The Effect of The Income Tax Reform 979/2016 On Employees' Income Equality

Table of Contents

1 Introduction
1.1 Background of the Study
1.2 Statement of the Problem
1.2.1 Research Questions
1.3 The Objective of This Paper
1.3.1 Objectives (General)
1.3.2 Specific Objectives
1.3.3 Scope of the Study
1.4 The Significance of the Study
1.5 Organization of the Paper
1.6 Limitation of the Research

2. The Theoretical and empirical Literature Review
2.1. Definition and Classification of Taxes
2.2. Theories of Taxation
2.2.1 The Haig-Simons Income Tax Theory
2.2.2 Samuelson Depreciation
2.3 Lorenz Curve, Gini Coefficient
2.4 Empirical Literature Review
2.5 The Research’s Empirical Contribution to other Similar Studies
2.6 Literature Gap and Summary
2.7 Conceptual Framework of the Study

3. Research Design and Method
3.1 Research Design
3.2 Sample and Sampling Techniques:
3.3 Source and Tools/Instruments of Data Collection
3.4 Method of Data Analysis

4. Data Analysis and Interpretation
4.1 General Information about Data
4.2 Descriptive Statistical Data Analysis and Interpretation
4.3 The paired sample means t-test
4.4 Analysis of Income Inequality among different income groups

5. Conclusion and Recommendation
5.1 Conclusion
5.2 Recommendation

References

Appendices
Appendix-I
Appendix–II
Appendix –III
Appendix –IV
Appendix–V
Appendix –VI

Acknowledgment

Thanks to St. Mary's mother of almighty God and Jesus Christ for all my progress in life without the help, it is impossible to write a word in this paper.

My wife Eyerusalem Temsgen, you are my strength, power, and wisdom. You give me love, Vision, Hope, and Passion to finish this research and my gratitude extends to work colleagues Lishan Gera and Nagassie Tikuye. God bless all your rest of life.

Finally, my deepest appreciation goes to my research advisor Dr. Abebaw Kassie from Addis Ababa University department of Finance and Accounting. Without his encouragement, support and professional advice, it is impossible to accomplish this thesis.

List of Tables

Table 1: Sources of Sample Data Collection

Table 2: Comparative Income Tax Payable Based on 286/2002 and 979/2016 Income Tax Proclamation

Table 3: Comparative Disposable Income Based on 286/2002 and 979/2016 Income Tax Proclamation

Table 4: Descriptive Statistics Result About the 286/2002 Income Tax Effect on 1120 Employees

Table 5: Descriptive Statistics Result About the 979/2016 Income Tax Effect on 1120 Employees

Table 6: The Paired Sample Means t-Test

Table 7: Paired Two Samples t-Test for Means

Table 8: The Lorenz Curve and Gini Coefficient Analysis

Acronyms

Abbildung in dieser Leseprobe nicht enthalten

Abstract

This research investigates the effect of the new income tax Proclamation 979/2016 on the employee’s disposable income, tax liability and the income inequalities among the high and low income earning groups of employees. For this, the quantitative research method is used and secondary payroll data is collected through the survey by using email and hard copy. The data is analyzed using the summary of descriptive statistics and paired sample means t-Test. Besides this, Gini- coefficient analytical tool is also used to measure the income inequalities among 1120 employees. The payroll data is gathered from 8 different public and private companies in Addis Ababa. The sample is selected by applying purposive sampling techniques and the sample size is determined using a statistical formula for an unknown population. The result shows that the tax reform brings a 9% increases on a disposable income and 30% decreases on the income tax liability of employees under this investigation. But on the contrary, the new tax reform doesn’t play its role in reducing the income inequality among different income earning groups of employees rather it shows 0.4% marginal increases in income inequalities. This is because of reform gives higher disposable income for the top 20% income earning groups than the lower one. Furthermore, the study evidences the existence of high-income inequality among employees which is 0.41 Gini coefficient. It is slightly higher than the national Gini coefficient it is because of the size and scope of the study.

Finally, the research indicates that 73% of the income tax revenue has paid by the top 20% income earning groups. So, it is advisable for policymakers to improve the minimum taxable income from birr 601 to birr1500 to reduce the income inequality by minimizing the tax burden of lower income earning groups.

Keywords: Employment income, income tax reform, income tax liability, and income inequality

1 Introduction

1.1 Background of the Study

According to the 2019 economic freedom index report, Ethiopia has the leading individual income tax rate 35 percent and the top corporate tax rate 30 percent. The overall tax burden equals 12.4 percent of total domestic income(Heritage, 2019). The tax burdens on labor are high as compared with other African countries average. Ethiopia implicit tax rate on labor, a summary measure that approximates an average effective tax burden on labor income in the economy, stood at 44% in 2014, the highest in Africa.

High taxes on labor contribute to loss of competitiveness and may have detrimental effects on economic growth and employment by negatively impacting labor supply and demand.

Therefore, it is recommendable to reduce the tax burden from employees and labor to have economic growth-friendly.

Since the early 1990s, the country has maintained a “developmental state” model with high public sector investment to encourage growth and improve access to basic services. Strong economic growth and improved public services have been the primary drivers of poverty reduction over the past decade(World Bank, 2015). Ethiopia has not only reduced poverty significantly—from 45.5 per- cent in 1995/96 to 29.6 percent in 2010/11 now it is about 24% but also maintained low inequality. With a 2011 Gini coefficient of 0.302 since then, it is marginally increased (for per capita expenditures), Ethiopia remains one of the less-unequal countries in low- and middle- income countries (Inchauste & Lustig, 2017).

Based on the information from Central Intelligent Agency (CIA, n.d.), low inequality does not mean that the individual has sufficient per capita income which is $2200 ranking the 204 among the world countries in the year 2017. Yet despite progress toward eliminating extreme poverty, Ethiopia remains one of the poorest countries in the world, due both to rapid population growth and a low starting base. Changes in rainfall associated with worldwide weather patterns resulted in the worst drought in 30 years in 2015-16, creating food insecurity for millions of Ethiopians. Revenue from the tax is one of the main sources of income for the nation to reduce poverty by redistribution to the society, but our country tax contribution to GDP is low 13.9% in the year 2017. One of the main reason is the country has an old and inappropriate tax system and reforms with inadequate research before and after the declaration and implementation of different tax policies ( Lencho, 2012).

With this regard, starting from the Haile Selassie to EPRDF, so many tax reform and amendments have made. But when we see the empirical shreds of evidence, there is no remarkable study has taken place to show the performance of these reforms as compared with its intended objectives after implementation of the reform.

Most commonly, it is evidenced that the main aim of tax reform is to maximize the government revenue and increasing its efficiency to collect the maximum revenue from individual and Business entities that may pay taxes to deliver public services as the per the expectation of the people under their authority(Geda & Shimelis, 2005).

But on the contrary, most tax reforms do not meet its purpose rather it indirectly uses for other purpose and sometimes even the government uses as a tool to stabilize their internal socio-political crisis to win their support from the people they are ruling. For this justification, it is better to see the 2018 Trumps-tax-reform-plan which gives more favor to low and high income earning groups rather than maximizing the tax revenues (Floyd, 2019).

According to Fana Broadcasting Corporate news released on July 8, 2016, the Ethiopian Federal Republic House of people representative declared the following proclamation that had been practicing since July 8, 2016 (MoFFC, 2016).

Income Tax proclamation 979/2016

Federal Tax Administration proclamation 983/2016

New trade license and registration proclamation 980/2016

As per the report, after 2002 income tax proclamation, there was no change and amendments for the past 15 years and the main reasons for this new tax reform are listed below:

1. There is a socioeconomic development in the country, but the existing tax law becomes outdated and incompatible.
2. The government obliged to proclaim income tax reform because there was a pressure coming from the people who earn a low income and severely affected by the high rate of taxation and inflation
3. The other reason which forced the government to act actively and launch resolution was the country existing socio-economic and political situation (2008E.C people’ protest).
4. The last but the influential reason for the change was the global situation in socio-political, economic and technological upheavals. It was the IMF and other international organization pressure for the reform.

According to Mr. Wasihun Abate, who was the chairman of the committee, the reform aim was to reduce the employee's income tax and increased their income by stepping the previous brackets from 150 to 600 and the high-income brackets 5000 to 10900.

The low-income tax bracket has increased by 300% from the previous one. Because of this, many taxpayers having income 150 to 600 are free of any tax liabilities and the high-income tax bracket increased by 118%, which can reduce the previous tax rate, which was 35% to 30%, 25%, and 20%, depending on the employees’ income which might give tax relief for many workers it becomes clear and proofed by this research.

The main purpose of this study is to show the tax reform impact on employees income after a proclamation by answering the question like what is the effect new tax reform on disposable income earned by employees having different income groups with the assumption of other things remains constant.

The research method is quantitative using descriptive summary statistical tools and paired sample mean t-Test to analyze the secondary cross-sectional data that will be collected through survey methods by using email and hard copy from 8 private and public companies using purposive sampling method which is a non-probability sampling technique where subjects are selected because of their representativeness of the population based on the professional judgment of the researcher .

1.2 Statement of the Problem

Based on the researcher’s long years of experiences as a finance manager, there are observable problems regarding income inequalities among high and low income earning groups and tax burton on low income earning employees. Besides this, there is no research to shows the problems. And the new tax reform is believed to solve the above-mentioned problems by its new progressive income tax brackets.

The tax system and reform in Ethiopia have a long history, but as per the researcher best knowledge, there is no such satisfactory impact analysis done following the reforms. But some researchers tried to address the impact of tax reform on employees’ performance (Gebisa, 2009), and other like (Asmare, 2018)and (Moges, 2000), shows the economic wide impact of direct tax reform on employees income, rental, corporate effect and the GDP impacts of tax reform and focusing on distributional implication.

But this study will try to fill the research gap by investigating the impact of tax reform on employees’ disposable income and tax liabilities rather than focusing on the economic wide effect and GDP.

So, the main initiation for this study is to show the 979/2016 income tax reform effect on employees’ income, employment tax liability and its distributional consequences on different groups to address the above-mentioned problems.

1.2.1 Research Questions

What are the effects of new income tax reform on the employee's disposable income and income tax liabilities?

Is there any significant means difference between the effects of 286/2002 income tax proclamation and 979/2016 on disposable income and income tax liabilities?

Does the new employment income tax reform contribute to reducing income inequalities among high and low income earning groups of employees?

1.3 The Objective of This Paper

1.3.1 Objectives (General)

To describe the effect of the new tax reform on employees’ income and income tax liabilities.

To compare the disposable income of employees before and after the tax reform.

To know the effect of new income tax reform on employees’ income inequality reduction before and after the proclamation of 979/2016.

1.3.2 Specific Objectives

To test the effect of the new tax reform on employees' disposable income and employment income tax liabilities.

Differentiate the employees’ income tax before and after tax reform.

Identify the existence of significant mean difference in disposable income and tax liabilities before and after the reform.

Analyze the Gini coefficient calculated before and after the tax reforms.

1.3.3 Scope of the Study

The research delimited in terms of geographical location which confined in Addis Ababa. According to the CSA finding (2012), majorities of employed persons (44.8 percent) were service, shop, market sales, craft, and related trade workers out of 5,726,116 employed persons at the country urban level. Those employed persons were in the Elementary Occupations comprise the simple and routine task which mainly requires the use of the hand-held tool which needs physical effort representing factory labor workers to occupy the second position (22.6 percent). Professionals, technical and associate professionals together made up 12.9 percent. So, it evidenced that in Addis Ababa most of the employees are working in the services giving sectors like educational sector, banks, and merchandises and manufacturing companies. So, from 8 private and public company's employees’ 2 of them are manufacturing while the other 5 are service giving and 1 is the merchandising company workers’ payrolls which can represent the population because the sample includes these sectors. And the two tax brackets of 286/2002 and 979/2016 are taken from the previous and new comprehensive income tax proclamations(MoCF,2002).

The study is conducted between the periods from October 2018 up to May 2019.

It is exactly 1120 employees’ income collected from all groups of tax brackets and calculated in both rates. The total population of the study is unknown, so our prediction limited to sample companies only.

1.4 The Significance of the Study

The study primarily will give benefit to the labor unions by giving information to strengthen their struggle for the improvement of employees’ income, payment and for further reduction of tax liability. Besides this, it can use as an input for policy makers for future reforms and amendments of tax bracket.

It also benefits the Ministry of Revenue just to know how much of the employment income tax revenues increase or decreases because of the enforcement of the new income tax proclamation. It also helps to predict the revenue collection budget on employment income in Addis Ababa.

It uses as an input for further study and feedback for the policymakers on implementing the new income tax proclamation. Other researchers who have an interest in the issues raised in this paper can get information as a reference for their study.

1.5 Organization of the Paper

This paper has five chapters, chapter one is an introductory section which includes the background of the study, research questions, objectives of the study and scope. Chapter two is about literature review and chapter four is focusing on data analysis and interpretation.

The last section of this paper is about conclusion and recommendation.

1.6 Limitation of the Research

One of the main limitations of the study is using cross-sectional data rather than time series data and it also assumes some employees who stay in the company for more than six months as they are working for a full budget year or it is annualized.

Furthermore, financial resources and time constraints are the limitations of this research because of this the researcher cannot increase the sample size. The availability of organized and reliable data on employees’ income and tax liabilities are also other obstacles to launch highly advanced research on employees’ income in Addis Ababa. These limit the researcher to use secondary data collected through the survey method and the cross-sectional data rather than primary and the time series data.

In many low-income countries, including Ethiopia, administrative data on wages are not available in a format that can be used for research. For example, the Ethiopian Revenue and Customs Authority collects this information mostly in hard copy form and in an incomplete format, so there is no detailed digital record at the individual employee level. The information available in digital format can only be disaggregated at the employer-level, not at the employee level. Hence, these data cannot be of much help in analyzing inequality, income distribution, and the effect of tax policy. Even the aggregate data that is available is of very poor quality because it is found as an institutional level and the hard copy form. As a result, at the moment it is very hard to get even basic information on employment incomes, such as the exact number of employees who pay tax in Ethiopia. The potential of these data for both tax administration and research remains untapped. Because of the lack of administrative data on wages, researchers have often relied on survey data in which this research also followed (Mengistu & Mascagni, 2018).

So, it is mandatory to use the statistical method to determine the sample size and forced to use the survey method of data collection mechanism. These can be considered as a weakness for this study besides this, it can be encouraged as an ice-breaking work for future researchers and other users. Besides these difficulties, some companies are not cooperative to provide data specifically NGO’s are closed their doors for researchers. With all the above data collection problems, this research is the first in its kind to break through the hassle by collecting 1120 employees’ payroll data from public and private companies to play its role for future endeavors.

2. The Theoretical and empirical Literature Review

2.1. Definition and Classification of Taxes

According to the contemporary researcher from the Economics department of AAU, (Asmare, 2018) who tried to see the 2016 tax reform for the first time defined the following terminologies:

Tax is the money paid by the societies, based on their income and value of goods purchased to the government for public purposes. He evidenced that the word “Tax” has also been defined by different authors and different organizations. Tax, is a payment levied by the government from households, business, product or activity to fund government spending (TJNA, 2011b).

The Organization for Economic Cooperation and Development(OCDE, 2018,p.2) also defines the tax as “compulsory unreturned payments to the government. Others also defined tax is the shift of resources from the private sector to the public sector to achieve the country's economic and social objectives. Tax is defined as a financial charge or levy imposed upon an individual or legal entity by a state, to support government expenditure or defined the tax as a monetary charge imposed by the government on persons, entities, transactions or properties to yield revenue and can be collected with no direct benefits attached with it (Gale, Krupkin, & Rueben, 2015).

Taxation: it refers to the compulsory charge imposed on private, individual institutions or groups by the government. Taxpayer: is a person, the group of persons or an entity that pays or responsible for the tax. Tax Effort: Tax effort measures the ratio of actual tax collection to the potential tax expected from the economy. Traditionally tax potential has been considered by gross domestic product (GDP) of a country; hence tax effort is the ratio of actual tax revenue to GDP.

Tax policy is defined as all the sets and main instructions that determine the structures of a tax system and manage it to finance public spending and support the overall activities. Tax reform: is defined as the increases or decreases in tax rates, brackets or thresholds and changes in the tax base; introducing new taxes and the elimination of old taxes; changes in the tax mix; change in administrative practices and procedures (Raghbendra, 2009), as stated the new income tax proclamation979/ 2016 has its own similarity with the above definition of tax reform by updating the tax brackets which is significant as compared with 2002 income tax reform which separately declared the tax administrative proclamation 983/2016 for the first time in the history of Ethiopian tax reform, etc.

However, not all changes in taxes (like a change in tax collection periods) should be called tax reform and we would do well to reserve this term for significant changes. It is the procedure of shifting the current tax system to a new level of the tax system with the intention that the tax system can serve the main objective of financing government expenditure and meet other objectives (Daba, 2014).

Direct tax: is a tax which is evaluated and collected directly from the individuals who should bear it. Usually, it is collected through an intermediary; and the most popular example is employment income tax. It is possible you have no contact with tax authorities; it can depend on individual circumstances; it is possible to change the average tax rate. Direct taxes are these taxes that are based on the income of individual or groups of individuals, corporate bodies and institutions.

2.2. Theories of Taxation

The empirical pieces of evidence show that there is a huge gap among scholars to have the common ground on theories of tax that the policymakers tried to apply. So the following discussions about different tax theories can give us an opening eye to study further and provide a recommendation for the government.

Different scholars have different approaches to tax theories and reforms, according to Lencho(2014), who wrote his doctoral dissertation on income tax policy and design tried to give a wide coverage of the untouched issues of the scheduler income tax and its imposition by Emperor Haile Silase unchanged until the 1940s it is now implementing more than half a century. According to his study, theories of taxation classified based on making the tax system good and favorable for society. He also evidenced that income tax as one of the principal sources of domestic government revenue since the beginning of modern taxation in the 1940s. The Ethiopian income tax system is “scheduler” in structure and orientation, the computation, assessment and collection of income taxes based on some identified sources of income, like income from employment, income from the rental of property and income from the business. According to his findings, the Ethiopian tax system may be described as a loose agglomeration of proclamations, regulations, directives, rules, etc., which despite their loose ends and rough edges, seem to fulfill the singular purpose for which they are designed, namely raising revenues for the Ethiopian government (Lencho, 2012).

According to another researcher (Asmare, 2018), the first theory of taxation is a socio-political theory of taxation which suggests that social and political objectives should be the pivotal factors in choosing the taxes. This theory is to support progressive taxation by using taxation to reduce income inequalities and it stated that a tax system should not be planned to support a single person from the society however it should ease the problems of society with these regards this study tried to show the progressive tax reform of 2016 and its impact on employment inequality.

Even though it is not comparable with the economist study on these issues because of scarce data on employees’ expenditures on the consumption goods, it is focused on the tax effect of their disposable income and inequalities among different income groups. According to this theory, taxation should be used effectively for overcoming the problem of the economy which arises from market failure (Ebieri& Ekwueme, Chikezi, 2016).

The second theory of taxation is expediency theory which proclaims that each tax proposal should pass the assessment of practicability. This theory proposes tax structure should not be designed to achieve ambitions pressure groups which protect and promote members interest if then the practicability of the tax will be in doubt (Ogbonna & Ebimobowei, 2012).

The third theory of taxation is the cost of service theory of taxation which focus on the citizens of a State must pay for the cost of any State under service they received.

The fourth theory of taxation is the ability to pay theory, which is based on the assumption that a citizen is to pay taxes just because he can and his relative share in the total tax burden is to be determined by his relative paying capacity and argued that this theory of taxation is just, fair and the most accepted theory of taxation because theory favors the income redistribution function and it is a progressive form of tax system and it is practicable in indirect taxes as people with greater ability will pay more(Jhingan, 2011) which is now applying in the country in the employment income tax proclamation of 979/2016 which gives a tax reliefs for those poor employees having monthly income less than 600ETB.

The fifth and the last theory of tax is an optimal tax theory and the dominant approach in optimal tax theory is to use the standard welfares’ framework in which the government sets taxes and transfers to maximize a social welfare function which is an explicit function of individual utilities. Social welfare is maximized subject to a government budget constraint and taking into account how individuals respond to taxes and transfers (Lencho, 2012).

But there is also another approach in theories of tax and tax reform in which the US scholars and others have been debating, one of the well-known writer Christopher Hanna (Hanna, 2006),who study the theories of tax and tax reform with different perspectives which is more relevant and good sources for income tax policymakers. Scholars will face difficulty to classify our countries tax theories but according to his work it seems a hybrid tax theory, but it is difficult to say it confidently because it is not well organized and codified rather they are scattering here and there. Tax law codification and management have several advantages. It helps for users to Judge purely in terms of accessibility and intelligibility, the organization of rules in a formal code with the logically coherent arrangement of rules is, without doubt, the most preferred form of rule organization.

Several countries such as Cameron, Colombia, Cote d'Ivoire, France, Gabon, Kazakhstan, and United States, have organized their tax laws in code like the civil and criminal law of our country (Lencho, 2012).

When we see the US tax reforms and individual income tax laws, they are initiated and declared by political leaders like Regan and Bush. According to Hanna (2006), in the late 1960s, Charles O. Galvin argued that a comprehensive income tax base (“CTB”) was both practical and desirable in the USA. He along with others used the Haig-Simons definition of income as a guide in defining a CTB.

Almost twenty years later, in the State of the Union Address on Jan. 25, 1984, Reagan said: “Let us go forward with a historic reform for fairness, simplicity, and incentives for growth. I am asking Secretary Don Regan for a plan for action to simplify the entire tax code, so all taxpayers, big and small, are treated more fairly. And I believe such a plan could cause that underground economy being brought into the sunlight of honest tax compliance. And it could make the tax base broader, so personal tax rates could come down, not go up. I’ve asked that specific recommendations, consistent with those objectives, be presented by December 1984….” (Bartlett, 2014, p.4).

Following his speech and commitment, Congress enacted the Tax Reform Act of 1986 (“1986 Act”), which broadened the income tax base and lowered marginal tax rates. As a result, the 1986 Act could be viewed as a partial victory for CTB advocates, such as Professor Galvin. However, if the 1986 Act is viewed as a move towards a CTB, then the tax acts in the years since 1986 should be viewed as moving away from a CTB as Congress enacted more exclusions, deductions, and other tax preference items that narrowed the tax base (Julia, 2018).

Similarly, twenty years later, in January 2005, President George W. Bush appointed a tax reform advisory panel to recommend improving the tax system. On November 1, 2005, the panel released its recommendations, proposing the United States adopt one of two different tax systems: a changed version of the current income tax system (“Simplified Income Tax Plan”) or a partial consumption tax system ( “Growth and Investment Tax Plan”). Because of the panel’s report, fundamental tax reform has once again become a timely topic with the CTB concept resurfacing in many discussions (Office of Press Secretary, 2004).

According to Hanna (2006), tax scholars have developed several theories over the years regarding a pure (or normative) income tax system. These theories seem to be more important than ever, particularly considering the current Administration's interest in tax reform. In developing a pure income tax system, three theories are of particular importance: the Haig-Simons definition of income, Samuelson depreciation, and the Cary Brown model. The Cary Brown model also is important in understanding a pure consumption tax system. This research paper discusses the three theories and shows an application of those theories.

The Haig-Simons definition of income, Samuelson depreciation and the Cary Brown model are discussed:

2.2.1 The Haig-Simons Income Tax Theory

Individuals’ income taxation has largely been based on some variant of the standard suggested by Haig (1921) and Simons (1938). This “Haig-Simons” (H-S) standard argues that an ideal income tax should be imposed on “comprehensive income”, and the H-S standard has been used to justify the frequently heard a call for a “Broad-based, Low-rate” tax reform strategy (Alm, 2018).

The Haig-Simons definition of income is generally considered by most tax scholars to be the ideal definition of income. However, the recent studies like Alm (2018) considered a truly H-S individual income tax has in fact never been fully applied.

It is sometimes referred to as the Schanz-Haig-Simons definition of income, reflecting the early contribution of Georg von Schanz. This definition is the accretion concept of income, which defines income as the sum of consumption and accumulation.

Robert Haig published his definition of income in 1921, explaining income as the increase or accretion in one’s power to satisfy his wants in a period in so far as that power comprises (a) money itself, or (b) anything susceptible of valuation in terms of money. More satisfy the definition of income which the economist offers is this: income is the money value of the net accretion to one’s economic power between two points of time(Hanna,2006).

According to Haig's definition of gross income is focused on the point when the power to satisfy one’s wants an increase, not necessarily the point when the wants are actually satisfied and it is stated on Us federal tax act 1986 code 61(Us federal Gov, 2001).

As a result, Haig included savings in income even though it had not yet been consumed. Henry Simons published his definition of income in 1938. They consider Simons’s definition a refinement of Haig’s definition, and it is Simons’s definition that is often cited today by different scholars. Simons wrote that income is the “algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the store's value of property rights between the beginning and end of the period in question(Brooks, 2018).

Simons also noted that income is merely the result got by adding consumption during the period to ‘wealth’ at the end of the period and then subtracting ‘wealth’ at the beginning. Probably, the most significant deviation from the Haig-Simons definition of income in the U.S. income tax system is the realization doctrine.

Under the realization doctrine, appreciation in property is not taxed until the property is sold or otherwise disposed of. For example, assume an individual owns publicly traded stock that has appreciated in value. Under a realization-based income tax system, the individual will defer paying taxes on the appreciation until a realization event, most likely a sale, takes place. As a result, much of the wealth of entrepreneurs and capitalists, such as Bill Gates and Warren Buffett, the two wealthiest Americans, has never been taxed because, in each case, the bulk of their wealth is held in stock of corporations they created or gained, Microsoft and Berkshire Hathaway, respectively. Gates and Buffet have primarily pretax wealth, while most individuals have primarily after-tax wealth(Hanna, 2006).

In our case we don't have a secondary market or well organized primary stock market to value and measure the appreciation of property but there is a capital gain tax in which the tax officers estimate the value of an asset with no tangible evidence to impose a tax at the time of disposal by sales which is the most controversial issues. For example, Highway Engineers and consultant Company faced the problem when the auditing service was taken place by ERCA Western Addis Ababa Branch Office tax audit officers in the year 2014/15.

The most discussed the method for eliminating the tax deferral benefit of the realization doctrine is a “mark-to-market method” of accounting. Most agree that a mark-to-market method is a theoretically correct approach in a pure income tax system. Mark-to-market accounting implements the Haig-Simons definition of income, which most tax theorists feel is the ideal definition of income.

As many scholars have noted, however, eliminating the realization requirement and adopting a mark-to-market approach for unrealized appreciation in property could lead to many problems. These problems include liquidity in paying the resulting income tax, administrability in determining the changes in the fair market value of the taxpayer’s assets (particularly those not publicly traded on an exchange), and possible political problems(Hanna, 2006).

In income tax, one of those rules and concepts is the doctrine of realization. Although a serious deviation from the pure concept of income, it was adopted to contend with practical difficulties inherent in taxing appreciation of assets held by the taxpayer. However, the doctrine of realization continues to be applied even in situations in which there is no practical impediment to imposing the tax on appreciation as it accrues. For example, gain from the appreciation of publicly traded securities could easily be taxed as those securities appreciate in value (David, 2001).

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