SSC CGL Economic Study Material – Notes on Tax System in India
SSC CGL Economic Study Material – Notes on Tax System in India
When country or a state legislature enacts a new tax, the debate usually includes some opinions about who should pay for running the government or for the particular program being supported by the tax. A means by which government finance their expenditure by imposing charges on citizens and corporate entitles.
Economists distinguish between those who bear the burden of a tax and those on whom a tax is imposed. Taxes in India are imposed by the Central Government and the state governments. Some minor taxes are also imposed by the local authorities such as Municipality.
According to Indian Constitution, Article 246 distributes legislative powers including taxation, between the Parliament of India and the State Legislature. The Central Board of Revenue or Department of Revenue is the apex body charged with the administration of taxes. It is a part of Ministry of Finance which came into existence as a result of the Central Board of Revenue Act, 1924.
Central Government levies taxes on income (except tax on agricultural income, which the State Governments can levy), customs duties, and central excise and service tax.
State Government levies taxes – Value Added Tax (VAT), Stamp Duty, State Excise, Land Revenue and Profession Tax.
Local bodies are empowered to levy tax on Properties, Octroi and for utilizations like water supply, drainage etc.
In Indian taxation system, system is divided into two taxes – Direct Taxation and Indirect Taxation.
The taxes levied by the government form a pool of resources to be used of the collective benefit of the public. The taxation is an exercise in the collective solution of individual problems. The state takes upon itself the duty of solving the problems of the underprivileged and need finance for this purpose. The government can mobilize resources by imposing taxes on the privileged ones. The taxation structure of the country can play a very important role in the working of our economy. Some time back the emphasis was on higher rates of tax and more incentives. But recently the emphasize has shifted to decrease in rates of taxes and withdrawal of incentives. While designing the taxation structure it has to be seen that it is in conformity with our economic and social objectives. It should not impair the incentives to personal savings and investment flow and on the other hand it should not result into decrease in revenue for the state.
In our present day economic structure income tax plays a vital role as source of revenue and a measure of removal of economic disparity. Our taxation structure provides for two types of taxes direct and indirect; the income tax, wealth tax and gift tax are direct taxes where as sales tax and excise duties are indirect taxes.
- Public Finance
- Public Revenue
1. Public Finance-
According to Dalton,’ Public finance is the branch of knowledge which is concerned with the income and expenditure of public authorities and with the adjustment of one to another.’ It deals with the study of revenue and expenditure of the government at the centre, state and local bodies.
Public finance is the study of the role of the government in the economy. It is the branch of economics which assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones.
The purview of public finance is considered to be threefold: governmental effects on (1) efficient allocation of resources, (2) distribution of income, and (3) macroeconomic stabilization.
The proper role of government provides a starting point for the analysis of public finance. In theory, under certain circumstances, private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy’s productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public good.
“Market failure” occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services.Externalities, public goods, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed “government failure.”
Government can pay for spending by borrowing (for example, with government bonds), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt. Deficit finance allows governments to smooth tax burdens over time, and gives governments an important fiscal policy tool. Deficits can also narrow the options of successor governments.
Public finance is closely connected to issues of income distribution and social equity. Governments can reallocate income through transfer payments or by designing tax systems that treat high-income and low-income households differently.
The public choice approach to public finance seeks to explain how self-interested voters, politicians, and bureaucrats actually operate, rather than how they should operate.
2. Public Revenue-
The income of the government through all sources is called public income or public revenue.
According to Dalton, however, the term “Public Income” has two senses — wide and narrow. In its wider sense it includes all the incomes or receipts which a public authority may secure during any period of time. In its narrow sense, however, it includes only those sources of income of the public authority which are ordinarily known as “revenue resources.” To avoid ambiguity, thus, the former is termed “public receipts” and the latter “public revenue.”
As such, receipts from public borrowings (or public debt) and from the sale of public assets are mainly excluded from public revenue. For instance, the budget of the Government of India is classified into “revenue” and “capital.” “Heads of Revenue” include the heads of income under the capital budget are termed as “receipts.” Thus, the term “receipts” includes sources of public income which are excluded from “revenue.”
In a modern welfare state, public revenue is of two types, tax revenue and non-tax revenue.
Objectives of taxation-
1. Economic Development:
One of the important objectives of taxation is economic development. Economic development of any country is largely conditioned by the growth of capital formation. It is said that capital formation is the kingpin of economic development. But LDCs usually suffer from the shortage of capital.
To overcome the scarcity of capital, governments of these countries mobilize resources so that a rapid capital accumulation takes place. To step up both public and private investment, government taps tax revenues. Through proper tax planning, the ratio of savings to national income can be raised.
2. Full Employment:
Second objective is the full employment. Since the level of employment depends on effective demand, a country desirous of achieving the goal of full employment must cut down the rate of taxes. Consequently, disposable income will rise and, hence, demand for goods and services will rise. Increased demand will stimulate investment leading to a rise in income and employment through the multiplier mechanism.
3. Price Stability:
Thirdly, taxation can be used to ensure price stability—a short run objective of taxation. Taxes are regarded as an effective means of controlling inflation. By raising the rate of direct taxes, private spending can be controlled. Naturally, the pressure on the commodity market is reduced.
But indirect taxes imposed on commodities fuel inflationary tendencies. High commodity prices, on the one hand, discourage consumption and, on the other hand, encourage saving. Opposite effect will occur when taxes are lowered down during deflation.
4. Control of Cyclical Fluctuations:
Fourthly, control of cyclical fluctuations—periods of boom and depression—is considered to be another objective of taxation. During depression, taxes are lowered down while during boom taxes are increased so that cyclical fluctuations are tamed.
5. Reduction of BOP Difficulties:
Fifthly, taxes like custom duties are also used to control imports of certain goods with the objective of reducing the intensity of balance of payments difficulties and encouraging domestic production of import substitutes.
6. Non-Revenue Objective:
Finally, another extra-revenue or non-revenue objective of taxation is the reduction of inequalities in income and wealth. This can be done by taxing the rich at higher rate than the poor or by introducing a system of progressive taxation.
Adam Smith’s four canons of taxation
According to Adam Smith, there are four canons or maxims of taxation on the administrative side of public finance which are still recognised as classic.
To him a good tax is one which contains:
- Canon of equality or equity.
- Canon of certainty.
- Canon of economy.
- Canon of convenience.
Canon of Equality:
Every fiscal economist, along with Adam Smith, stresses that taxation must ensure justice. The canon of equality or equity implies that the burden of taxation must be distributed equally or equitably in relation to the ability of the tax payers.
Equity or social justice demands that the rich people should bear a heavier burden of tax and the poor a lesser burden. Hence, a tax system should contain progressive tax rates based on the tax-payer’s ability to pay and sacrifice.
Canon of Certainty:
Taxation must have an element of certainty. According to Adam Smith, “the tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the amount to be paid ought to be clear and plain to the contributor and to every other person.”
The certainty aspects of taxation are:
- Certainty of effective incidence i.e., who shall bear the tax burden.
- Certainty of liability as to how much shall be the tax amount payable in a particular period. This the tax payers as well as the exchequer should unambiguously know.
- Certainty of revenue i.e., the government should be certain about the estimated collection of revenue from a given tax levied.
Canon of Economy:
This principle suggests that the cost of collecting a tax should not be exorbitant but be the minimum. Extravagant tax collection machinery is not justified. According to Adam Smith, “Every tax has to be contrived as both to take and keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.”
Owing to the complex and ever-changing nature of taxation laws in India, government has to maintain elaborate tax collection machinery with a large staff of highly trained personnel involving high administrative costs and inordinate delay in assessment and collection of tax.
Canon of Convenience:
According to this canon, tax should be collected in a convenient manner from the tax payers. Adam Smith stresses: “Every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.” For example, it is convenient to pay a tax when it is deducted at source from the salaried classes at the time of paying salaries.
Classification of Tax-
Economists have classified taxes from different angles. The various taxes may be classified under the following major heads:
- Direct and Indirect Taxes
- Proportional, Progressive and Regressive Taxes
1. Direct and Indirect Taxes-
Direct and indirect taxes include all the different types of taxes levied by the government. Direct taxes include the taxes that cannot be transferred or shifted to another person, for instance the income tax an individual pays directly to the government. In this case, the burden of the tax falls flatly on the individual who earns a taxable income and cannot shift the tax to others.
Indirect taxes, on the other hand, are taxes which can be shifted to another person. An example would be the Value Added Tax (VAT) that is included in the bill of goods and services that you procure from others. The initial tax is levied on the manufacturer or service provider, who then shifts this tax burden to the consumers by charging higher prices for the commodity by including taxes in the final price.
Both direct and indirect taxes are critical components of governmental revenue and consequently the economy. The variations in the indirect taxes may come down in the future once the Goods and Services Tax bill is passed by the parliament, probably by next year.
2. Proportional, Progressive and Regressive Taxes-
Under a regressive tax system, individuals and entities with low incomes pay a higher amount of that income in taxes compared to high-income earners. Rather than implementing a tax liability based on the individual or entity’s ability to pay, the government assesses tax as a percentage of the asset that the taxpayer purchases or owns.
For example, a sales tax on the purchase of everyday products or services is assessed as a percentage of the item bought and is the same for every individual or entity. However, a sales tax of 7% has a greater burden on lower-income earners than it does on the wealthy because the ability to pay is not taken into consideration. Regressive taxes include real estate property taxes, state and local sales taxes as well as excise taxes on consumables such as cigarettes, gasoline, airfare or alcohol.
A proportional tax system, or a flat tax system, assesses the same tax rate to taxpayers regardless of income or wealth. It is meant to create equality between marginal tax rate and average tax rate paid. Under a proportional tax system, individual taxpayers pay a set percentage of their income regardless of total income earned.
For example, an income tax of 10% that does not increase or decrease as income rises or falls results in a proportional tax. In this example, an individual who earns $20,000 annually pays $2,000 under a proportional tax system, while someone who earns $200,000 each year pays $20,000 in taxes. Some specific examples of proportional taxes include per capita taxes, gross receipts taxes and occupational taxes.
The current federal income tax is a progressive tax system, in that the proportion of tax liability rises as an individual or entity’s income increases. Tax burdens are meant to be more of an imposition to wealthy, high-income earners than they are to low- or middle-class individuals.
Under a progressive tax system, taxes assessed on income and business profits are based on a progressive or increasing tax rate schedule. Marginal tax rates under a progressive tax system are often higher than the average tax rates that are paid. Estate taxes are another example of progressive taxes, as a greater burden is placed on wealthy individuals.
To conclude, we can say that the instrument of taxation is of great significance on
- increasing the level of economic activity – Regressive taxation
- reducing income inequalities – progressive taxation
- promoting economic growth – Funds could be reinvested
Social-Welfare Objective – Tax payment helps reduce the gap between the haves and have-nots. As it helps in mobilizing the surplus income from the haves and reinvesting them for public welfare, it helps these surplus funds to reach the have-nots.
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