebates (primary rebate and rebate for age 65 and over)

NET TAX LIABILITY

Personal income tax rate structure

• Unit of taxation/filing status• Consider:

– Single vs married vs family with children– One partner vs two earning an income

• Equal marginal sacrifice principle• Progressivity• Marginal tax rates.

Supply of labour and income tax on personal income

The excess burden of proportional tax on personal income

Effect of an income tax on savings

Equity, administrative efficiency and tax revenueEquity• Sensitivity of labour supply to price and taxAdministrative efficiency• Simplicity• Presumptive taxation• Laffer curve.

The Laffer curve

Flexibility

• Bracket creep• Real income• Nominal income.

Company taxation

Reasons for taxing companies• Separate entities• Recipients of benefits from government• Ability to limit personal income tax liability• Address market failures through taxing excessive

profits of imperfectly competitive firms• Administratively simple• Derive revenue that would otherwise accrue to

foreign investors.

Structure of company tax

The company tax base• Incorporated

– Private and public

• Unincorporated– Sole proprietorships and partnerships

• MiningTaxable income• Total receipts (revenue) – Allowable expenses

(costs).

Type of company tax

• Classical system– Double taxation

• Full integration system• Dual tax rate – basic tax on companies• Proportional tax• Secondary tax (STC).

Cash-flow tax

• Real & financial cash-flow tax base equals [(sales + borrowing + interest received) – (real purchases + interest payments + debt repayment)]

• Advantages– Simple definition– Neutral

• Shortcomings– Windfall tax revenue gains/losses– Full & immediate expensing– Base shifting– International taxation– Administration?

Economic effects of company tax

• Economic efficiency• Investment

– Decision to invest– Non-tax factors– Tax incentives– Tax holidays.

Tax incentives – arguments for and againstFor

• Incentives for market failures• Compensation for regulatory

distortions• Addressing labour market

distortions• Constraints in capital markets• Temporary investment

incentives for infant industries• External benefits (innovation)• Signal for foreign investors.

Against

• Administration• Erosion of tax base

(necessitating higher tax rates)• Pressure group action• Uneven tax burden• Less successful in attracting

foreign investment• Windfall gains would have

taken place anyway• Obstacles to investment better

address directly.

Capital gains tax

• As accrue vs as realised• Change in ownership of an asset• Capital losses• First R20,000.00 excluded• Exemptions.

Capital gains can be defined as increases in the net value of assets over a period (e.g. an accounting period or fiscal year).�

Capital gains tax – arguments for and againstFor

• Protect integrity of personal income tax base

• Ensure horizontal equity• Ensure vertical equity• Improve economic efficiency.

Against

• Administrative challenges• If nominal profits are taxed,

equity is at risk• Lock in rather than realise

investments.

Income tax reform

• Flat rate income tax• Duel income tax

– Personal capital income separately taxed from labour income

– Labour income– Company income– Nordic countries.

Dual Income Tax – arguments for and againstFor

• Impact of globalisation and international mobility of capital

• Efficiency• Administration.

Against

• Splitting of income (capital & labour)

• Lack of responsiveness to international competition

• Vertical inequity.

Thank you.