Taxation and Tax System in India PDF

# Taxation and Tax System in India ## 1.21 - The Canon of Equality * The first canon of Adam Smith is the canon of equality. * Subjects of every state should contribute to the support of the government, as nearly as possible, in proportion to their respective ability, that is in proportion of the...

# Taxation and Tax System in India ## 1.21 - The Canon of Equality * The first canon of Adam Smith is the canon of equality. * Subjects of every state should contribute to the support of the government, as nearly as possible, in proportion to their respective ability, that is in proportion of the revenue which they respectively enjoy under the protection of the state. * This canon is based on justice and equitable sharing of the cost of running the state. * "Support of the government" signifies the political object of taxation. * "Protection of the state" indicates services rendered by the state to its people. * "Ability to pay" indicates equitable sharing of the tax burden. ## 1.22 - Tax System in India ### 1. Objectives of Taxation The basic objective of taxation is to raise resources for the state. But experts contend that taxation is only for securing revenue. Any other objective besides securing revenue is not taxation. #### 1. Objective of Raising Revenue - Modern governments need enormous amounts for national defense, creation of infrastructure, and social upliftment schemes. - This necessitates regular and systematic resource mobilization. - The only other important non-tax revenue source for government is debt, which is borrowed from financial institutions, the general public, and foreign lenders. - Tax mobilizes required revenue to fulfill public expenditure obligations of the state. #### 2. Regulatory Objectives Taxation plays an important regulatory in different socio-economic aspects: * **Regulating Consumption**: The state can discourage consumption of harmful and undesirable goods by imposing higher tax rates. For example, high tax rates on tobacco products, liquors, etc., are implemented to minimize their usage by the public. * **Regulating Production**: Production can be encouraged by exempting new industries from taxation for a specific time, reducing tax on capital goods, or raising taxes on imported goods to support local production. * **Regulating Imports and Exports**: Imports of undesirable products can be curbed by imposing prohibitively high import duties. Exports can be promoted by cutting export duties. * **Regulating the Effects of Inflation, Depression, etc.** Tax rates can be raised to reduce consumption and overall demand. Higher tax rates can reduce purchasing power and the collected funds used to increase supply of goods, stabilize the supply and demand equation, and control inflation. * State can reduce tax rates in times of economic depression to increase purchasing power and stimulate demand, reviving production and industries, resulting in greater economic activity and employment. #### 3. Developmental Objectives Taxation can be used effectively to achieve higher levels of economic development and employment: * **Economic Development**: Economic development is measured in terms of GNP. Taxation can be used to stimulate any or all three sectors of the economy: agriculture, industry, and services. * Implementing judicious changes in tax rates can encourage investment and production. * For example, capital gains on the sale of long-term assets are exempted if they are reinvested in approved securities. Income from agricultural activities is fully exempt from income tax. These policies encourage higher investment and production, resulting in higher growth. * **Capital Formation**: India has a high household savings rate of around 26%, one of the highest in the world. This can be channeled into investment avenues through appropriate policy measures. * Taxation plays a major role in high savings by providing different kinds of exemptions from tax on contributions to provident funds, insurance premiums, and national savings certificates. * **Increasing Employment Opportunities**: Small and medium enterprises have the greatest potential for employment. * Industrial estates, special economic zones, export-oriented parks, etc., have high employment potential. * Tax concessions can be implemented to start small-scale and medium-scale units and create jobs on a large scale. * Similarly, tax incentives and exemptions can be offered to export-oriented units and industrial units in SEZs, which will lead to greater employment. #### 4. Objectives of Reducing Inequalities Inequalities are common in income, regional development, etc. Taxation can help reduce them: * **Reduce Economic Disparities**: Income levels vary widely in India. Taxation can be used to tackle income disparities. * High levels of taxation on the wealthy that cannot be evaded can be used to support the poor. * **Reduce Regional Imbalances**: Some regions may become more developed than others in a country. * Tax incentives and exemptions can be offered to start industries in backward regions. * Tax incentives and exemptions can be offered to start small-scale and cottage industries in rural areas and for infrastructure projects. These different objectives of taxation, each desirable by itself, can have different implications. The state should formulate a comprehensive and cohesive tax system to balance these different objectives. ### 2. Canons of Taxation A canon of taxation is a rule, principle, or criterion. The principles serve as guidelines when implementing a tax system and help make the system effective. #### 1. Adam Smith's Four Canons of Taxation Adam Smith was the first to enunciate four canons of taxation, which have become "classical" in tax and public finance literature. British Prime Ministers Gladstone and Peele utilized Adam Smith's canons to implement fiscal reforms. **Canon of Equality:** * The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities, that is, in proportion to the revenue which they respectively enjoy under the protection of the state. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation. * This canon is based on justice and equitable sharing of the cost of running the state. * "Support of the government" signifies the political objective of taxation. * "Protection of the state" indicates services rendered by the state to its people. * "Ability to pay" indicates equitable sharing of the tax burden. #### 2. Canons of Taxation Proposed by Other Western Economists Other economists have added several canons to the four canons of Adam Smith: **Canon of Certainty**: * 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 quantity to be paid, ought all to be clear and plain to the contributor and to every other person. * This canon aims at the elimination of uncertainty and arbitrariness in taxation. * The tax payer should know exactly when to pay the tax, to whom to pay the tax, and the exact amount. **Canon of Convenience**: * Every tax ought to be so levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it. * This canon seeks to reduce the "psychic burden" and inconvenience of paying tax. * The timing and manner of collecting tax should be convenient for the taxpayer to ensure optimal compliance. **Canon of Economy**: * Every tax ought to be so contrived as both to take out 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. * The state should pay as little as possible for collecting taxes. * This should be economical from the taxpayers' point of view and not prohibitive. **Canon of Productivity**: * Taxation should have productivity. * Productivity of a tax can be observed in two ways. * It should yield a satisfactory amount for the government. * It should not obstruct or discourage production and productive efficiency of the economy. **Canon of Elasticity**: * The structure of taxation should be elastic in character and capable of expansion and contraction in times of change. * The state should be able to increase its revenue by way of taxation when the situation demands, such as during times of war, national calamities like floods, earthquakes and famines. * The tax system should be flexible to contract taxes when citizens are bearing too much tax. **Canon of Diversity**: * The tax system should not rely on a single tax for raising the entire resources needed to run the state. The tax burden should be distributed on the wide base of the entire economy. * Modern economists recommend "multiple tax policies" with diverse characters. * There should be a combination of direct and indirect taxes so that every citizen is involved and contributes to the country's development. * Diversity does not mean that there should be too many taxes. The focus should be on a judicious mix of taxes to produce required revenue without sacrificing productivity and the economy. **Canon of Simplicity**: * Taxes and the tax system should be easily understood by the taxpayer. The nature, aim, time of payment, method, and basis for estimating each tax should be easily implemented by the taxpayer. * The taxation rules and regulations should be simple, clear, and understandable by all. * The tax administration process should also be simple. * Complex tax systems and confusing tax laws can cause people to avoid paying taxes. **Canon of Expediency**: * A tax may be desirable, but the government may not find it expedient or convenient to impose it, perhaps due to political reasons or "vote bank politics". * While considering the implementation of every tax, its social, political, and economic ground realities must be considered. **Canon of Coordination**: * Taxes are imposed by central, state, and local governments in democratic countries. * This necessitates coordination between different taxes imposed by the tax authorities. * This is necessary for the benefit of both the taxpayer and the government. * Overlapping of taxes and double taxation should be avoided, which can lead to hardship for taxpayers and encourage them to evade taxes. #### 3. Canons of Taxation Relevant to Indian Conditions R.J. Chelliah explored the relevance of the canons to conditions in India in his book "Fiscal Policies in Underdeveloped Countries": * **Mobilisation of Economic Surplus**: In a country like India, where capital formation and economic development are essential, taxation should prioritize the "mopping up" of surplus currently unused for productive investments. * **Taxation According to Unused Capacity**: Every person should contribute to taxation in accordance with their unused capacity or their ability to contribute to economic development. * **Canon of Income - Elasticity of Taxation**: Taxation should be designed to prevent consumption from increasing proportionately with income. This principle emphasizes the need for "built-in flexibility" in the tax system. #### 4. Characteristics of A Good Tax System A good tax system balances the need to raise maximum possible resources and to minimize the tax burden on taxpayers and the economy. It should incorporate the canons of taxation discussed above. ## 1.23 - Definition of Tax Tax is defined in various ways. Some experts highlight particular aspects. * **Prof. E.A.R. Seligman**: A Tax is a compulsory contribution from the person to the state to defray the expenses incurred in the common interest of all without any reference to the special benefits conferred. * **W. Taussig**: The essence of a tax is the absence of a direct "Quid Pro Quo" between the tax payer and the public authority. ## 1.24 - Features or Characteristics of a Tax From the definitions of tax provided above, a number of key features can be highlighted: * **A Tax is a Legal Collection**: It has "statutory sanction." It can't be imposed arbitrarily. It requires following certain legal procedures. * **A Tax is a Personal Obligation**: It creates a personal responsibility for the tax payer. * **A Tax is a Compulsory Contribution**: The state has the right to tax. It can't be refused, even if the tax payer doesn't benefit from it. * **A Tax Entails Sacrifice**: When paying taxes, there's a sense of sacrifice, as the money is spent for the common good of society, rather than for the benefit of the person paying. * **A Tax is Imposed by the Government**: Only the government has the authority to levy taxes. * **A Tax is for Revenue Collection**: The power of taxation is used to raise sufficient revenue for the state. It can include achieving additional objectives. * **A Tax has Socio-Economic Objectives**: Modern governments use tax as a tool to achieve structural changes and realizing socio-economic objectives. * **A Tax is a Contribution for the Common Good**: It's levied for the common good of society, without any regard to the benefit of any particular individual. The proceeds are used for community benefit. * **Benefit is not a Condition for Tax Payment**: No specific benefit is promised in return for paying tax. Taxes are paid due to their compulsory nature. * **A Tax is not Imposed to Realize the Cost of Benefit**: Taxes are not a payment for a service or benefit. * **Taxes are Assessed on Capital or Income, but Paid Out of Income**: A tax may be imposed on capital or income, but taxes are paid out of income. * **A Tax May be Imposed on a Commodity, Property, or Individual**: A tax may be imposed on a commodity, property, or an individual.