Tax farming
Encyclopedia
Farming is a technique of financial management
, namely the process of commuting (changing), by its assignment by legal contract
to a third party, a future uncertain revenue stream into fixed and certain periodic rents, in consideration for which commutation a discount in value received is suffered. It is most commonly used in the field of public finance
where the state wishes to gain some certainty about its future taxation revenue for the purposes of medium-term budgetting of expenditure. The tax collection process requires considerable expenditure on administration and the yield is uncertain both as to amount and timing, as taxpayers delay or default on their assessed obligations, often the result of unforeseen external forces such as bad weather affecting harvests. Governments (the lessors) have thus frequently over history resorted to the services of an entrepreneurial financier (the tenant) to whom they lease or assign the right to collect and retain the whole of the tax revenue due to the state in return for his payment into the Treasury
of fixed sums (rent) in exchange.
might let it (i.e. lease it out) under a contract, not as a sub-infeudated
fee, as a going concern
, that is to say as a unit producing a revenue stream, together with its workers, livestock and deadstock (i.e. implements), for exploitation by a tenant who was licenced by the contract, or firma, to keep all the revenue he could extract from the holding in exchange for fixed rents. Thus the rights to the revenue stream produced by the land had been farmed by the lessor (therefore strictly perhaps the "farmor") and the tenant became the "holder of the farm", or to coin a word, "farmee". Because this was the form of the farming transaction most known to popular society, the word "farmer" became synonymous with a tenant of an agricultural holding.
ferme ("farm, rent, revenue; revenue collected from a farmer; factor, stewardship, meal, feast"), from Old English feorm, farm ("provision, stores of food, supplies, possessions; provisions supplied to the king or a lord by a tenant or vassal; rent, feast, benefit, assylum"), from Proto-Germanic *firmō, *firχumō ("means of living, subsistence"), from Proto-Indo-European
*perkwu- ("life, strength, force"). It is related to other Old English words such as feormehām ("farm"), feormere ("purveyor, grocer"), feormian ("to provision, sustain"), and feorh ("life, spirit"). The Old English word is stated by these sources as having unusually been borrowed by Medieval Latin
as firma or ferma and to have provided the Old French
ferme "farm", Occitan ferma "farm". This is refuted by those sources which state firma to derive from classical Latin firmus-a-um. The word continued the same senses of "rent, farmed office, source of revenue, feast". The meaning "rent, fixed payment", which was already present in the Old English word, was further strengthened due to the word's resemblance to the unrelated (so say these sources) Latin firmus-a-um ("firm, solid"), and firmitas ("security, firmness").
has reduced such calculations to scientific formulae, the mind of the astute financier of past ages would have well understood the calculations involved, whether they were performed mentally or by making marks with a stick in the sand. An estimate is made of the long-term average yearly gross value of the revenue stream in question, which can be derived from examination of past records & accounts, adjusted for any new circumstances affecting the future. Then a discount for a risk element is deducted with a further discount deducted for the time value of money. The risk in question relates to the possibility of some of the debts forming the revenue stream being defaulted on or paid late. This causes variability in the revenue stream. These concepts must always have been second-nature to the successful merchant throughout the ages. The resultant figure forms the maximum rent the tenant is willing to pay to the lessee of the farm. His profit becomes the excess of whatever revenues he can extract from the farm less the rents payable, less his administration, levying and collection expenses. The skill of the tenant of a farm is therefore firstly in negotiating a favourable rent which he does by overstating the riskiness (variability) of the cash flow stream in question and secondly in his management of the debts thus assigned to him, that is to say his skills as a debt-collector and manager in general. He must also be satisfied that he has the ability to enforce payment of the debts, ultimately by use of a court of law, in which he must pay the standard fee for bringing a suit, under the legal system generally instituted by the government authority which is the lessor of the farm. He does not act as the lessor's agent but as a principle.
practice whereby the burden of tax collection was reassigned by the Roman State to private individuals or groups. In essence, these individuals or groups paid the taxes for a certain area and for a certain period of time and then attempted to cover their outlay by collecting money or saleable goods from the people within that area. The system was set up by Gaius Gracchus
in 123 BC
primarily to increase the efficiency of tax collection within Rome
itself but the system quickly spread to the Provinces
. Within the Roman Empire, these private individuals and groups which collected taxes in lieu of the bid (i.e. rent) they had paid to the state were known as publicani, of whom the best known is the disciple
Matthew
, a publicanus in the village of Capernaum
in the province of Galilee
. The system was widely abused, and reforms were enacted by Augustus
and Diocletian
. Tax farming practices are believed to have contributed to the fall of the Roman empire.
. An example is the following writ
of King William II
(1087–1100) granting a hundred court to be held in fee-farm by Thorney Abbey
:
by providing a method for collecting taxes across a large area without the need for a tax-collecting bureaucracy
, or during periods when such a bureaucracy is unworkable or impossible to maintain. Systems of tax farming similar to the Roman model were used in Pharaonic Egypt, various medieval Western European countries, the Ottoman
and Mughal
empires, and in Qing Dynasty
China. As states become stronger, buoyed up by revenues brought in by tax farming, the practice was discontinued in favour of centralized tax collection systems. In part this was because tax farming systems tended to rely on wealthy individuals outside the state machinery, gang
s, and secret societies.
, where private individuals or companies collect taxes and pass them to the state in return for a commission or fee, without bearing any risk consequent of default by the taxpayer. Tax farming is speculative
, meaning that the tenant of the farm bears the full risk of defaulted debts. In addition, a tenant is often required as a term of the lease to make an early rent payment, which must be financed from his own resources until the revenue stream subject to the farm has started to be collected.
, some tax collection of "lower value debts" by HMRC has been out sourced to Debt Collection Agencies from July 2010. However, debt collection agencies, like invoice factors are not truly farmers of revenue streams, as they do not bear any risk of defaults. Rather they make loans in expectation of future receipts, such loans being always recoverable and secured on the income stream itself.
(VAT) that should be paid per month even though VAT is an ad valorem
tax, that is to say of variable yield. The NBR took this step because under the self-clearance system monitoring of production and sales of cigarettes proved to be difficult. It was agreed that if the cigarette producing firms paid the minimum revenue fixed by the NBR, physical monitoring would be withdrawn. The NBR resorted to this technique of financial management to avoid the large costs of monitoring while gaining more in revenue with certainty.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, namely the process of commuting (changing), by its assignment by legal contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
to a third party, a future uncertain revenue stream into fixed and certain periodic rents, in consideration for which commutation a discount in value received is suffered. It is most commonly used in the field of public finance
Public finance
Public finance is the revenue and expenditure of public authoritiesThe purview of public finance is considered to be threefold: governmental effects on efficient allocation of resources, distribution of income, and macroeconomic stabilization.-Overview:The proper role of government provides a...
where the state wishes to gain some certainty about its future taxation revenue for the purposes of medium-term budgetting of expenditure. The tax collection process requires considerable expenditure on administration and the yield is uncertain both as to amount and timing, as taxpayers delay or default on their assessed obligations, often the result of unforeseen external forces such as bad weather affecting harvests. Governments (the lessors) have thus frequently over history resorted to the services of an entrepreneurial financier (the tenant) to whom they lease or assign the right to collect and retain the whole of the tax revenue due to the state in return for his payment into the Treasury
Treasury
A treasury is either*A government department related to finance and taxation.*A place where currency or precious items is/are kept....
of fixed sums (rent) in exchange.
Derivation from classical Latin
Some sources derive "farm" with its French version ferme, most notably used in the context of the Fermiers Generaux, from the mediaeval Latin firma, meaning "a fixed agreement, contract", ultimately from the classical Latin adjective firmus, firma, firmum, meaning "firm, strong, stout, steadfast, immoveable, sure, to be relied upon". The modern agricultural sense of the word stems from the same origin, in that a mediaeval land-"holder" (none "owned" land but the king himself under his allodial title) under feudal land tenureFeudal land tenure
Under the English feudal system several different forms of land tenure existed, each effectively a contract with differing rights and duties attached thereto. Such tenures could be either free-hold, signifying that they were hereditable or perpetual, or non-free where the tenancy terminated on the...
might let it (i.e. lease it out) under a contract, not as a sub-infeudated
Subinfeudation
In English law, subinfeudation is the practice by which tenants, holding land under the king or other superior lord, carved out new and distinct tenures in their turn by sub-letting or alienating a part of their lands....
fee, as a going concern
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...
, that is to say as a unit producing a revenue stream, together with its workers, livestock and deadstock (i.e. implements), for exploitation by a tenant who was licenced by the contract, or firma, to keep all the revenue he could extract from the holding in exchange for fixed rents. Thus the rights to the revenue stream produced by the land had been farmed by the lessor (therefore strictly perhaps the "farmor") and the tenant became the "holder of the farm", or to coin a word, "farmee". Because this was the form of the farming transaction most known to popular society, the word "farmer" became synonymous with a tenant of an agricultural holding.
Derivation from Old English
According to other sources, the word farm comes from Middle EnglishMiddle English
Middle English is the stage in the history of the English language during the High and Late Middle Ages, or roughly during the four centuries between the late 11th and the late 15th century....
ferme ("farm, rent, revenue; revenue collected from a farmer; factor, stewardship, meal, feast"), from Old English feorm, farm ("provision, stores of food, supplies, possessions; provisions supplied to the king or a lord by a tenant or vassal; rent, feast, benefit, assylum"), from Proto-Germanic *firmō, *firχumō ("means of living, subsistence"), from Proto-Indo-European
Proto-Indo-European language
The Proto-Indo-European language is the reconstructed common ancestor of the Indo-European languages, spoken by the Proto-Indo-Europeans...
*perkwu- ("life, strength, force"). It is related to other Old English words such as feormehām ("farm"), feormere ("purveyor, grocer"), feormian ("to provision, sustain"), and feorh ("life, spirit"). The Old English word is stated by these sources as having unusually been borrowed by Medieval Latin
Medieval Latin
Medieval Latin was the form of Latin used in the Middle Ages, primarily as a medium of scholarly exchange and as the liturgical language of the medieval Roman Catholic Church, but also as a language of science, literature, law, and administration. Despite the clerical origin of many of its authors,...
as firma or ferma and to have provided the Old French
Old French
Old French was the Romance dialect continuum spoken in territories that span roughly the northern half of modern France and parts of modern Belgium and Switzerland from the 9th century to the 14th century...
ferme "farm", Occitan ferma "farm". This is refuted by those sources which state firma to derive from classical Latin firmus-a-um. The word continued the same senses of "rent, farmed office, source of revenue, feast". The meaning "rent, fixed payment", which was already present in the Old English word, was further strengthened due to the word's resemblance to the unrelated (so say these sources) Latin firmus-a-um ("firm, solid"), and firmitas ("security, firmness").
Valuation of a farm
The tenant of a farm can only make a profit if he makes a careful assessment of its value. Although modern financial management theoryFinance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
has reduced such calculations to scientific formulae, the mind of the astute financier of past ages would have well understood the calculations involved, whether they were performed mentally or by making marks with a stick in the sand. An estimate is made of the long-term average yearly gross value of the revenue stream in question, which can be derived from examination of past records & accounts, adjusted for any new circumstances affecting the future. Then a discount for a risk element is deducted with a further discount deducted for the time value of money. The risk in question relates to the possibility of some of the debts forming the revenue stream being defaulted on or paid late. This causes variability in the revenue stream. These concepts must always have been second-nature to the successful merchant throughout the ages. The resultant figure forms the maximum rent the tenant is willing to pay to the lessee of the farm. His profit becomes the excess of whatever revenues he can extract from the farm less the rents payable, less his administration, levying and collection expenses. The skill of the tenant of a farm is therefore firstly in negotiating a favourable rent which he does by overstating the riskiness (variability) of the cash flow stream in question and secondly in his management of the debts thus assigned to him, that is to say his skills as a debt-collector and manager in general. He must also be satisfied that he has the ability to enforce payment of the debts, ultimately by use of a court of law, in which he must pay the standard fee for bringing a suit, under the legal system generally instituted by the government authority which is the lessor of the farm. He does not act as the lessor's agent but as a principle.
Roman empire
Tax farming was originally a RomanAncient Rome
Ancient Rome was a thriving civilization that grew on the Italian Peninsula as early as the 8th century BC. Located along the Mediterranean Sea and centered on the city of Rome, it expanded to one of the largest empires in the ancient world....
practice whereby the burden of tax collection was reassigned by the Roman State to private individuals or groups. In essence, these individuals or groups paid the taxes for a certain area and for a certain period of time and then attempted to cover their outlay by collecting money or saleable goods from the people within that area. The system was set up by Gaius Gracchus
Gaius Gracchus
Gaius Sempronius Gracchus was a Roman Populari politician in the 2nd century BC and brother of the ill-fated reformer Tiberius Sempronius Gracchus...
in 123 BC
123 BC
Year 123 BC was a year of the pre-Julian Roman calendar. At the time it was known as the Year of the Consulship of Balearicus and Flamininus...
primarily to increase the efficiency of tax collection within Rome
Rome
Rome is the capital of Italy and the country's largest and most populated city and comune, with over 2.7 million residents in . The city is located in the central-western portion of the Italian Peninsula, on the Tiber River within the Lazio region of Italy.Rome's history spans two and a half...
itself but the system quickly spread to the Provinces
Roman province
In Ancient Rome, a province was the basic, and, until the Tetrarchy , largest territorial and administrative unit of the empire's territorial possessions outside of Italy...
. Within the Roman Empire, these private individuals and groups which collected taxes in lieu of the bid (i.e. rent) they had paid to the state were known as publicani, of whom the best known is the disciple
Disciple (Christianity)
In Christianity, the disciples were the students of Jesus during his ministry. While Jesus attracted a large following, the term disciple is commonly used to refer specifically to "the Twelve", an inner circle of men whose number perhaps represented the twelve tribes of Israel...
Matthew
Matthew the Evangelist
Matthew the Evangelist was, according to the Bible, one of the twelve Apostles of Jesus and one of the four Evangelists.-Identity:...
, a publicanus in the village of Capernaum
Capernaum
Capernaum was a fishing village in the time of the Hasmoneans. Located on the northern shore of the Sea of Galilee. It had a population of about 1,500. Archaeological excavations have revealed two ancient synagogues built one over the other...
in the province of Galilee
Galilee
Galilee , is a large region in northern Israel which overlaps with much of the administrative North District of the country. Traditionally divided into Upper Galilee , Lower Galilee , and Western Galilee , extending from Dan to the north, at the base of Mount Hermon, along Mount Lebanon to the...
. The system was widely abused, and reforms were enacted by Augustus
Augustus
Augustus ;23 September 63 BC – 19 August AD 14) is considered the first emperor of the Roman Empire, which he ruled alone from 27 BC until his death in 14 AD.The dates of his rule are contemporary dates; Augustus lived under two calendars, the Roman Republican until 45 BC, and the Julian...
and Diocletian
Diocletian
Diocletian |latinized]] upon his accession to Diocletian . c. 22 December 244 – 3 December 311), was a Roman Emperor from 284 to 305....
. Tax farming practices are believed to have contributed to the fall of the Roman empire.
Feudal England
Mediaeval English kings frequently made grants "in fee-farm", a form of feudal tenureFeudal land tenure
Under the English feudal system several different forms of land tenure existed, each effectively a contract with differing rights and duties attached thereto. Such tenures could be either free-hold, signifying that they were hereditable or perpetual, or non-free where the tenancy terminated on the...
. An example is the following writ
Writ
In common law, a writ is a formal written order issued by a body with administrative or judicial jurisdiction; in modern usage, this body is generally a court...
of King William II
William II of England
William II , the third son of William I of England, was King of England from 1087 until 1100, with powers over Normandy, and influence in Scotland. He was less successful in extending control into Wales...
(1087–1100) granting a hundred court to be held in fee-farm by Thorney Abbey
Thorney Abbey
Thorney Abbey was on the island of Thorney in The Fens of Cambridgeshire, England.- History :The earliest documentary sources refer to a mid-7th century hermitage destroyed by a Viking incursion in the late 9th century. A Benedictine monastery was founded in the 970s, and a huge rebuilding...
:
"William, king of the English, to all the sheriffSheriffA sheriff is in principle a legal official with responsibility for a county. In practice, the specific combination of legal, political, and ceremonial duties of a sheriff varies greatly from country to country....
s and baronsEnglish feudal baronyIn England, a feudal barony or barony by tenure was a form of Feudal land tenure, namely per baroniam under which the land-holder owed the service of being one of the king's barons. It must be distinguished from a barony, also feudal, but which existed within a county palatine, such as the Barony...
of HuntingdonshireHuntingdonshireHuntingdonshire is a local government district of Cambridgeshire, covering the area around Huntingdon. Traditionally it is a county in its own right...
, greeting. Know that I have granted the hundred of Normancross to the abbotAbbotThe word abbot, meaning father, is a title given to the head of a monastery in various traditions, including Christianity. The office may also be given as an honorary title to a clergyman who is not actually the head of a monastery...
and monks of Thorney to be held in fee-farm for an annual rent of 100 shillingShillingThe shilling is a unit of currency used in some current and former British Commonwealth countries. The word shilling comes from scilling, an accounting term that dates back to Anglo-Saxon times where it was deemed to be the value of a cow in Kent or a sheep elsewhere. The word is thought to derive...
s which I order them to pay to my sheriff at Huntingdon. And I forbid any of my officers to do them injury or insult in respect of this"
Other
Besides the Romans, historical examples include the tax collection methods of the Ptolemies, Seljuks, Mamluks, Ottomans, the French State prior to Louis XVI, and Russia prior to 1862. In many cases, such as the Abbasid practice of Iqta, these rights were granted by an authority, in this example the caliph, for services rendered or promised. In the Byzantine pronoia system, similar rights were often purchased from the crown.[5] Though such arrangements in some respects seem similar to the feudal system, there are significant disparities, including continuance of state power and, at least in the case of pronoia, theoretical time limits on the grant. In many cases, including those mentioned, tax rights were not transferable or divisible, unlike feudal fiefdoms.Advantages
Tax farming was historically an important step in the development of economic developmentEconomic development
Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
by providing a method for collecting taxes across a large area without the need for a tax-collecting bureaucracy
Bureaucracy
A bureaucracy is an organization of non-elected officials of a governmental or organization who implement the rules, laws, and functions of their institution, and are occasionally characterized by officialism and red tape.-Weberian bureaucracy:...
, or during periods when such a bureaucracy is unworkable or impossible to maintain. Systems of tax farming similar to the Roman model were used in Pharaonic Egypt, various medieval Western European countries, the Ottoman
Ottoman Empire
The Ottoman EmpireIt was usually referred to as the "Ottoman Empire", the "Turkish Empire", the "Ottoman Caliphate" or more commonly "Turkey" by its contemporaries...
and Mughal
Mughal Empire
The Mughal Empire , or Mogul Empire in traditional English usage, was an imperial power from the Indian Subcontinent. The Mughal emperors were descendants of the Timurids...
empires, and in Qing Dynasty
Qing Dynasty
The Qing Dynasty was the last dynasty of China, ruling from 1644 to 1912 with a brief, abortive restoration in 1917. It was preceded by the Ming Dynasty and followed by the Republic of China....
China. As states become stronger, buoyed up by revenues brought in by tax farming, the practice was discontinued in favour of centralized tax collection systems. In part this was because tax farming systems tended to rely on wealthy individuals outside the state machinery, gang
Gang
A gang is a group of people who, through the organization, formation, and establishment of an assemblage, share a common identity. In current usage it typically denotes a criminal organization or else a criminal affiliation. In early usage, the word gang referred to a group of workmen...
s, and secret societies.
Disadvantages
The key flaw in the tax farming system is the tension between the state, which seeks a long-term source of taxation revenue, and the tax farmers, who seek to make a profit on their investment in as short a time as possible. As a result tax-farmers often abuse the taxpayers in various ways, tending them to switch their economic activity from strategic long-term projects to short-term revenue generation. A common abuse by tax farmers is the undervaluation of goods received in lieu of taxes, allowing the tax-farmer to re-sell the goods to create a second profit source. Such abuses stifle economic growth by restricting the ability of the tradesman to reinvest in his business, thereby limiting the quantity of taxes generated over the long-term.Indian sub-continent
In Bangladesh and India tolls on bridges and roads and dues from public properties such as lakes and forests are often leased to private persons or firms.Privatized tax collection
Tax farming is not synonymous with modern privatized tax collectionPrivatized tax collection
Privatized tax collection occurs wherever the state passes on its obligation to collect taxes to private companies or firms in return for a fixed or ad valorem fee...
, where private individuals or companies collect taxes and pass them to the state in return for a commission or fee, without bearing any risk consequent of default by the taxpayer. Tax farming is speculative
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
, meaning that the tenant of the farm bears the full risk of defaulted debts. In addition, a tenant is often required as a term of the lease to make an early rent payment, which must be financed from his own resources until the revenue stream subject to the farm has started to be collected.
Factoring
In the United KingdomUnited Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
, some tax collection of "lower value debts" by HMRC has been out sourced to Debt Collection Agencies from July 2010. However, debt collection agencies, like invoice factors are not truly farmers of revenue streams, as they do not bear any risk of defaults. Rather they make loans in expectation of future receipts, such loans being always recoverable and secured on the income stream itself.
Simple commutation
In 1999 the National Board of Revenue in Bangladesh (NBR) negotiated with cigarette producing firms a minimum amount of Value Added TaxValue added tax
A value added tax or value-added tax is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the "value added" to a product, material or service, from an accounting point of view, by this stage of its...
(VAT) that should be paid per month even though VAT is an ad valorem
Ad valorem tax
An ad valorem tax is a tax based on the value of real estate or personal property. It is more common than a specific duty, a tax based on the quantity of an item, such as cents per kilogram, regardless of price....
tax, that is to say of variable yield. The NBR took this step because under the self-clearance system monitoring of production and sales of cigarettes proved to be difficult. It was agreed that if the cigarette producing firms paid the minimum revenue fixed by the NBR, physical monitoring would be withdrawn. The NBR resorted to this technique of financial management to avoid the large costs of monitoring while gaining more in revenue with certainty.
See also
- MaonaMaonathumb|upright|Vincenzo Giustiniani was the last owner of the genoese "Maona of Chios"A maona or Societas comperarum was a medieval Italian association of investors formed to manage the purchased shares of the revenue due to the relevant city-state through tax farming; the shares were individually...
- Privatized tax collectionPrivatized tax collectionPrivatized tax collection occurs wherever the state passes on its obligation to collect taxes to private companies or firms in return for a fixed or ad valorem fee...
- Publicani
- Farmers-General
- Revenue FarmRevenue FarmA Revenue Farm is a franchise with a license to collect state revenue, with a monopoly right to practice a certain business. Such a monopoly was granted by the state government to a "Farmer" for a limited period of time in a strictly defined location in a city, district or province. In return,...
Further reading
- Chowdhury, F. L. (2007): NBR's attempt at Tax Farming - fixed VAT on Cigarettes in 1999, Desh Prokashon, Dhaka.
- Levi, M. Of (1988), Rule and Revenue, California Series on Social Choice and Political Economy (13), University of California Press.
- Stella, P., (1992) Tax Farming: A Radical Solution for Developing Country Tax Problems? (September 1992). IMF Working Paper No. 92/70.