Unit 1 PPIT Notes PDF

ALLIANCE UNIVERSITY ALLIANCE SCHOOL OF BUSINESS Class: B. Com Semester 5th Subject: PPIT Faculty Name: Dr. Tarun Kashni (Asst Prof)...

ALLIANCE UNIVERSITY ALLIANCE SCHOOL OF BUSINESS Class: B. Com Semester 5th Subject: PPIT Faculty Name: Dr. Tarun Kashni (Asst Prof) NOTES Unit: 1 Fiscal Policy Fiscal policy refers to the government's decisions regarding its revenue collection through taxes and spending on public goods and services. It aims to stabilize the economy, promote growth, and achieve equitable distribution of income. Objectives of Fiscal Policy 1. Stabilization of Economic Growth: Fiscal policy aims to smooth out fluctuations in economic activity and stabilize growth rates. During economic downturns, governments typically increase spending or reduce taxes to stimulate demand and support economic recovery. Conversely, during periods of overheating, fiscal policy may involve increasing taxes or reducing spending to curb inflationary pressures. Example: During the global financial crisis of 2008-2009, governments around the world, including India, implemented fiscal stimulus packages to boost demand and mitigate the impact of the recession on their economies. India introduced various measures like tax cuts, increased infrastructure spending, and support for key sectors to stimulate growth. 2. Achieving Full Employment: Fiscal policy aims to create a conducive environment for generating employment opportunities and reducing unemployment rates. By increasing government spending on infrastructure projects, education, and healthcare, fiscal policy can stimulate job creation and reduce unemployment. Example: India's National Rural Employment Guarantee Act (NREGA), enacted in 2005, guarantees 100 days of wage employment per year to rural households whose adult members volunteer to do unskilled manual work. This initiative aims to enhance livelihood security in rural areas and promote inclusive growth. 3. Promoting Income Redistribution: Fiscal policy can be used to redistribute income and reduce economic inequality by implementing progressive taxation and targeted social welfare programs. These measures aim to ensure that the benefits of economic growth are shared more equitably among different segments of society. Example: India's progressive taxation system imposes higher tax rates on higher-income individuals and corporations. Additionally, the government implements various social welfare programs such as  subsidized food distribution (Public Distribution System) and direct cash transfers (e.g., PM-KISAN) to support vulnerable populations and reduce income disparities. 4. Ensuring Price Stability: Fiscal policy plays a role in controlling inflation and maintaining price stability by adjusting taxes and expenditures in response to inflationary pressures. By moderating aggregate demand through fiscal measures, governments can help stabilize prices and prevent hyperinflation or deflation. Example: In response to rising inflationary pressures, governments may reduce discretionary spending or increase taxes on luxury goods to dampen demand and curb price increases. Conversely, during periods of deflationary pressures, governments may increase spending to stimulate demand and prevent a prolonged economic downturn. 5. External Balance: Fiscal policy also aims to maintain external balance by influencing trade and current account balances. Governments may use fiscal measures to support export-oriented industries, impose tariffs to protect domestic industries, or adjust spending to manage trade deficits or surpluses. Example: India periodically adjusts customs duties and tariffs on imports to protect domestic industries and promote exports. Fiscal policies related to trade and external balance are often coordinated with monetary policies to achieve overall economic stability. Components of Fiscal Policy 1. Government Revenue: This component deals with the sources of revenue for the government, primarily through taxation. It includes taxes on income (personal and corporate), consumption (such as GST in India), wealth, property, and customs duties on imports. Revenue generation is crucial as it funds government expenditures and public services. 2. Government Expenditure: This component refers to the government's spending on goods and services, including infrastructure projects, social welfare programs, defense, education, healthcare, and public administration. Government expenditure stimulates aggregate demand in the economy and plays a critical role in achieving various policy objectives, such as promoting growth, employment, and social welfare. 3. Budgetary Deficit: The fiscal policy's deficit component reflects the difference between government revenue and expenditure. A budget deficit occurs when government spending exceeds its revenue, leading to borrowing to cover the shortfall. Conversely, a budget surplus occurs when revenue exceeds expenditure. The deficit/surplus influences the government's borrowing requirements, interest rates, and overall economic stability. 4. Taxation Policies: Fiscal policy includes various taxation policies aimed at influencing economic behavior, redistributing income, and generating revenue. Tax policies can be progressive (higher rates for higher incomes), regressive (imposing a higher burden on lower incomes), or proportional (same rate regardless of income). Tax incentives and exemptions are also part of fiscal policy to promote specific economic activities or sectors. 5. Public Debt Management: Governments use borrowing as a fiscal tool to finance deficits or fund development projects. Public debt management involves issuing government bonds, treasury bills,  and other securities to raise funds from domestic and international markets. Effective debt management is crucial to maintaining fiscal discipline and ensuring debt sustainability. 6. Automatic Stabilizers: These are built-in fiscal measures that automatically stabilize the economy during economic fluctuations without specific government intervention. Examples include progressive income taxes (revenues increase during economic expansions and decrease during contractions) and unemployment benefits (increase during recessions, reducing the impact on household incomes). 7. Discretionary Fiscal Policy: This refers to deliberate changes in government spending and taxation policies to achieve specific economic objectives, such as stimulating demand during recessions or controlling inflation during economic expansions. Discretionary fiscal policy involves legislative actions and policy decisions aimed at influencing aggregate demand, investment, consumption, and production levels. 8. Fiscal Rules and Frameworks: Governments often establish fiscal rules and frameworks to guide fiscal policy decisions, ensure transparency, and maintain fiscal discipline. These rules may include targets for budget deficits/surpluses, debt-to-GDP ratios, expenditure limits, and fiscal responsibility laws to promote sustainable fiscal management over the long term. Indirect Tax An indirect tax is a type of tax that is levied on goods and services rather than on income or profits directly. Unlike direct taxes (such as income tax or corporate tax), which individuals or businesses pay directly to the government, indirect taxes are imposed on the production, distribution, or consumption of goods and services. The burden of indirect taxes is typically passed on to consumers in the form of higher prices for goods and services. Indirect Taxes are under Central Board of Indirect Taxes and Customs which is under the Ministry of Finance, Department of Revenue Types of Indirect Tax 1. Goods and Services Tax (GST): A comprehensive indirect tax levied on the manufacture, sale, and consumption of goods and services. It is a destination-based tax, which means it is collected at the point of consumption. Example: In India, GST was implemented on July 1, 2017, replacing multiple central and state taxes like VAT, service tax, excise duty, etc. 2. Customs Duty: A tax imposed on goods imported into or exported from a country. It aims to regulate trade, protect domestic industries, and generate revenue.  Example: In India, customs duty is levied on imported goods such as electronics, automobiles, and textiles. 3. Excise Duty: A tax levied on the manufacture of goods within a country. It is typically imposed on specific goods like alcohol, tobacco, and petroleum products. Example: Before GST, India imposed excise duty on the production of alcohol and tobacco products. 4. Sales Tax: A tax on sales or receipts from sales. It is typically added to the price of goods and services at the point of sale. Example: Sales tax in India was replaced by GST on July 1, 2017. However, states like Tamil Nadu still impose a sales tax on petroleum products and alcohol. 5. Value Added Tax (VAT): A type of consumption tax placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale. Example: In India, VAT was replaced by GST, but it still applies to certain items like petrol and diesel. 6. Service Tax: A tax levied on service providers on certain service transactions, but is actually borne by the customers. Example: In India, service tax was applicable on services like consulting, legal, and hospitality before it was replaced by GST. 7. Entertainment Tax: Description: A tax imposed on financial transactions related to entertainment, such as movie tickets, exhibitions, and amusement parks. Example: Before GST, states in India levied entertainment tax on movie tickets and events. Post-GST, this tax has been subsumed into GST. 8. Stamp Duty: Description: A tax paid on the legal recognition of certain documents, such as property transactions, stocks, and shares. Example: In India, stamp duty is charged on the purchase of property and shares. The rates vary by state and type of document. Features of Indirect Taxes Indirect taxes are levied on goods and services rather than on income or profits directly. They play a crucial role in fiscal policy and have several distinctive features: 1. Levy on Goods and Services: Indirect taxes are imposed on the production, distribution, and consumption of goods and services. This means they are collected at various stages of the supply chain and are included in the final sale price. Example: GST (Goods and Services Tax) in India is applied to most goods and services, making it a comprehensive indirect tax system. 2. Shifted Tax Burden: While the initial tax liability lies with the seller or service provider, the burden is ultimately transferred to the consumer. The tax amount is embedded in the price of goods and services, which the end consumer pays. Example: A retailer collects GST from customers at the point of sale and remits it to the government. 3. Evasion Resistance: Indirect taxes are difficult to evade because they are integrated into the price of goods and services. Compliance is enforced through the transactional nature of these taxes, which are collected at the point of sale. Example: Excise duty on fuel is included in the pump price, ensuring that all consumers pay the tax. 4. Uniform Tax Rates: Indirect taxes typically apply a uniform rate to all consumers, regardless of their income levels. This contrasts with direct taxes, where higher income can mean higher tax rates. The uniform application makes indirect taxes regressive, as they take up a larger proportion of income from lower-income individuals. Example: GST applies the same rate to a particular product for all buyers, irrespective of their income. 5. Regressive Nature: Indirect taxes are considered regressive because the tax rate is the same for everyone, which means they take a larger percentage of income from lower-income earners compared to higher-income earners. This characteristic can exacerbate income inequality.  Example: A 10% GST on essential goods impacts low-income families more significantly than high-income families. 6. Economic Influence: Indirect taxes can influence consumer behavior and economic activity. Higher taxes on certain goods can discourage consumption (e.g., tobacco and alcohol), while lower taxes on essentials can promote their accessibility. Example: Reduced GST rates on essential medicines make them more affordable for the general population. 7. Revenue Generation: Indirect taxes provide a stable and significant source of revenue for the government, funding public services and infrastructure projects. They are crucial for maintaining fiscal health. Example: The substantial revenue generated from GST helps fund various government initiatives and programs. 8. Administrative Efficiency: These taxes are easier to administer and collect compared to direct taxes. The burden of collection lies with businesses, which simplifies the process for the government. Example: The streamlined GST system in India has reduced the complexity of multiple tax layers, making tax administration more efficient. Difference Between Direct Taxes V/S Indirect Taxes Aspect Direct Taxes Indirect Taxes Definition Taxes levied directly on income or Taxes levied on goods and services wealth Incidence and Impact Paid directly by the individual or Paid by consumers but collected by entity intermediaries (e.g., businesses) Examples Income Tax, Corporate Tax, GST, VAT, Excise Duty, Customs Duty Wealth Tax Burden Cannot be shifted to others Can be passed on to the end consumer Progressiveness Generally progressive (higher Generally regressive (same rate regardless rates for higher incomes) of income) Administration Collected by tax authorities Collected by intermediaries (e.g., sellers) directly from taxpayers and remitted to the government Basis of Taxation Based on the ability to pay Based on consumption (purchases of  (income, profits, wealth) goods and services) Taxpayer Visibility Taxpayers are aware of the Tax is embedded in the price of amount they pay goods/services; less visible to consumers Compliance Requires detailed record-keeping Collected at the point of sale; compliance and filing by taxpayers is typically simpler for consumers Evasion Potential Higher potential for evasion (e.g., Lower potential for evasion (tax included underreporting income) in sale price) Examples in India Income Tax, Corporate Tax GST (Goods and Services Tax), Customs Duty Adjustment to Adjustments often require Adjustments can be made relatively Economic Conditions legislative changes quickly through rate changes Advantages (Merits) of Indirect Taxes 1. Broad-Based Revenue Generation: Indirect taxes apply to a wide range of goods and services, ensuring a broad tax base and stable revenue for the government. 2. Convenience for Taxpayers: Taxpayers find indirect taxes convenient as they are paid automatically at the time of purchase, eliminating the need for separate filings or calculations. 3. Equitable Contribution: Taxes can be structured to ensure equitable contributions, with lower rates on essential goods and higher rates on luxury items. 4. Ease of Administration: Governments find indirect taxes easier to administer compared to direct taxes, as they are collected directly from businesses during transactions. 5. Encouragement of Positive Consumption: Indirect taxes can be used to promote positive behaviors, such as reduced consumption of harmful products through higher taxes on such items. 6. Stable Revenue Source: Indirect taxes provide a stable and predictable source of revenue for governments, as they are less susceptible to fluctuations compared to direct taxes. 7. Cost of Collection:  The cost of collecting indirect taxes is relatively low, as they are collected by businesses as part of their normal operations. 8. Flexibility in Economic Policy: Governments can adjust indirect tax rates quickly to respond to economic conditions or policy goals, such as inflation control or environmental protection. Disadvantages (Demerits) of Indirect Taxes 1. Regressive Nature: Indirect taxes can be regressive, meaning they take a higher proportion of income from lower-income individuals compared to higher-income groups. 2. Impact on Affordability: Taxes on essential goods and services can disproportionately impact lower-income households, making basic necessities relatively more expensive. 3. Complexity in Pricing: Multiple layers of indirect taxes can complicate pricing for businesses and consumers, potentially leading to confusion and higher costs. 4. Cumulative Tax Burden: Indirect taxes can accumulate through various stages of production and distribution, leading to higher overall prices for consumers. 5. Inflationary Pressures: Higher indirect taxes can contribute to inflationary pressures by increasing the cost of goods and services throughout the economy. 6. Potential for Tax Evasion: Despite being embedded in prices, there is a risk of tax evasion or avoidance, particularly in informal sectors or through underreporting by businesses. 7. Impact on Business Competitiveness: Industries may face increased production costs due to indirect taxes on raw materials or inputs, affecting their competitiveness in the global market. 8. Unpredictability in Revenue: Revenue from indirect taxes can fluctuate based on consumer spending patterns and economic conditions, making budget planning challenging for governments. Constitutional Provisions Relating to Indirect Taxes in India 1. Article 265: This article states that "No tax shall be levied or collected except by authority of law." It emphasizes the principle that all taxes, including indirect taxes, must be authorized by law passed by Parliament or State Legislature. 2. Article 13(3): Defines "law" to include any ordinance, order, by-law, rule, regulation, notification, customs, or usage having the force of law within the territory of India. This broad definition ensures that any form of legislative or regulatory imposition must comply with constitutional principles. 3. Article 366(10): Defines "existing law" to encompass any law, ordinance, order, by-law, rule, or regulation passed or made before the commencement of the Constitution. This provision ensures continuity and application of pre-constitutional laws unless modified or repealed by subsequent legislation. 4. Article 245: Empowers the Parliament to make laws for the whole or any part of India, including laws related to indirect taxes such as customs duties, excise duties, and service tax. 5. Article 246: Enumerates the legislative powers between the Union (Central Government) and the States through three lists: Union List (List I): Includes exclusive powers of the Parliament to legislate on matters such as duties of customs, excise duties on tobacco and other goods, service tax (now subsumed under GST), and other taxes not mentioned in List II or List III. State List (List II): Grants exclusive powers to State legislatures to levy taxes such as sales tax (now subsumed under GST), excise duties on alcoholic liquors, taxes on entertainment, etc. Concurrent List (List III): Allows both Parliament and State legislatures to make laws on matters such as taxes on income other than agricultural income, stamp duties, and other specified taxes. 6. Entries in the Seventh Schedule (Union and State Lists): Union List (List I) - Seventh Schedule Entry 41: Trade and commerce with foreign countries; import and export across customs frontiers; definition of customs frontiers. Entry 83: Duties of Customs including export duties. Entry 84: Duties of Excise on tobacco and other goods manufactured or produced in India, excluding alcoholic liquors for human consumption, opium, Indian hemp, and other narcotic drugs and narcotics. Includes medicinal and toilet preparations containing alcohol or any substance mentioned in the exclusions. Entry 92C: Tax on Services. This entry was inserted by the 88th Constitutional Amendment Act, 2003, empowering the Parliament to levy and collect service tax.  Entry 97: Any other matter not enumerated in List II (State List) or List III (Concurrent List), including any tax not mentioned in either of those lists. This entry provides residual powers to the Union Parliament to legislate on matters not explicitly assigned to the States or Concurrent List. State List (List II) - Seventh Schedule The State List includes entries that grant exclusive powers to State legislatures to legislate on various subjects. Some relevant entries include: Entry 51: Duties of excise on alcoholic liquors for human consumption, opium, Indian hemp, and other narcotic drugs and narcotics. This entry excludes medicinal and toilet preparations containing alcohol or any substance mentioned. Entry 54: Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I (Union List). Entry 60: Taxes on professions, trades, callings, and employments. Entry 62: Taxes on luxuries, including taxes on entertainments, amusements, betting, and gambling. 7. Article 112: Deals with the Annual Financial Statement (Budget) that the President lays before Parliament, outlining estimated receipts and expenditure of the Government of India for each financial year. The Budget includes provisions for both direct and indirect taxes, reflecting the financial planning and fiscal policies of the government. 8. Finance Acts: Each year, the Finance Act is passed by Parliament to give effect to the financial proposals of the Central Government, including amendments to tax laws, rates, and regulations related to indirect taxes. Need Constitutional amendment. 1. Clarity and Uniformity: Indirect taxes affect the entire economy and society. Constitutional amendments can provide clarity on the distribution of powers between the central and state governments regarding the imposition and collection of these taxes. This clarity helps in avoiding conflicts and ensures uniformity in tax administration across the country. 2. Stability and Predictability: Amendments can introduce stability and predictability in the tax regime by laying down clear principles and guidelines for the levy and collection of indirect taxes. This stability is essential for businesses and individuals to plan their finances and investments effectively. 3. Ensuring Fairness: Amendments can address issues of fairness and equity in the taxation system. They can include provisions to prevent regressive taxation, where lower-income groups bear a disproportionately higher burden of taxes relative to their income.  4. Harmonization of Laws: Constitutional amendments can facilitate the harmonization of laws related to indirect taxes across states. This can reduce compliance costs for businesses operating in multiple states and promote ease of doing business. 5. Adaptability to Economic Changes: Amendments can provide mechanisms to adapt the tax system to changing economic conditions and emerging challenges. This flexibility allows governments to respond effectively to economic crises or shifts in global trade patterns. Legislative Journey of Tax on Services in India 1. Initial Introduction (1994-2003): Service Tax was first introduced in 1994 under the Finance Act, 1994. Dr. Manmohan Singh, then Finance Minister, initiated the tax on services such as telephone services, non-life insurance, and stockbrokers based on recommendations from the Tax Reforms Committee chaired by Dr. Raja J. Chelliah. 2. Constitutional Amendment (2003): In response to legal challenges, the 88th Constitutional Amendment Act, 2003 was passed, which introduced Entry 92C in the Union List and Article 268A in the Constitution. This empowered Parliament to legislate on taxes on services, settling constitutional validity issues. 3. Expansion and Conceptual Changes (2012): From July 1, 2012, the concept of a negative list was introduced under the stewardship of the Ministry of Finance, encompassing all services except those explicitly listed as exempt. This phase also saw the elimination of service-specific definitions and valuation methods. 4. Transition to GST (2017): The Goods and Services Tax (GST) was implemented from July 1, 2017, under the leadership of the Government of India. GST replaced various indirect taxes, including service tax, aiming to create a unified tax regime across India. 5. Current Status: Under GST, services are categorized into different tax slabs (5%, 12%, 18%, and 28%) based on their nature, contributing to a streamlined tax structure.