The literal meaning of patrimony is the estate that descended from the father to his descendants.  However, this does not exclude the estate that descends from the mother to her descendants and/or from other ancestors in the paternal as well as in the maternal line. 

In the law of property, patrimony may have a different meaning.  As it is discussed in Marcel Planiol, a person’s rights and obligations appreciable in money looked upon as a whole are called his/her patrimony.  There is a link between a person and patrimony.  This link can be expressed in the following four ways:

A)   Only persons have patrimony with the exclusion of other beings. Persons are beings that are capable of having rights or owing obligations.

B)  Every person necessarily has a patrimony, irrespective of the fact that the person has no property at all.  Patrimony is linked to the personality of the person.

C)    Patrimony is a unit.  All the property and all the charges of a person form a single mass.  However, this principle of unity of patrimony is subject to exceptions.  One example of the exceptions is — an heir seems to have two patrimonies.

D)       Patrimony is inseparable from the person.  Therefore, there can’t be a total transfer of property of the person while he/she is still alive.  A person can dispose only part of the constituent elements of his/her patrimony, one after the other.  His/her patrimony, considered as universality, is the consequence of his/her own personality and necessarily remains attached to his/her personality.  Transmission of patrimony in its totality takes place only after the person’s death.  At that moment, the deceased’s patrimony is attributed to his/her successors.

Many legal experts argued, based on these principles of patrimony, that a person should not have the right to regulate his/her estate after his/her death, as death has brought a complete separation of the person and patrimony.  (See Wills below for details of discussion on this point)

Opening of Succession

As it is expressed in Article 826 of the Civil Code, the succession of the person opens at the place he/she had his/her principal residence at the time of his/her death. (For detailed consideration of the concept of residence, refer your Law of Persons material.)  According to Article 174 of the 1960 Civil Code, the residence of the person is the place where he normally resides. The normality of residence will show that the person’s socio-economic life in the society. When a person has many residences, one of such residences may be considered as a principal residence of such person. For the purpose of opening of the succession of the deceased, it is appropriate to consider the principal residence of the deceased the place where he/she has most of his/her inheritable property.  

The succession of the deceased shall open just at the time of his/her death. Assume that Ato Markos, in the above example, died on August 29th just at 3:00 O’clock in the afternoon; Ato Markos’s succession has opened at the moment when his death occurred. That is, his succession has opened just at 3:00 O’clock. The deceased may have his/her societal ties at his/her principal residence.

According to Article 1 of the Civil Code, the human person is subject of rights (and also duties) from its birth to its death. This means a dead person has no rights or duties. But there are certain rights and obligations of the deceased person that pass to the heirs and/or legatees of the deceased.  There are also rights and obligations of the deceased that terminate with his/her death. Most of the rights and obligations that are associated with the person of the deceased shall extinguish with the death of the deceased. However, many of the rights or obligations that are related with the property and/or money of the deceased shall pass onto his/her heirs and/or legatees.

Some obligations of the deceased could also pass to his heirs and/or legatees.  For instance, if the deceased is a debtor, his heirs and/or legatees are bound to pay back his debts. As you will learn in the future, the heirs and/or legatees of the deceased will not be bound to pay the debts of the deceased from their own personal property.  They are only bound to pay such debts from the property of the inheritance, according to the rules of the Ethiopian law of successions.

Things making up a Succession

Generally speaking, what transfer from the deceased to his/her heirs and legatees are those rights and duties of the deceased which arise from various relations which the deceased had with third parties during his/her lifetime. It is possible to indicate some of the principal relations between the deceased and third parties which can serve as source of rights and duties of the deceased like: contractual relations the deceased had with third parties; contract of insurance between the deceased; rights which arise from court proceedings between the deceased and third parties; and those rights generally referred to as property rights – those rights we create and exercise against things, corporeal (movable or immovable) or incorporeal.

Under this sub-section, discussions will be made on the features of inheritable property of the deceased. As a matter of principle, all of the property which were owned or possessed by the deceased on the day of his/her death shall constitute his/her inheritance. All the inheritable property left by the deceased at the time of his/her death are called the hereditary estate.  The hereditary estates are not limited to corporeal (tangible) things.  They also include incorporeal (intangible) things such as the works of the mind or literary rights.

Sometimes it may be difficult to clearly identify the property of the deceased that constitute the inheritance.

Life insurance

As prescribed in Article 827 of the Civil Code, life insurance could or could not constitute a hereditary estate.

Art. 827. — Things making up inheritance. — Life insurance

$1(1)               Monies due in performance of a contract of life insurance to which the deceased was a party, shall form part of the inheritance where the deceased has not determined the beneficiary or the insurance is made to the benefit of the heirs of the deceased without any other indication.

(2)               In other cases, they shall not form part of the inheritance.

Read also the following provision, which is taken from the Commercial Code of 1960.

Art 691. — Definition

A life insurance is a contract whereby the insurer undertakes against the p ayment of one or more premiums to pay to the subscriber or to the beneficiary a specified sum on certain conditions dependent upon the life or death of the subscriber or third party insured.

From the definition of life insurance it can be seen that:

A)    Life insurance is a contract.

B)    The contract is made between the insurer (insurance company e.g. the Ethiopian Insurance Corporation) and the subscriber (a person who buys the life insurance policy and makes a periodical payment of premiums to the insurer).

C) The insurer undertakes or commits itself to pay the agreed amount of money to the beneficiary upon death of the subscriber.

How life insurance would make up inheritance is an important question that deserves discussion. Read the following example carefully.

Only under the above two conditions that the money to be collected from the insurer upon death of the subscriber forms part of the inheritance.  If the subscriber, Wro.  Genet, designates her spouse or only one of her children, or any other person, the money to be collected upon death of the subscriber of the life shall not form part of the inheritance of the subscriber. In this case, the money will be available only to the designated beneficiaries. 

There is no unanimity in decisions of courts of various levels regarding the rule under Art. 701(2) is concerned. Some courts make this provision applicable to all cases. For instance, if Ato Kassa buys a life insurance policy to the benefit of his brother Gobena, some courts make his wife Wro. Chaltu and his children Meron and Abdissa beneficiary of the life insurance.  These courts mainly base their arguments on the expression of the law that says the subscriber’s spouse is beneficiary even if the marriage is concluded after the policy was entered and also the subscriber’s children are beneficiaries even if they are not mentioned by name. Other courts do not accept this argument. The Federal Supreme Court usually rejects decisions on such arguments. According to the latter courts, it is only the person who is indicated as beneficiary who is going to collect the money. The spouse shall be beneficiary only when the subscriber makes her/him beneficiary, even the insurance is entered before the conclusion of the marriage. The subscriber must indicate that his wife or her husband shall be beneficiary of the life insurance. Likewise, he/she must indicate that the insurance is made to the benefit of his/her children without indicating their name. If a spouse or the children are not indicated in this manner and if another person is appointed as beneficiary, they have no chance of becoming beneficiaries.

Which line of argument do you favor?  

For detailed information on this issue, read Journal of Ethiopian Law, Vol. 16, pp 67—80 and Ethiopian Bar Review, Vol. 1 № 1, pp 35—94

Pensions and Indemnities

In Ethiopia, pension is regulated by ‘Public Servants’ Pensions Proclamation № 345/2003 and the amendment Proclamation № 424/2004. The main purpose of pension scheme in Ethiopia is to support the person who was a public servan during the time when he/she is unable to work. In addition to this, the pension scheme has the purpose of supporting those persons who were maintained by the pensioner during his/her life time. Pension is money payable to the spouse, children or parents of the deceased person based on conditions specified under Proclamation № 345/2003.  The mechanism of payment is regualted by Articles 34 — 39 of this Proclamation.  According to Art 35(1) of this Proclamation, if a person who is a government employee dies, the widow or the widower would be entitled to receive 50% of the pension to which the deceased was or would have been entitled.  The Proclamation also prescribes the amount of orphan's pension and parent's pension.  Accordingly, each of the deceased's children would receive 20% of the pension to which the deceased was or would have been entitled.  Orphans are entitled to receive this amount so long as they are less than 18 years of age.  The money collected from pension allowance can be given to the persons who were supported by the pensioner. Pension money is not the estate left by the deceased at the time of his death. The purpose of pension is, as indicated above, to support the pensioner when he/she is unable to earn his/her livelihood through his/her work or to support those who were dependent on the pensioner (only spouse and very close relatives) upon his/her pension allowance. The spouse or the relative of the pensioner has no right to pass the pension allowance to which he/she is entitled to his/her heirs when he/she (the spouse or the relative) dies. Therefore, pension allowance does not constitute the hereditary estate of the deceased.

Indemnity is money to be paid to the spouse or relatives of the deceased person.  Assume that a car hits Dawit and killed him. The driver or the owner of the car may be obliged to pay compensation to the spouse or relatives of Dawit.  These persons sustained injury because of the death of Dawit.  The one who caused the death of the person may pay compensation or indemnity to these persons.  However, such money cannot form part of the inheritance of the deceased. For instance, if the person who is entitled to receive the indemnity payment dies, the money cannot go to his heirs.

A person’s succession may be conducted in one of the two types of successions. As it is prescribed in Art. 829, succession could be either testate or intestate. It could also be the combination of the two types. Testate succession is a succession in which the estate of the deceased person shall pass to his heirs and/or legatees according to the order of the deceased in the will he/she made.  If the deceased made a valid will, his/her succession would be conducted in accordance with the will. A person who left a will is called a testator.  The testator shall regulate as to what should happen to his property after his death. If the testator had no will at all, or his/her will is not valid, the succession of such person shall be conducted by the operation of the law.  That is, in the case where there is no will, or where the will is invalid, the law shall distribute his estate among his heirs.

Sometimes it may happen that the succession is a combination of both intestate and testate. Many circumstances could lead to such a situation. For instance, property which was not included in the will may be discovered later; the will may be partially invalidated; the testator may appoint a universal legatee who is not a legal heir to take only some portion of the hereditary estate and with respect to the rest of the estate he/she may keep silent; etc

The history of taxes reveals that their coercive nature is of comparatively recent development. The original idea of a tax was that payment was not obligatory upon the subject, but consisted rather as a voluntary contribution toward the expenses of government, as appears from the Medieval Latin term donum, and the English "benevolence." This conception of the relation between the subject and government was gradually transformed; payment becoming more and more obligatory, until finally coercive taxation resulted. At the present time payment of taxes is obligatory in all civilized nations; where the rate or imposition is at all dependent upon the taxpayer, the tax takes the form of a fee or payment for contractual services.

Resources were allocated among the various sectors of the economy differently in the imperial and revolutionary periods. Under the emperor, the government dedicated about 36 percent of the annual budget to national defense and maintenance of internal order. Toward the end of the imperial period, the budgets of the various ministries increased steadily while tax yields stagnated. With a majority of the population living at a subsistence level, there was limited opportunity to increase taxes on personal or agricultural income. Consequently, the imperial government relied on indirect taxes (customs, excise, and sales) to generate revenues. For instance, in the early l970s taxes on foreign trade accounted for close to two fifths of the tax revenues and about one-third of all government revenues, excluding foreign grants. At the same time, direct taxes accounted for less than one-third of tax revenues.

The revolutionary government changed the tax structure in 1976, replacing taxes on agricultural income and rural land with a rural land-use fee and a new tax on income from agricultural activities. The government partially alleviated the tax collection problem that existed during the imperial period by delegating the responsibility for collecting the fee and tax on agriculture to peasant associations, which received a small percentage of revenues as payment. Whereas total revenue increased significantly, to about 24 percent of GDP in l988/89, tax revenues remained stagnant at around l5 percent of GDP. In l974/75, total revenue and tax revenue had been l3 and 11 percent of GDP, respectively. Despite the 1976 changes in the tax structure, the government believed that the agricultural income tax was being underpaid, largely because of under assessments by peasant associations.

The government levied taxes on exports and imports. In 1987 Addis Ababa taxed all exports at 2 percent and levied an additional export duty and a sur-tax on coffee. Import taxes included customs duties and a 19 percent general import transaction tax. Because of a policy of encouraging new capital investment, the government exempted capital goods from all import taxes. Among imports, intermediate goods were taxed on a scale ranging from 0 to 35 percent, consumer goods on a scale of 0 to l00 percent, and luxuries at a flat rate of 200 percent. High taxes on certain consumer goods and luxury items contributed to a flourishing underground economy in which the smuggling of some imports, particularly liquor and electronic goods, played an important part.

Although tax collection procedures proved somewhat ineffective, the government maintained close control of current and capital expenditures. The Ministry of Finance oversaw procurements and audited ministries to ensure that expenditures conformed to budget authorizations.

Current expenditures as a proportion of GDP grew from l3.2 percent in l974/75 to 26.1 percent in l987/88. This growth was largely the result of the increase in expenditures for defense and general services following the 1974 revolution. During the l977-78 Ogaden War, for example, when the Somali counteroffensive was under way, defense took close to 60 percent of the budget. That percentage declined after l979, although it remained relatively higher than the figure for the pre-revolutionary period. Between l974 and l988, about 40 to 50 percent of the budget was dedicated to defense and government services.

Economic and social services received less than 30 percent of government funds until l972/73, when a rise in educational outlays pushed them to around 40 percent. Under the Dergue regime, economic and social service expenditures remained at pre-revolutionary levels: agriculture's share was 2 percent, while education and health received an average of l4 and 4 percent, respectively.

The Ethiopian Tax Reform of 2002

Since 1992/93, the Government of Ethiopia has made a major economic policy shift from Central Planning to market oriented economic system. In line with this change, a series of tariff and tax reform measures have been taken. The reasons to these were: outdated tariff and tax laws; weak customs and tax administration; failure of the tariff and tax regime to attract investment, to facilitate trade and to generate adequate revenue to cover current and capital expenditure, and hence finance development and poverty reducing projects. 

The series of tariff and tax reform programs have helped to increase both Federal Government and national revenue. As per the reports of the Ministry of Revenue, the Federal Revenue has increased to Birr 6.7 billion in 2002/2003 from Birr 2.54 billion in 1993/94 as the result of which federal revenue as percentage of the GDP increased from 8.97% in 1993/94 to 11.87% in 2002/03. The increase in revenue mainly attributes to the modest increase in both direct and indirect taxes, mainly the foreign trade taxes. As well, National tax revenue as percentage of GDP has increased to 15.1% in 2002/03 from 10.9 in 1993/94. Despite, the series of reforms and increase in revenue, the overall budget deficit with and without grant has been increasing. For example, the overall budget deficit without grants as percent of GDP has increased from -5.2% in 1996/97 to -14.5% in 2002/03. This shows that performance of revenue collection in Ethiopia has been low compared to the rest of Sub-Saharan African countries which is over 23% of the GDP. 

Hence, coupled by a series of reduction in the import tariff, excise tax and income tax and widening of the budgetary deficit, introducing a neutral and efficient tax, i.e. the VAT with broad tax base was considered. Value Added Tax (VAT) has become a major tax instrument worldwide.  The global trend to introduce VAT in more countries is continuing.  VAT has also become an indispensable component of tax reforms in developing countries.  Ethiopia's tax reform program has introduced VAT since January, 2003. 

VAT revenue performance and its neutrality and efficiency are also the reasons for superiority of this tax in contrast to other common tax instruments such as the turnover tax.  The emerging conventional wisdom, based largely on practice and numerous country case studies, suggests that a single rate VAT (with the rate between 10 and 20%), with very few exemptions and, therefore, a broad base is superior to a VAT with multiple rates and many exemptions which reduce its base and complicate administrations.  Ethiopia's standard VAT rate of 15% and 10% equalization for services and 2% for goods have to be studied in the medium term whether or not they could broaden the tax base and register high revenue performance. The three major taxes and their respective Tax Reforms are explained below:

1. Taxes on Income and Profits

Tax on employment income used to be guided by Income Tax Proclamation No. 173/1961. In the 1990s, this proclamation was amended with modifications to the legislation regulating income tax on employment: rural land and agricultural income tax; rental income tax; taxes on business and other profits; tax on income form mining activities; capital gains tax, and taxes on other sources of income such as chance wining (which carries a tax rate of 15 per cent), royalties (with a tax rate of 5 per cent) and tax on non-resident persons offering services in Ethiopia (which carries a tax rate of 10 per cent).

This reform resulted in a schedule for marginal tax rate which is currently being applied to income exceeding Birr 150, the assumed minimum wage rate. Compared to the marginal tax rate of 89 per cent during the military (Dergue) period; the current reform which reduced the maximum marginal tax rate to 35 per cent was quite radical. The 1978 income tax for rural land and agricultural activities was also amended in 1995 and 1997. For land use, farmers are now taxed Birr 10 for the first hectare and Birr 7.5 for each additional half hectare. Moreover, annual income exceeding Birr 1,200 is subject to a progressive tax rate (as outlined in Appendix Table 1). The land use fee for state farms is Birr 15 per hectare. A novel aspect of the latest tax policy concerning the agricultural sector is the fact that an agricultural investor is exempted from income tax for two consecutive five-year periods. A progressive marginal tax rate schedule was also enacted in 2002 for income derived from the rent of houses (including manufacturing plants).

2. Taxes on Goods and Services

The reform in this category refers to Excise Tax Proclamation (No. 68/193, 77/1997, and No. 149/1999), and the applicable tax rate ranges from a low of 10 per cent on textiles and television sets to 100 per cent for alcohol, perfumes and automobiles. Sales tax on goods constitutes the second category and these ranges from 5 per cent (mainly for agricultural goods) to 15 per cent. Many basic goods are exempt from taxation. The reform also introduced a 5 per cent tax rate for work contracts and financial services, while a 15 per cent rate is applied to the sale of other services. Valued-added tax (VAT) was introduced in January 2003 and may mean a shift from Ethiopia’s dependence on foreign to domestic trade, but it is too early to evaluate its impact. It is not, however, difficult to see that its implementation is a challenge, owing to the predominance of small and informal operators in the country, its history of tax evasion and corruption, lack of standard recordkeeping systems as well as the lack of knowledge about VAT and a tax-base for its computation.

3. Taxes on International Trade

The reform of taxes on international trade relates to levies on imports (customs duty, import excise tax, import sales tax) and tax on exports. The custom tariff reform that took place between 1993 and 2002 grouped imports into 97 categories based on the Harmonized System of Tariffs Classification Code. An ad valorem rate ranging from 0 to 35 per cent was introduced. The same rates were applied for import excise and sales taxes as those established for goods and services (see section above). An important development in the export sector was the abolition of all export taxes, with the exception of coffee. Similarly, to encourage exports, schemes for duty drawback and duty free imports were implemented (see Appendix Table 1 for details).

Other miscellaneous tax-related reforms have been carried out in the last decade. These include the amendment of stamp duties (Proclamation No. 110/1998); the introduction of a 3 per cent withholding tax (Proclamation No. 227/2001), a 2 per cent withholding tax on income (Proclamation No. 227/2001), as well as a 5 per cent withholding tax on interest income (Proclamation No. 227/2001).

Major Types of Taxes in Ethiopia

The major types of taxes that exist in Ethiopia, their meaning, rates and conditions, as provided by the Federal Inland Revenue Authority, are presented as follows:

1.   Value Added Tax (VAT)

This is a sales tax based on the increase in value or price of product at each stage in its manufacture and distribution. The cost of the tax is added to the final price and is eventually paid by the consumer.

The rate and impose of VAT:

1. The rate of VAT is 15% of the value for every taxable transaction by a registered person, all imported goods other than an exempt import and an import of services;
2. The export of taxable goods or services to the extent provided in regulations for zero tax rate are:
3. The export of goods or services to the extent provided in the regulation;

• The rendering of transportation or other services directly connected with international transport of goods or passengers, as well as the supply of lubricants and other consumable technical supplies taken on board for consumption during international flights;
• The supply of gold to the National Bank of Ethiopia; and
• A supply by a registered person to another registered person in a single transaction of substantially all of the assets of a taxable activity or an independent functioning part of a taxable activity as a going concern, provided a notice in writing, signed by the transferor and transferee, is furnished to the authority within 21 days after the supply takes place and such notice includes the details of the supply.  

2.   Excise Tax

This is imposed and payable on selected goods, such as, luxury goods and basic goods which are demand inelastic. In addition, it is believed that imposing the tax on goods that are hazardous to health and which are cause to social problems will reduce the consumption thereof. Excise tax shall be paid on goods mentioned under the schedule of 'Excise Tax Proclamation No. 307/2002'(a) when imported and (b) when produced locally at the rate prescribed in the schedule. Computation of excise tax is applied (a) in the case of goods produced locally, production cost and (b) in the case of imported goods, cost, insurance and freight /C.I.F./. Payment of excise tax for locally produced goods is by the producer and for imported goods by the importer. Time of payment of excise tax for imported goods is at the time of clearing the goods from the customs area, and for locally produced goods it is not later than 30 days from the date of production.
 

3.   Turnover Tax

This is an equalisation tax imposed on persons not registered for value-added tax to fulfil their obligations and also to enhance fairness in commercial relations and to complete the coverage of the tax system. Administrative feasibility considerations limit the registration of persons under the value-added tax to those with annual transactions to the total value exceeding 500,000 Birr.

Rate of turnover tax is 2% on goods sold locally and 10% on others; as provided by the 'Excise Tax Proclamation No. 307/2002'

 4.   Income Tax

Income taxable under the Ethiopian 'Income Tax Proclamation No. 286/2002' shall include, but not be limited to:

• Income from employment;
• Income from business activities;
• Income derived by an entertainer, musician, or sports person from his personal activities;
• Income from entrepreneurial activities carried  out by a non-resident through a permanent establishment in Ethiopia;
• Income from movable property attributable to a permanent establishment in Ethiopia;
• Income from immovable property and appurtenances thereto, income from livestock and inventory in agriculture and forestry, and income from usufruct and other rights deriving from immovable property that is situated in Ethiopia;
• Income from the alienation of property referred to in (e);
• Dividends distributed by a resident company;
• Profit shares paid by a resident registered partnership;
• Interest paid by the national, a regional or local Government or a resident of Ethiopia, or paid by a non-resident through a permanent establishment that he maintains in Ethiopia;
• License fees including lease payments, and royalties paid by a resident or paid by a non-resident through a permanent establishment that he maintains in Ethiopia.  

5.   Business profit tax

Taxable business income of bodies is taxable at the rate of 30%

Taxable business income of other taxpayers shall be taxed in accordance
with the following expenses:

Sources of Ethiopian Tax Laws

Tax laws basically emanate from three sources; legislative, administrative and judicial sources. The major sources of Ethiopian tax laws are legislative sources. There are a number of laws that have been adopted by the legislature of the country to deal with the different types of taxes in the country and their administration. The first law that can be taken as a source is the FDRE Constitution which has numerous provisions dealing with the administration of taxes. Then after, there are a number of proclamations and regulations dealing with taxes in the country, the most prominent of which include Income Tax Proclamation No. 286/2002 (amended by (Pro.No. 608/2008) and (Pro.No. 693/2010)); Council of Ministers Income Tax Regulation No. 78/2002 (amended by (Reg. No. 164/2008)); Value Added Tax Proclamation No. 285/2002 (amended by (Pro.No. 609/2008)); Council of Ministers Value Added Tax Regulation No. 79/2002; Turnover Tax Proclamation No. 308/2002 (amended by (Pro.No. 611/2008)); and Excise Tax Proclamation No. 307/2002 (amended by (Pro.No. 570/2008) and (Pro.No. 610/2008)).

As a subfield of public economics, fiscal federalism is concerned with "understanding which functions and instruments are best centralized and which are best placed in the sphere of decentralized levels of government". In other words, it is the study of how competencies (expenditure side) and fiscal instruments (revenue side) are allocated across different (vertical) layers of the administration.

It may be noted that the ideas of fiscal federalism are relevant for all kinds of government, unitary, federal and confederal. The concept of fiscal federalism is not to be associated with fiscal decentralization in officially declared federations only; it is applicable even to non-federal states (having no formal federal constitutional arrangement) in the sense that they encompass different levels of government which have de-facto decision making authority. This however does not mean that all forms of governments are 'fiscally' federal; it only means that 'fiscal federalism' is a set of principles that can be applied to all countries attempting 'fiscal decentralization'. In fact, fiscal federalism is a general normative framework for assignment of functions to the different levels of government and appropriate fiscal instruments for carrying out these functions. The questions arise: (a) How federal and non-federal countries are different with respect to 'fiscal federalism' or 'fiscal decentralization' and (b): How fiscal federalism and fiscal decentralization are related (similar or different)? While fiscal federalism constitutes a set of guiding principles, a guiding concept that helps in designing financial relations between the national and sub-national levels of the government, fiscal decentralization on the other hand is a process of applying such principles. Federal and non-federal countries differ in the manner in which such principles are applied. Application differs because unitary and federal governments differ in their political & legislative context and thus provide different opportunities for fiscal decentralization.

An original definition of fiscal federalism states that "fiscal federalism" concerns the division of public sector functions and finances among different tiers of government. In undertaking this division, Economics emphasizes the need to focus on the necessity for improving the performance of the public sector and the provision of their services by ensuring a proper alignment of responsibilities and fiscal instruments. While economic analysis, as encapsulated in the theory of fiscal federalism, seeks to guide this division by focusing on efficiency and welfare maximization in determining optimal jurisdictional authority, it needs to be recognized that the construction of optimal jurisdictional authority in practice goes beyond purely economic considerations. Political considerations, as well as historical events and exigencies, have in practice, played major roles in shaping the inter-governmental fiscal relations in most federations. 

Even in non-federal states, there has been a growing movement towards greater fiscal decentralization in recent years. Some analysts have attributed this to globalization and deepening democratization the world over on the one hand and increasing incomes on the other. Other specific reasons for increasing demand for decentralization are:

• Central governments increasingly are finding that it is impossible for them to meet all of the competing needs of their various constituencies, and are attempting to build local capacity by delegating responsibilities downward to their regional governments.

• Central governments are looking to local and regional governments to assist them on national economic development strategies.

• Regional and local political leaders are demanding more autonomy and want the taxation powers that go along with their expenditure responsibility.

Moreover, in recent years, decentralization has become a feature of reform agenda promoted and supported by the World Bank (as stated in the World Bank Report of 1997) and other multilateral institutions. The rationale for this has been in part that decentralization promotes accountability. It is not therefore surprising that by 1997, 62 of 75 developing nations had embarked on one form of decentralization or another.

Fiscal federalism in Ethiopia has been adopted within a unique political landscape of ethnic federalism. The TPLF-led government that replaced the Dergue has redrawn the political map of the country and adopted ethnic based federal structure of government. This experiment has been formalized in the 1994 Constitution. However, the constitutional provisions operate with political centralism that has remained to be the distinguishing feature of the current political system.

Fiscal federalism derives its nature and characteristics from constitutional provisions as well as the state of economic development, the pattern of income and resource distribution, and the institutional capacity of the system. The constitutional provisions define the framework within which decision-making would be exercised and establishes the vertical and horizontal structures that find meaning within the prevailing socio-economic environment of the system. The vertical structure defines the assignment of fiscal decision-making power between the federal and lower tiers of government. The horizontal structure outlines the nature of interaction across cross-sections of government levels. This aspect addresses how regional governments interact to each other especially when there are externalities and spillovers. The main economic rationale behind fiscal decentralization is improving efficiency of public resource utilization, creating enabling environment for private sector development and the growth of the national economy. The theory of fiscal federalism addresses three issues related to fiscal decision-making: assignment of responsibilities and functions between the federal government and the regional governments, the assignment of taxation power and the design of inter-governmental transfer (subsidy) of fiscal resources coupled with provisions about the borrowing windows to sub-national governments. These factors give rise to a third issue of the relative size of the public sector in the national economy. It is therefore the dynamics of these processes and public policy choices that ultimately shapes the performance of the fiscal sector and its impact on the national economy.

An important aspect of the exercise of fiscal federalism is the assignment of fiscal functions to the federal and the sub-national governments and the appropriate means of financing these responsibilities. The theory of fiscal federalism does not provide a clear-cut separation of fiscal responsibilities that would promote economic efficiency and resource distribution. The broad thrust of normative theory is that expenditure responsibilities in areas of macroeconomic stabilization and redistribution functions should remain within the domain of the federal government whereas allocation functions should be assigned to lower levels of government. The argument is based on the reasoning that lower levels of government have limited capacity and policy instruments to provide stabilization and redistribution functions. Due to the nature of the responsibilities, the federal government usually assumes macroeconomic stabilization and income redistribution functions and make sure that regional governments would not take measures that are not compatible with such functions. Moreover, there are functions such as national defense and foreign affairs that have national public good character and hence usually assigned to the central government.

Fiscal decentralization and the assignment of functions can generate economic efficiency of the public sector. If preferences are heterogeneous across jurisdictions, which is most likely the case, decentralized decision-making power as to the provision of local public goods and services improves efficiency by tailoring services to the preferences of the local population. The main argument is that local governments are closer to the local population and can identify their choice and preferences better than the central government. Accordingly, when the decision to provide a bundle of public goods is made by local officials and these officials are directly accountable to the local voters, there is an incentive for the local public officials to provide services that reflect the preferences of the local population. Moreover, as long as there is close relation between the benefits from public services and taxes on the local taxpayers, there is additional incentive to utilize resources efficiently and cost effectively. At least by implication, the theory recognizes the need for local authorities to exercise choice in the provision of public services that are of higher local demand instead of resorting to the unitary solution. The decentralization theorem suggests that, under such conditions, decentralization of fiscal decision-making can improve efficiency of the public sector and the welfare of the local population.

Once the allocation of expenditure responsibilities is conducted according to such broad principles, the fiscal system needs to address the issue of assigning taxing power that broadly identifies who should tax, where and what. The imposition of taxes, in the absence of lump-sum source of taxation, always involves a certain degree of economic inefficiency. In the context of fiscal federalism, the assignment process needs to identify the comparative efficiency and effectiveness of providing the fiscal instruments to the multi-tier decision-making centers so as to finance public functions and activities in the most efficient manner possible.

What kind of taxes should be assigned to the federal government and which should be assigned to the local governments? The theory and practice in the assignment of taxation power identifies the following main criteria in assignment process: taxes on mobile tax bases, redistributive taxes, taxes that could easily be exported to other jurisdictions, taxes on unevenly distributed tax bases, taxes that have large cyclical fluctuations, and taxes that involve considerable economies of scale in tax administration should be assigned to the national or federal government. There are efficiency and equity considerations behind such principle of tax assignment.

The assignment of taxing power between the federal and the regional governments and the provision for concurrent power to share establishes the basic link in which the behavior of one of the parties would influence the decision making power of the other and its effective tax base. There is a possibility for vertical tax externality that might require additional policy instruments to correct their effect on other levels of government. When there are clear cases in which vertical tax externalities are prevalent, the tension between the federal and the state governments would arise. This in turn would require mechanisms for the assignment of taxing power and revenue based on the nature and characteristics of the tax base.

The assignment of taxing power is a thorny issue in fiscal policy and its application is influenced by a number of considerations. First, despite the legislative assignment of taxes, the actual potency of the tax network depends on the nature and development of the national economy, the relative distribution of economic activities across jurisdictions, and the administrative efficiency of the taxation system. Second, the practice of fiscal federalism, especially when citizens across regions with diverse economic and demographic situations are treated unequally, gives rise to the violation of one of the core principles of horizontal fiscal equity. Moreover, fiscal decentralization might also potentially breach the principle of vertical fiscal equity by not treating taxpayers with different capacity to pay differently. Third, despite the monopoly of taxing power resides at the disposal of the government, the reach of the taxation network depends on the economic circumstances of the potential taxpayers.

The fiscal system of Ethiopia has historically been characterized by high centralization and concentration of fiscal decision-making power at the center. Moreover, the structure of the fiscal system shares important features with other underdeveloped economies in terms of reliance on indirect taxes, dependency on international trade taxes, and persistent fiscal deficits. The current fiscal system of Ethiopia features some departures from the previous systems and striking continuities in the structure and essential elements of fiscal performance of the economy. The main features of fiscal aggregates of Ethiopia suggest that either the government is not willing to fundamentally change its fiscal policy stance or the fiscal system is governed by the structural features of the economy that are not easily amenable to change in response to fiscal policy reforms. A closer examination of the main features of the fiscal system suggests that both factors play a role in the process. The nature and structure of the economy, the resulting tax bases, the excessive dependence on international trade taxes and external grants, and persistent deficits all contribute to the prevailing features of the fiscal sector as do the fiscal policy stance of the government.

For the period 1980/81-2001/02, the government on average extracted about 18 percent of GDP from the public and spent about 28 percent of GDP, of which recurrent spending took more than 19 percent and only 9 percent left for capital spending. This behavior of excessive spending left an average fiscal gap of about 10 percent. Foreigners provided about 3 percent as charity and lent about 4 percent of GDP and the rest was financed mainly from domestic banking system. A fiscal system that resorts to borrowing to cover about 36 percent of its spending appetite would sooner or later confront the consequence of its behavior. It is an important predictor of a looming crisis. This behavior of fiscal spending also affected the macroeconomic situation in which aggregate expenditure run in excess of domestic production. The country has become increasingly dependent on foreign aid and borrowing to finance its consumption and investment expenditure.

The fiscal system, nonetheless, witnessed important changes over time. Government revenue increased during the 1980s and reached a peak of 24.8 percent of GDP in 1988/89 before it declined drastically during the subsequent two years of political turmoil in the country. The fiscal regime was extremely coercive and led to distortions in resource allocation. The prohibitively high marginal tax rate had driven most activities underground and tax evasion and corruption were on the rise. Such a system was indeed unsustainable and the change in the political regime precipitates a collapse in the fiscal system. The decline in revenue was particularly severe from business profit taxes, export taxes and revenue from government investment income. The collection of government revenue collapsed from about a quarter of GDP to about 10.6 percent by 1991/92.

The transitional government introduced a number of fiscal and monetary policy reforms that had mixed implications on the revenue collection. The amendment in the tax codes, devaluation and gradual depreciation of the exchange rate, elimination of taxes on exports (except coffee duties), and the privatization process have had important implications on the amount and structure of government revenue. The average domestic revenue to GDP ratio has recovered gradually and for the period 1991/92 to 2001/02 the average reached about 17.2 percent with a gradual and yet increasing trend. The average tax revenue for the period was about 11.7 percent of GDP.

One typical feature of the tax structure is its narrow base. There is an increasing dependency on foreign trade, especially import, taxes in recent years. The devaluation of the currency and its subsequent depreciation over time somewhat expanded the domestic currency denominated tax base on imports. The tax revenue-to-GDP ratio for developing countries is about 18 percent and for African countries is about 20 percent. The ratio of tax revenue in GDP for advanced countries is significantly higher than developing countries, at about 38 percent, reflecting the state of economic development, the tax base and the efficiency of tax administration. This pattern could broadly be attributable to the structure and performance of the economy, the administration of the taxation system, and the design of the taxation system.

A longer view of the fiscal resource allocation behavior of the government, despite marginal changes in some aspects of the fiscal components, suggests that there has not been enduring and significant shift in policy over the past two or so decades. The current government in power, except some marginal changes, shares important characteristics and behavior in fiscal policy with its predecessor. The current regime spends about 26 percent of GDP and extracts from the public about 17 percent of GDP.

Foreigners still provide about 3 percent as grants and lend about 3.7 percent of GDP. The remainder of about 2.4 percent of GDP has been financed from domestic borrowing. The relative performance of the current fiscal regime shows some improvement and yet it still covers about 23 percent of its spending by borrowing. The result of such features of government revenue and expenditure has been the emergence of persistent fiscal deficits and the accumulation of public debt. Domestic government revenue apparently has been barely enough to cover recurrent government expenditure let alone to generate resources for financing capital expenditure. The level of deficit has increased so much so that in recent years it has been as much as the total tax revenue collection of the government. Such a stance of fiscal policy is unsustainable and the external grants, even if important to partially narrow the gap, would not and could not resolve the problem. The government has increased its appetite for borrowing from foreign sources to bridge the gap and when external borrowing does not satisfy it resorts quite easily to borrow from the domestic banking sector.

The fiscal performance of the country is reflections of a typical underdeveloped and agrarian based economy in which the majority of the population lives in chronic poverty and a government that devotes its effort to extraction of resources from the economy and failing to allocate these resources to priority areas and sectors of the economy. When this is coupled with a de facto fiscal centralization and stance of inefficient public resource allocation, it fails to address the priorities of the majority of the population and hence becomes increasingly unsustainable. However, both political imperatives and changes in the overall economic policy of the country opened the door for fiscal policy innovation.

As far as the current system of fiscal federalisms and division of revenues in Ethiopia goes, the FDRE Constitution provides that the Federal Government and the States all collect taxes and shall share revenue, taking the federal arrangement into account. By taking into consideration principles such as ownership of revenue, regional character of revenues sources, convenience for administration, population, and wealth distribution, sharing of revenue between the Federal Government and the State Governments serves the following purposes: enhancing the efficiency of the central and the regional governments so as to enable them to carry out their respective duties and responsibilities; helping the regional governments to develop their regions on their own initiatives; narrowing the existing gap in development and economic growth between the regions of the country; and encouraging common interest activities of the regions.

In sharing of revenues, taxes are grouped into three: central (that of the Federal Government), regional and joint. As far as collection of the revenues goes, the regional governments collect their own revenues whereas the Federal Government collects not only its own revenues but also the joint revenues, of course with a possibility of delegation whenever deemed necessary.

According to Article 96 of the FDRE Constitution the revenues of the Federal Government include customs duties, taxes and other charges levied on the importation and exportation of goods; income tax collected from employees of the Federal Government and international organizations; income, profit, sales and excise taxes collected from Federal Government owned enterprises; taxes collected from national lotteries and other games of chance; taxes collected from income generated through air, rail, and sea transport services; taxes collected from rent of houses and Federal Government owned properties; charges and fees on licenses issued and services rendered by the Federal Government; taxes on monopolies; and Federal stamp duties.

In a similar manner, Article 97 enumerates the revenue sources of the regional governments of the country as comprising of income taxes collected from employees of the States and of private enterprises; fees collected from land usufructuary rights; taxes collected from the income of private farmers and farmers incorporated in cooperative associations; profit and sales taxes collected from individual traders operating within state territories; taxes on income from water transportation within state territories; taxes collected from rent of houses and State Government owned properties; profit, sales, excise and income taxes collected from State owned enterprises; taxes on income, royalties, and land rentals from mining operations; charges and fees on licenses issued and services rendered by the State Governments; and royalties for use of forest resources.

Apart from these, there are certain revenue sources which are shared by the Federal and State governments. The joint revenues are listed in Article 98 of the FDRE Constitution as constituting profit, sales, excise and income taxes on enterprises jointly established by the Federal and State governments; profits of companies and dividends of shareholders; and income and royalties derived from large-scale mining operations and all petroleum and gas operations. For those powers of taxation which have not been explicitly stated in the provisions of the FDRE Constitution, such as value added tax, Article 99 clearly stipulates that the exercise of such powers is to be determined by a two-third majority vote in a joint session conducted by the House of Federation and the House of People’s Representatives, thus subjecting the exercise of this so-called “undesignated power” to strict requirements.

The exercise of the taxing powers of both the Federal and Regional governments has to take certain considerations into account. For one, both governments are required to ensure that any tax is related to the source of the revenue taxed and that it was determined per the proper procedures. Secondly, both governments are required to ensure that the relationship amongst themselves is not adversely affected by the tax and that the rate and amount of taxes are commensurate with the services that the taxes help deliver. Finally, both governments are prohibited from levying and collecting taxes on each other’s properties unless it is a profit-making enterprise.

The FDRE Constitution gives much power to the regional states. Collectively, the regional states are granted the status of a nation. They are given self-determination up to secession. Self-determination is broadly understood to mean as the use and development of one's language, culture, history and administrative structure. Beyond the "unrestricted right to administer itself", self-determination also includes proportional representation at federal organs. In order to resolve conflicting claims over representation, territory and resource, the constitution has created the House of Federation whose members are elected by State Councils. The ethnic groups are represented at this institute. This House is composed of "representatives of nations, nationalities and people" at least one for each of them, plus an additional member for nation or nationality for each one million of its population". Ethnical conflicts and boarder disputes are referred to the House of Federation. This body has the role of supreme interpretation of the constitution and resolving key question of the nationalities/ethnic groups.

The regional states have their respective autonomous governments set up. Accordingly, each regional government includes a State Council (the highest organ of state authority) and a State Administration (highest organ of executive power). The State Council is the highest political authority: it defines the region's policy and has all legislative, executive and judiciary powers regarding the region, except for those under the responsibility of the central government, such as defense, foreign affairs, economic policy etc. The State Council plans, approves, heads and controls economic and social development programs. It drafts, approves and manages the regional budget. The State Administration is the highest executive authority of regional government. It is elected by the State Council and includes 15 Executive Committee members. The State Administration enforces, as appropriate, the policies, proclamations, regulations, plans, guidelines and decisions of the central government and of the State Council. It manages, coordinates and supervises the activities of regional offices, zone administration offices and Weredas (district) offices. It drafts and submits economic and social projects to the State Council for approval, and manages the projects once they have been approved. It drafts the region's budget, submits it for approval to the State Council and manages the budget once approved.

At the broadest level, the general principle underlying the allocation of authority and legislative responsibility in federal systems has been that matters of common interest and concern to the country as a whole should be assigned to the federal government, and matters of a decidedly regional or local character should be assigned to the regional governments. In actual fact, however, there is a weak federal executive power whose relationship with the regional governments is not yet clearly coordinated. Constitutionally, the federal government is not effectively centralized through presidentialism. The president has a symbolic role. The federal executive power is vested in the Prime Minister and in the Council of Ministers which are politically accountable to the House of Peoples' Representatives in all the decisions it adopts. As enshrined in Article 77 of the Constitution, the Council of Ministers among others, ensures implementation of laws, and decisions adopted by the Federal Parliament, decided organizational structure of Ministries and other Federal Parliament, decided on organizational structures of Ministries and other organs of government responsible to it, coordinates the activities of organs of government, discusses and refers draft proclamations to the Lower House, and decides on the general socio-economic and political strategies the country should pursue.

State Councils of the regions are also responsible for appointment of the highest executives in charge of the various organs of State. The respective constitution of the various regional states stipulates that the State Councils are entrusted with the power of forming the Executive Committee, which is the highest state-level executive organ. State executive bodies are responsible for the execution of laws, policies and strategies falling within their jurisdiction. These include administering land and other natural resources in keeping with Federal laws, formulating and execution economic, social and development policies, strategies and plans of the state in question.

Consequently, health, security, and agricultural development and similar other matters seriously demand that the pertinent Federal and State executive organs work in close collaboration. There could be contexts where the common decisions of the two become vital to ensure maximum benefits in a particular area. But there is a weak exchange of information between the two levels. Under such circumstances, it is possible that the regional states can only issue and enforce their own laws not that of the federal government.

The most important factor which underlines the further autonomy of the regional states is the assigning of residual power. The Federal Constitution as stipulated in Article 52(1) states that "All powers not given expressly to the Federal Government alone, or concurrently to the Federal Government and States are reserved to the States". Accordingly, any residual power unspecified in the constitution is left for the States. It thus allocates residual authority to the constituent units. The significance of the residual power is that the regional states can exercise legislative power over matters not specified in the constitution.

The above three points suggest that the relationship between the federal government and the regional states is asymmetrical, even though they are in principle considered to be equal. Nonetheless, the financial and manpower resources of the regions are very limited. The revenue base of the regions is not that productive and expansive. Currently, they are dependent on federal fund, particularly for capital budget. They are not yet economically strong to claim that their laws supersede that of the federal law. According to the constitution, they are given all the power to develop their region.

As can be inferred from Sub-Article 7 of Article 62 of the FDRE Constitution, which enumerates the powers and functions of the House of Federation, there is a possibility by which the Federal Government may transfer revenue to the regional governments. Such a system of transfer payments or grants, by which a central government shares its revenues with lower levels of government, is an important aspect of the subject matter of ‘fiscal federalism’. The underlying rationale behind transfer of revenue is the existence of a fiscal gap at the sub-national level emanating from lack of locally generated own revenue to finance own expenditure; differences in the regions’ level of economic development and endowment with natural resources lead to the formation of a fiscal gap.

Federal governments use this power to enforce national rules and standards. Such transfers of revenues usually fall under three categories: conditional, unconditional and equalization grants. A conditional transfer from a federal body to a state, or other territory, involves a certain set of conditions. If the lower level of government is to receive this type of transfer, it must agree to the spending instructions of the federal government. The second type of grant, unconditional, is usually a cash or tax point transfer, with no spending instructions. Unconditional grants are usually general purpose grants aimed at addressing vertical imbalances. The third type of grant, equalization grant, is used to address horizontal imbalances between regional governments through the channeling of resources from the relatively wealthier regions to poorer ones; thereby equalizing the capacity of regional governments to provide a national standard level of goods and services.

Taxation is the earliest and most prevalent form of government inter­ference with the economic life of individuals and business enter­prises. The right of the chief authority to collect taxes, and the general policy which determines who is to be taxed, how much the tax shall be, and for what purposes it shall be levied has always been a controversial issue. The tremendous increases in public spending accompanying recent depressions and war periods have brought the question of taxation to the mind of each and every citizen. Moreover, the extension of the powers of governments and the creation of modern greater states has necessitated larger revenue for the administration of states. As such, the development of general taxation was inevitable.

When dealing with taxation, it is unavoidable to have important and complicated questions popping up into our heads. Some common questions include those such as:

If public revenue contains returns from non-tax sources and from taxation, is it possible to increase the former?

Is it to the advantage of the common that this should be done?

When we take the revenue obtained by taxation, how ought the burden to be distributed?

The answers to questions like these will be governed by the view we take of the function of the State. Considering the possible solutions to such questions (issues) has led to the development of certain theories pertinent to taxation.

An individualistic theory would lead, so to speak, to man having as little as possible to do with the State. Every person needs, say, protection and justice, and experience shows that these can best be obtained in a society; the taxes he/she pays may be a quid pro quo, a payment for the services rendered. However, such a view was evidenced to lead to absurd conclusions. Does it not cost just as much to protect a man not blessed with very much of this world's goods as it does to protect a rich person? If we consider only real property, it may be that the cost of protecting it does not increase proportionately with the amount and, at any rate, “if security is to be sold like an ordinary commodity, there ought, on the strictest commercial principles, to be some allowance made to the purchaser of a large quantity." The requirement that everybody share an equal amount of revenue is equally absurd.

On the other hand, a State can be considered as the most definite institution in society; and, further, since from one point of view wealth has no meaning except in a society, the part played by that society in the production of wealth may be looked upon as making the State "the residual owner of all income which exceeds the requirements of maintenance and normal growth”. A further extension of the same idea would be for the State to attempt to level the existing large inequalities in the incomes of its individual members by a heavily graduated tax. Thus, the socialistic ideal is widely different from the individualistic one. Is it possible to arrive at the golden mean?

As a preliminary to this it seems necessary to get rid of any sort of a priori reasons for an individualistic or a socialistic view of the functions of government; it may be argued that it is impossible to lay down any general principles which apply to every case of State interference. Each example has to be judged on its own merits statistics can help us here, but it is difficult to see the use of applying any hard and fast rule. If this be the case, we reach the faculty or ability theory of taxation. Provided that the sole aim in imposing taxation is to obtain revenue, then a reasonable distribution of taxation could surely be based upon the citizens' ‘abilities to pay’. The difficulty comes in when we try to assign a definite meaning to this idea; at the present time, it is the most generally accepted theory, but possibly that is because it is so conveniently vague. ‘Ability to pay’ has at least three different and distinct meanings. We may consider it entirely from the point of view of equity or from that of the consumption, or of the production of wealth.

If taxation is to be levied solely to obtain revenue, then equality may be a very desirable ideal at which to aim. But what does equality mean? Obviously everybody should not pay an equal share of taxation, and there are three important possible forms of distribution which have been suggested from time to time; each is intended to secure equity and each supposed to be based on the ‘ability to pay’.

The first is the pure proportional form; taking income as the standard, it is laid down that the criterion of ability to pay would be attained by taxpayers paying in proportion to their income proportion being considered in the strict mathematical sense of the word. This is perhaps the view of Adam Smith, but surely it must be repudiated by common sense, as a single example will show. Suppose that a quarter of a man's income was required by the State; then a man earning 10 Birr a week would pay 25 cents, and the one getting 2 Birr a week would pay l0 cents each week; the first man might now no longer be able to keep a motor cycle, while the latter would hardly be able to feed his wife and family.

Such considerations as these have led men to think of a progressive or graduated form of distribution, in which the rate of taxation levied increases with the size of the income. But another aspect of the matter can well be brought in here. J. S. Mill says; “Equality of taxation”, therefore, as a maxim of politics, means equality of sacrifice. It means apportioning the contribution of each person towards the expenses of government, so that he/she shall feel neither more nor less inconvenience from his/her share of the payment than every other person experiences. But he/she is considering only the consumption aspect of income. He is asking, in effect, “How much ought a man to pay in taxation and how much ought he to have left for his own consumption?” But surely we ought to consider also his production as well as his consumption of wealth. “In estimating a man's faculty or ability to pay we must not alone think of the burden imposed on him in parting with his property or income, but we must also consider the opportunities he has enjoyed in securing that property or income. If this is so, we have a plain case that equity requires a graduated rate of taxation; many higher incomes (and the so-called “unearned” incomes) are obtained as the result of particular privileges particularly that of inheritance and this legal or social privilege enjoyed in the production of an individual's income increases its " ability to pay." The strongest argument against this graduated form of taxation seems to be that it checks saving. But so also, in a way, does any form of taxation; a progressive system affects most considerably the very large incomes, but it encourages saving among the middle classes and the people with relatively small incomes.

It should be noticed that although income and inheritance taxes are the particular ones to which graduation is most easily applicable, yet progression can also be realized to a certain extent by levying heavy taxes on luxuries and the better kinds of a number of articles. Thirdly, we come to a form of distribution which may be called a qualified proportional one. Here, once again taking income as the standard, "equality of sacrifice" can be obtained (it is said) by exempting a certain amount of income and levying a uniform or possibly a slightly graduated rate of tax on any income above that limit. This is, of course, the way in which our present income tax works, which allows "a personal allowance " of 135, or 225 " in the case of an individual whose wife is living with him/her to be free of income tax.

The two central principles of taxation relate to the impact of tax on efficiency concerned with the allocation of resources) and equity (concerned with the distribution of income). As the major principles of taxation in any system, it is worth taking an in-depth look at “efficiency” and “equity (fairness)”.

A good tax system should be efficient in that it should be able to waste as little money and resources as possible. Efficiency can be measured against three standpoints: administrative costs, compliance costs and excess costs. These three relate to the cost of operation of the tax system, to its flexibility and certainty. Administrative costs are the costs to the government (and ultimately to the taxpayer) of collecting tax revenue. In order to collect taxes, the government must hire collectors to collect the revenue; data entry clerks to process the tax returns; auditors to inspect questionable returns; lawyers to deal with disputes; and accountants to track the flow of money. All these costs are those that are incurred by the government to administer the tax system. Compliance costs, on the other hand, are the costs (other than the taxes themselves) of making tax payments to the government. In order to comply with their obligation to pay taxes, citizens are bound to incur certain costs. These compliance costs include not only the money that people spend on accountants, tax preparers and/or tax lawyers, but also the time spent in filing tax returns and keeping records. The third aspect of efficiency, excess burden, relates to tax-induced change in behavior displayed by tax payers. When the government levies taxes on goods, it distorts consumer behavior as people are bound to buy less of taxed goods and more of other goods. Thus the intrinsic value of goods is shadowed by the taxes which are imposed on the goods. In general the larger any of these costs get, the worse it is for efficiency.

The other major principle of taxation is that the burden of tax should be distributed fairly.Accordingly, equity or fairness is further highlighted by two principles: the ability-to-pay principle and the benefits principle. The ability-to-pay principle holds the idea that the amount of taxes that people pay should be based on their ability to pay. This principle implies two things:

Horizontal Equity: People in equal positions should be made to pay the same amount of taxes.

Vertical Equity: A tax system should distribute the burden of paying taxes fairly across people with different abilities to pay. Thus, people who earn more should pay more than those people who make less than them.