Purpose of Taxation

For a government to function properly, it must raise money to meet its expenditures. There are basically two major ways of raising money to fund recurrent and capital expenditures. Taxation is one of the ways in which a government can raise revenue to meet its budgets. Tax is a percentage of money that is deducted from individual and company incomes within a country. Taxation plays a critical role in the economy because it allows governments to raise money to fund operations and run major development projects. Some of the major reasons for taxation include:

Raising revenue: Government uses taxation to generate revenue, which is then used by government in providing goods and services such as roads, electricity, healthcare, education, and salaries. Taxation is justified because when people are taxed, the government can raise money to provide essential goods and services to the public.

Discouraging consumption of certain products: Taxation is sometimes used to discourage the consumption of certain products for some reason. For example, a tax rate of 50% can be imposed on alcoholic products and cigarettes, which are considered harmful to the people. Taxation increases the prices of such products, hence reducing their demand and consumption.

Discouraging importation of certain products: Another important purpose of taxation is to discourage importation of certain products, e.g. sugar in order to protect local industries. Heavy taxes on imports and import duties can help in limiting the importation of certain products and protecting local industries. When export duties are lowered, export trade increases.

Reducing inequality in income distribution: Taxation reduces inequality in income distribution by taxing the rich and using finances realized to finance activities that benefit the poor. This purpose of taxation justifies the role of government in fighting poverty and inequality.

Controlling inflation/maintaining economic stability: During times of prosperity, the government may raise tax levels to control unplanned expenditure by people. Excessive expenditure may raise inflation in the society. During tough economic times, tax rates may be reduce making goods relatively cheaper and thus encouraging consumption in the economy.

Helps in location of businesses: High tax on businesses located in urban areas would make entrepreneurs locate their businesses in rural areas where tax is less. This assists in solving localisation and delocalisation. When governments aim to promote investment in rural areas, they might choose to increase taxation for businesses located in urban areas so that they can relocate to rural areas.

Protection of local industries: Another important function of taxation is protection of local industries. Heavy taxation makes imported goods more expensive than local ones. Individuals therefore prefer relatively cheaper locally manufactured goods. Local industries therefore have already market for their goods and are able to compete favourably with foreign firms.

Helps in correction of balance of payments: high tax on imported products discourage importation, thereby increasing balance of payments. Balance of Payment (BOP) is the difference between imports and exports of a country. When exports are more than imports, there is a positive balance of payment. If imports are more than exports, the balance of payment is negative. Taxation can be imposed on imports to minimize deficits in the balance of payment.

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