Correct Option: B. Progressive Tax
Explanation of Why the Answer is Correct:
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Definition of PAYE: PAYE stands for "Pay As You Earn." It is a system of tax withholding where employers deduct income tax from employees' salaries before they receive their pay. This system is designed to ensure that tax is collected in a timely manner and reduces the burden on individuals to pay their taxes in a lump sum at the end of the year.
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Understanding Progressive Tax: A progressive tax is a tax system where the tax rate increases as the taxable amount increases. In other words, individuals with higher incomes pay a higher percentage of their income in taxes compared to those with lower incomes. This system is designed to reduce income inequality by placing a larger tax burden on those who can afford to pay more.
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How PAYE Functions as a Progressive Tax: In Nigeria, the PAYE system is structured so that tax rates increase with income levels. For example, lower income earners may pay a lower percentage of their income in taxes, while higher income earners pay a higher percentage. This means that as an individual's income rises, they move into higher tax brackets, which is characteristic of a progressive tax system.
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Example Calculation:
- Suppose the tax brackets in Nigeria are as follows:
- 0% for income up to ₦300,000
- 7% for income from ₦300,001 to ₦600,000
- 11% for income from ₦600,001 to ₦1,000,000
- 15% for income above ₦1,000,000
- If an individual earns ₦800,000:
- The first ₦300,000 is taxed at 0% = ₦0
- The next ₦300,000 (from ₦300,001 to ₦600,000) is taxed at 7% = ₦21,000
- The remaining ₦200,000 (from ₦600,001 to ₦800,000) is taxed at 11% = ₦22,000
- Total tax = ₦0 + ₦21,000 + ₦22,000 = ₦43,000
- The effective tax rate is ₦43,000 / ₦800,000 = 5.375%, which is lower than the highest marginal rate of 15%.
Explanation of Why Other Options are Wrong or Weaker:
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A. Indirect Tax: Indirect taxes are taxes that are not directly paid by the individual but are instead included in the price of goods and services (e.g., VAT, sales tax). PAYE is a direct tax because it is directly deducted from an individual's income, making this option incorrect.
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C. Regressive Tax: A regressive tax is one where the tax rate decreases as the taxable amount increases, meaning that lower-income individuals pay a higher percentage of their income in taxes compared to higher-income individuals. This is the opposite of what PAYE represents, as it is designed to be progressive, not regressive.
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D. Community Tax: Community tax typically refers to taxes levied by local governments for community services. PAYE is a national tax system and does not fall under the category of community taxes, making this option incorrect.
Revision Summary:
- PAYE (Pay As You Earn) is a system where income tax is deducted from salaries before payment.
- It is classified as a progressive tax because higher earners pay a higher percentage of their income in taxes.
- Indirect taxes are not applicable to PAYE, which is a direct tax.
- Regressive taxes impose a heavier burden on lower-income earners, contrary to the nature of PAYE.