Analyzing the Role of Taxation in Public Financial Management System

This report provides a comprehensive analysis of the role of taxation in public financial management. It begins by defining public finance and taxation, highlighting their significance in economic development and government operations. The report explores key aspects such as tax equity, the benefit and capability-to-pay principles, and different tax bases including direct and indirect taxes. It also delves into the principles of an effective tax system, including equity, simplicity, economy, certainty, and convenience. The analysis covers the objectives of taxation, its impact on resource allocation, income distribution, and economic stabilization, emphasizing the crucial role taxation plays in generating government revenue and ensuring smooth financial operations. The report concludes by underscoring the importance of taxation in achieving effective public financial management.

Running head: THE ROLE OF TAXATION IN PUBLIC FINANCIAL MANAGEMENT
The Role of Taxation in Public Financial Management
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1THE ROLE OF TAXATION IN PUBLIC FINANCIAL MANAGEMENT
Table of Contents
Introduction......................................................................................................................................2
What is Public Finance?..................................................................................................................2
What is Taxation in Public Finance?...............................................................................................3
Tax Equity.......................................................................................................................................4
Tax Base and Tax Yield..................................................................................................................5
Principles of an Effective Tax System.............................................................................................6
Taxation and Public Financial Management...................................................................................8
Conclusion.......................................................................................................................................9
References......................................................................................................................................11

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Introduction
Effective management of public finance is considered as a crucial aspect for the overall
economic development of country or a particular region. In addition, the success of public sector
is largely dependent on the effective management of public finance. Public financial
management involves in managing the flow of the source of resources with ensuring the
sufficient flow of revenue and income in the financial system for ensuring the smooth flow of
overall operations (Shoup, 2017). There are many aspects that create impact on the effective
management of public finance and taxation is one of those crucial aspects. Taxation is a major
tool for the government that is utilized for imposing on the parties in order to collect revenue or
income. Therefore, taxation plays a crucial role in ensuring the incoming of adequate income or
revenue in the public finance system so that all the operations can be carried out appropriately
(Bailey, 2017). The main aim of this report is the assessment of the role of taxation in the public
financial management. In order to achieve this aim, this report delves into the aspects like the
exploration of taxation in public finance, tax equity, bases and yields of taxation, mechanism of
taxation and other.
What is Public Finance?
Public finance refers to the term whose application can be seen in the specific groups of
the policy related issues that involve in using the measures of taxation and expenditures.
Therefore, public finance is associated with government’s operations in the areas of revenue,
debt and expenditures along with the impact of these aspects on the society. The major
components of public finance include taxation system, budget procedures, expenditure programs,
stabilization instruments, debt issue, extent of governance and others. The main need for public

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finance can be seen in the areas of resource allocation, distribution function, stabilization
function and sourcing the revenues for government (Fisher, 2018).
What is Taxation in Public Finance?
In public financial management, Taxation can be considered as the mechanism of
imposing on and collecting taxes from the wealth and income of the individuals and companies
by the government for financing its regulatory and social activities. Therefore, taxation
associated study takes into account the complete taxation mechanism that includes taxation
policies, laws and administrations. Therefore, the revenue of the government is derived from
taxation. A tax is a mandatory and compulsory contribution that the government receives from
the taxpayers. It is considered as mandatory because of the presence of a lawful certificate that
provides the government with the permission of collecting such payment from the taxpayers.
However, careful analysis shows this particular definition of taxation as penalties and fines paid
to the government. For this reason, as per the most reliable and dependable definition of taxation,
a tax is a obligatory contribution that imposed by a public authority irrespective of the precise
amount of provided services to the taxpayer in return and not imposed as a fine or penalty for
any lawful offence (Gadenne, 2017).
Tax imposition leads to the creation of liability upon those have the liability of paying the
amount of imposed tax. Government always expresses a tax liability in economic provisions and
it is important to mention it that a burden is created by any monetary liability. More specifically,
a tax burden is created on the taxpayers because of the imposition of taxes (Edwards, Schwab &
Shevlin, 2016). In the management of public finance, three main objectives of taxation can be
seen; they are appropriate allocation of resources, appropriate distribution of income through

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lessening inequalities in the income and wealth distribution and brining stabilization through the
implementation of tax policies, government expenditures, monetary policy and debt
management. Therefore, it can be seen that taxation has a crucial role to play in public finance.
Tax Equity
In the public finance management, equity in taxation is the fairness to distribute the tax
burden. For the purposes of complying and fending off the public disagreement, there is a greater
need for allocate the tax burden in more reasonable manner. There are two principles developed
by the government as a guide to taxation equity (Świstak, Wawrzak & Alińska, 2015). They are
The Benefit Principle and The Capability of Paying Principle.
The Benefit Principle – This particular approach states that the apportionment of taxes is done
as per their derived benefits from government spending and activities. Therefore, the need is to
treat the taxes as a compensation for the service provided and goods sold as provided by the
government.
The capability of Paying Principle – The main concern of this is the reasonable allocation of
taxes as per the affirmed taxable capability or capability of paying off an individual or business
organization. This particular approach puts emphasis on distributing the income in such a manner
that the individuals or organizations with higher income sacrifice more so that the appropriate
equitable distribution of income can be achieved (Caichen & Shan, 2017).
Equality is necessary for both of these principles. In order to accomplish this much
needed equality in taxation, the governments make the taxes to be professional, progressive or
regressive based on whether taxes are collected from individuals or companies with higher
income the same amount of tax as compared to the collected tax from people of low income.

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Therefore, the general taxation philosophy of benefit or capability of paying the taxes alone does
not answer the question associated with best tax method and this contributes to the necessity of
political process. All the taxation related principles are put into use for the development of the
most appropriate taxation mechanism or framework. For these reason, tax equality is regarded as
a crucial aspect in the management of public finance (Salihu, Annuar & Obid, 2015).
Tax Base and Tax Yield
Taxes are classified into two bases in public finance management; they are Direct taxes
and Indirect taxes. The role of both of these tax bases in public finance management is discussed
below.
Direct Taxes – Government levies these taxes directly on the income of the individuals or
business organizations. The main components of these taxes are income tax, payroll levy and
other withholding taxes. Income is considered as the base for these direct taxes. More
specifically, direct taxes refer to the tax based income. The tax income or tax yield from the
direct taxes is reliant on the income of individuals and business corporations (Puzule, 2015).
While discussing the advantages of direct taxes, it needs to be mentioned that there is not
any inflationary tendencies in them; and general price levels are not generally affected with the
increase or decrease in direct taxes. Moreover, in case of progressive taxes, high equality can be
seen in these direct taxes (Ibadula et al., 2017).
Along with these advantages, there are certain disadvantages of direct taxes in public
finance management. It is hard to ascertain the taxable income of the taxpayers in the cash
economies where the taxpayers have low general level of education. There are many disputes
associated with the direct taxes because of the difficulties in understudying these taxes. Since

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direct taxes affect the disposal income, they are highly unpopular. Progressiveness associated
with the direct taxes may be discouragement to hard work that creates discouragement in savings
and investments. Direct taxes have a narrow tax base and it is not possible to shit the tax
incidents.
Indirect Taxes – Government levy indirect taxes on goods or services. Therefore, goods
produced and rendered services are the main bases of indirect tax and tax yields from the indirect
taxes are largely dependent on the goods produced and service rendered. The collected revenue
from a particular indirect tax will there be reliant on how broad the tax base of that particular
indirect tax is.
Certain advantages of indirect taxes largely contribute to effective management of public
finance. It is easy to collect the indirect taxes which increase the revenue of the government; and
indirect taxes provide a brad tax base that creates revenue potential. Moreover, the tax
inducements can be shifted to the last consumers as the taxes are incorporated in the prices of the
taxable goods and services (Banerjee, 2018).
At the same time, indirect taxes have certain disadvantages that are not good for public
finance management. Indirect taxes tend to be regressive, particularly when they are imposed on
goods and services consumed by the earners of low income. In addition, inflationary tendencies
can be seen in the indirect taxes and thus, the general price level is likely to be disturbed due to
the increase in tax rates. Hence, they affect the effective management of public finance.
Principles of an Effective Tax System
Taxation which is a compulsory contribution from businesses and individuals to the
government for discharging the public expenditure by the government has certain positive effects

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on the economy and the social life of the society. These effects can both be constructive or
destructive for the economy. The presence of certain principles or criteria to evaluate the taxation
system can be seen for minimizing the destructive impact of taxation on the economy. The
principles are discussed below:
Equity – Equity involves in levying the taxes in such a manner so that fairness is promoted. This
is connected with the progressive tax system that takes away proportionately more income from
the individuals and companies with higher income and less income from the individuals and
companies with lower income. Therefore, the characteristics of the taxation system should
include a progressive structure and a minimum exemption policy. This leads to treat the equals
equally and the unequal unequally. This promotes effective public finance management
(Downer, 2016).
Simplicity – A tax system needs to be simple and this effortlessness means the taxpayer should
have the understandability of the taxation system along with the tax base. This makes the
taxpayers able in computing their taxation liabilities along with the fines or penalties involved
for neglecting the taxation law. Therefore, it becomes possible for the taxpayers in paying the
taxes in time that increases the earnings of the government which facilitates public finance
management (Hedau, 2018).
Economy – Effective management of public finance requires the taxation system to be least
expensive in case of both manpower and material. The cost benefit analysis needs to be
considered as there is not any point in spending more money that the collected revenue. There is
a need for optimizing the collected costs for judging whether a tax system is uneconomic or not;
and this requires considering both the financial and non-financial costs (Waris & Latif, 2015).

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Certain – In order to provide assistance in government’s forward planning and public financial
management, the imposition of tax needs to be yield the expected return. There are certain rates
of taxes on some commodities and others have uncertain tax rates. This particular criterion
advocates that the taxpayers have the knowledge and information of knowing precisely and
exactly the time to pay tax along with the amount of payment and manner of payment.
Convenience – In order to be effective, tax needs to be taxed at the time and manner so that it
becomes convenient to the taxpayers. The systems that allow the taxpayers in paying the tax after
crop harvest season or make payment arrangements are considered as convenient to the tax-
payers; and a tax system that puts heavy tax load on the taxpayers long-after the income is
exhausted is considered as an inconvenient tax system. Hence, it is clear that convenient tax
system ensures flow of revenue that facilitates effective public finance management (Hosen,
2019).
Elasticity to Changes in the Tax Base – A good and effective tax system should have elasticity
to change in the tax base and a tax is considered as elastic when the yielded amount of revenue
ensures the fast growth in income of the economic activities. Therefore, the government can
ensure the inflow of sufficient revenue for the planned projects (Van Zyl, 2015).
Taxation and Public Financial Management
Two important roles are played by the tax policy for ensuring effective management of
public finance. One role can be seen in maintaining an economy at a higher level of employment
so that there is increase in the saving capacity of people with the increase in income per head.
The second role can be seen in raising the marginal tendency to save of the community as above
the average tendency to maximum possible extent without discouraging the work effort or

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violation of taxation equity components. The generation of savings can be done in two ways;
through the increase of real output or decrease in real consumption (Donohoe, 2015).
The primary goal of the tax system of a country is the generation of adequate revenues
for paying off the government expenditures at all levels. Since public expenditures have the
tendency of growing as fast as the national product, taxes are considered as the main vehicle of
public finance that is responsible for producing revenue that grows equally. This criteria is met
by income taxes, value added taxes and sales taxes (Poledna & Thurner, 2016).
Apart from the generation of revenue and income, government may use the tax policy for
the promotion of economic stability and public finance. Changes in tax liability having no match
with the changes in expenditures mitigate repeated fluctuation in price, production and
employment. Built-in-flexibility takes place as the income tax liabilities strongly reacts to the
economic condition changes. Revenue and debt is used by the governments for financing the
public expenditures; and taxes are considered as the main source of public finance. Fairly equal
split of income taxes and commercial taxes ensures that the government has adequate flow of
revenue and income so that all the aspects of public finance can be achieved (Evers, Miller &
Spengel, 2015). Moreover, these aspects increase the importance of taxation in the effective
management of public finance.
Conclusion
The above analysis shows different roles of taxation in public financial management. In
public finance, the main function of taxation mechanism can be seen in imposing and collecting
the taxes from the individuals and companies on a proportionate basis. These collected taxes are
considered as the main income or revenue of the government for facilitating different function of

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public finance such as expenditure programs, budgeting procedures, issue of debt and others. In
this whole process, two main plans of tax equity that are the benefit plan and the capacity of
paying principles ensure the presence of fairness in the distribution of tax burden. For example,
more tax is collected from individuals with higher income and less tax is collected from
individuals with lower income. Both the direct taxes and indirect taxes ensure the yield of
adequate revenue from tax liabilities so that effective management of public finance can be
achieved. At the same time, the principles of an effective taxation system ensure that the taxation
rules and policies have a positive impact on the taxpayers along with economy. On the overall
basis, taxation large contributes to the correct management of public finance by ensuring the
presence of adequate revenue in the system. Moreover, effective taxation system also assists the
governments in other aspects of public finance such as budget management, debt issue and many
others.

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Its Implications. Taxation Research, (4), 2.
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Fisher, R. C. (2018). State and local public finance. Routledge.
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accountability. American Economic Journal: Applied Economics, 274-314.