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1. INTR INTROD ODUC UCTI TION ON 1.1 1.1
Taxatio xation n in in Ind India ia – A Cont Contex extua tuall Out Outli line ne A tax (from the Latin taxo) is a financial charge or other levy imposed upon a taxpayer (an individual or legal entity) entity) by a state or the functional equivalent of a state to fund various public expenditures. expenditures.1 A tax is a pecuniary burden laid upon individuals or property owners, particularly contributed to government, and it is a payment exacted by legislative authority. t is not a voluntary payment or donation, but an enforced contribution to support the government. !axes consist of direct direct or or indirect indirect taxes and taxes and may be paid in money or as its labour equivalent (often but not always unpaid labour). "irect tax, in a general sense, is imposed upon an individual person (#uristic or natural) or property (i.e. real and personal property, livestoc$, crops, wages, etc.). A direct tax is one that cannot be shifted by the taxpayer to someone else. ncome tax, corporation tax, estate tax, property tax are a few example of direct taxes. ndirect ndirect tax (such (such as sales tax, tax, per unit tax tax,, value added tax (%A!), tax (%A!), or goods or goods and services tax (&'!)), tax (&'!)), on the other hand, is a tax tax collect collected ed by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the consumer). !he intermediary later files a tax return and forwards the tax proceeds to government with the return. n this sense, the term indirect tax is contrasted with a direct tax, tax, which is collected directly by government from the persons (legal or natural) na tural) on whom it is imposed. ndia has a well developed taxation structure. !he tax system in ndia is mainly a three tier system which is based between the entral, 'tate &overnments and the local government organiations. organiations. n most cases, these local bodies include the local counci councils ls and the the mu muni nicip cipali aliti ties. es. Accordi ccording ng to the the onst onstit ituti ution on of ndia ndia,, the the government government has the right to levy taxes on individuals individuals and organiations. organiations. *owever, *owever, the constitution states that no one has the right to levy or charge taxes except the authority of law. +hatever tax is being charged has to be bac$ed by the law passed by the legislature or the parliament. Article - ('/%/0!* '*/"L/) of the
ndian onstitution, distributes legislative powers including taxation, between the 7arliament and the 'tate Legislature. n the ndian economy, the taxation has not contributed a lot to the national income mainly due to distribution effect of the national income. 8or raising the contribution of taxation, it becomes essential that investment decisions are liberal to the development of large9scale industries. !he non9optimal relationship between the direct and indirect taxes has also affected the contribution of taxation to the generation of national income. t is found that direct taxes contribute only 1: per cent of the total tax revenue. 8or raising the instrumentality of taxation, it is essential that the contribution of direct taxes is raised to a considerable extent. n ;1:9;1, the gross tax collection of the entre amounted to
trillion ('<; billion)=.
Objectives 'et in the above perspective or bac$ground, the broad ob#ective of the study is to>
. !o study tax and its effect on economic growth of ndia and to analyse its impact on &"7.
H!ot"esis ndirect tax is a ma#or contributor to the developing economy of ndia and is beneficial to the economy with changing times.
$ite%atu%e Revie& 1) !axation and /conomic &rowth &areth ". 2yles !his article gives a theoretical perspective through which the effects of taxation on economic growth can be explored. t shows many theoretical models that isolate a number of channels through which taxation can affect growth and this growth can be very substantial. ) ndirect !ax Beforms in the ndian /conomy !.B. Bustagi !his paper highlights the importance of indirect taxes, through its evolution and its impact in current times. t records the progress done by the country with the changing times since independence and suggests the scope of improvement that still needs to be done for further development of the ndian economy. =) !hirty years of !ax Beform in ndia 'han$ar Acharya !his paper highlights the contours of ndiaCs tax reform story from the mid9 1DE;s to the present and presents the enormous progress that has been made in the last =; years, #udged by the standards of economic efficiency, equity, built9 in revenue elasticity and transparency.
(co!e o) t"e stud !he present pro#ect is an attempt to analye taxation, specifically indirect and direct tax and its effect on the ndian economy and conclude the study thusly.
+et"odolo, o) t"e stud !his pro#ect is based on a non9doctrinal research methodology. Belevant points along with some examples have been provided to prove some points in the topic.
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Accumulation of the information on the topic includes various secondary sources such as boo$s, articles, e9articles, etc. !he matter from these sources has been complied and analysed to understand the topic in a better way.
CHAN-IN- (CNARIO AND TA/ R0OR+( !ax systems the world over have undergone significant changes during the last
twenty years as many countries across the ideological spectrum and with varying levels of development have underta$en reforms. !he wave of tax reforms that began in the mid91DF;s and accelerated in the 1DD;s, was motivated by a number of factors. n many developing countries, pressing fiscal imbalance was the driving force. !ax policy was employed as a ma#or instrument to correct severe budgetary pressures. n others, the transition from a planned economy to a mar$et economy necessitated wide ranging tax reforms. 6esides efficiency considerations, these tax reforms had to address the issues of replacing public enterprise profits with taxes as a principal source of revenue and of aligning tax policy to change in the development strategy. Another motivation was the internationaliation of economic activities arising from increasing globaliation. Gn the one hand, globaliation entailed significant reduction in tariffs, and replacements had to be found for this important and relatively easily
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administered revenue source. Gn the other, globaliation emphasied the need to minimie both efficiency and compliance costs of the tax system. nli$e most developing countries, which were guided in their tax reforms by multilateral agencies such as the nternational 2onetary 8und, ndian tax reforms have largely borne a domestic brand. !hus, even when the government sought assistance from multilateral financial institutions, the recommendations of these institutions did not directly translate into an agenda for tax reform. "espite this, the tax system reforms were broadly in conformity with international trends and advice proffered by expert groups and was in tune with international best practices. nevitably tax policy in the country has responded to changing development strategy over the years and to the changing global scenario. 'ome of the changes during past few years include reduction in excise duties in post global financial H economic crisis, alignment of custom tariffs to the levels prevailing in A'/A0 countries, introduction of 'ervice tax in 1DD-9D: besides introduction of the onstitution(11:th Amendment) 6ill in the Lo$ 'abha in 2arch ;11 to operationalie I&oods H 'ervices !axJ(&'!). n ndia, the authority to levy taxes is divided between the nion government and the 'tate &overnments under the relevant Acts. !he nion &overnment levies direct taxes such as personal income tax and corporate tax, and indirect taxes li$e custom duties, excise duties and central sales tax. !he 'tates are empowered to levy 'tate sales tax and other local taxes li$e entry tax, etc.
3. RO$ O0 TA/ IN INDIAN CONO+
!ax is a contribution exacted by the state. t is a non9penal but compulsory and unrequited transfer of resources from the private to the public sector, levied on the basis of predetermined criteria. !he classical economic were in view that the only ob#ective of taxation was to raise government revenue. 6ut with the changes in circumstances and beliefs, the aim of taxes has also been changed. !hese days apart from the ob#ect of raising the public revenue, taxes is levied to affect consumption, production and distribution with a view to ensuring the social welfare through the economic development of a country. 8iscal policy or budget has become important instrument in promoting growth and
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development in such economies. !axation is an important part of fiscal policy which can be used effectively by governments of developing economies.
Role o) Di%ect and Indi%ect Taxes !he role of taxation in developing economies can be explained as> 1. Besource 2obilisation !axation enables the government to mobilise a substantial amount of revenue. !he tax revenue is generated by imposing> "irect !axes such as personal income tax, corporate tax, etc., ndirect !axes such as customs duty, excise duty, etc. n ;;9;E, it is estimated that the tax revenue of the central government (ndia) was F1K of the total revenue receipts, whereas, non tax revenue was only 1DK-. . Beduction in nequalities of ncome !axation follows the principle of equity. !he direct taxes are progressive in nature. Also certain indirect taxes, such as taxes on luxury goods are also progressive in nature. !his means the rich class has to bear the higher incidence of taxes, whereas, the lower income group is either exempted from tax (direct taxes) or has to pay lower rate of duty (indirect taxes) on goods consumed by the masses. !hus, taxation helps to reduce inequalities of income and wealth. =. 'ocial +elfare !axation generates social welfare. !he social welfare is generated due to certain undesirable products li$e alcoholic products, tobacco products and such other products are heavily taxed, which restricts their consumption, which in turn facilitates social welfare. A part of the tax revenue is utilised for social development activities, such as health, education and family welfare, which also improve social welfare as well as social order in the society.
&aurav A$rani, Bole of !axation in "eveloping ountries li$e ndia, 6logspot, (=; "ec. ;1;), http>??$alyan9 city.blogspot.in?;1;?1?role9of9taxation9in9developing.html
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-. 8oreign exchange !axation encourages exports and restricts imports. &enerally, developing countries and even the developed countries do not impose taxes on export items. 8or instance, in ndia, exports are exempted from excise duty, %A!, customs duty and other duties. *owever, there is customs duty on imported goods. !herefore, taxation helps to earn foreign exchange through the promotion of exports. :. Begional "evelopment !axation plays an important role in regional development !ax incentives such as tax holiday for setting up industries in bac$ward regions, which induces business firms to set up industries in such regions, !ax revenue collected by government is also utilised for development of infrastructure in bac$ward regions. . ontrol of nflation !axation can be used as a tool of controlling inflation. !hrough taxation, the &overnment can control inflation as follows f inflation is due to high rise in prices of essential items, then the &overnment may reduce the rate of indirect taxes. f inflation is due to increase in demand, the &overnment may try to cut down the effective demand by increasing the tax rate. ncrease in tax rate may restrict consumption, which may reduce demand, and subsequently inflation may be controlled.
#. CONTRIUTION O0 TA/ATION IN INDIAN CONO+ ndia is believed to have lower tax &"7 ratio. As per +orld 6an$ "atabase (!axes collected by entral &overnment) the 1;.E K ratio in case of ndia , during ;1, is less than the world average of 1-.- K and much lower than 1D.- K ratio in case of /uropean nion, which has traditionally higher levels of !ax &"7 Batio. 0eighbouring economies li$e 6angladesh H 7a$istan also have ratio at around 1;K. 'ome argue that higher tax &"7 ratio translates into better infrastructure etc by taxing the rich through direct taxes but in the globalised world, things have become increasingly complex as lower taxes might attract more business.
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Gverall tax ratio (including 'tate taxes, social security contributions etc.) is also widely used by many, including G/" countries. As per the data compiled by them, the average tax to &"7 ratio in G/" countries was =-. per cent in ;1 compared with =-.1 per cent in ;11 and ==.F per cent in ;1;. n ' (-K) H 3apan (FK) on the other hand, continue to have the ratio below =; K .!he Becent recovery of G/" countries is still below the most recent pea$ year of ;;E when tax revenues to &"7 ratios averaged =:.; per cent. n ndia too, even though the tax &"7 ratio increased marginally during ;;F9;D and ;;D91; , the annual growth rate (about 9= K) was far below the period immediately preceding and succeeding these years when the growth was more than a quarter (i.e. above :K). As per ndian 7ublic 8inance 'tatistics ;19 1=, 2inistry of 8inance, including 'tates share also, ndiaJs tax &"7 ratio was expected to be around 1E.K reaching to about the same level as before financial crisis in ;;F. As one moves up the income ladder, the ratio is expected to climb because it is non9 subsistence income that are taxed. 6ut much wealthier countries in the region li$e 2alaysia H !hailand also do not have significantly higher tax &"7 ratio (entral &ovt taxes> ;1) with the values at 1.1 H 1.: K respectively , even though their higher per capita income puts them in an advantageous position to bear higher tax burden. /ven hina, which has about three times per capita income compared to ndia, has tax &"7 ratio at levels identical to that of ndia. *ence the level of taxation in case of ndia seems in consonance with the prevalence elsewhere in Asia. *owever introduction of comprehensive goods H services tax (&'!) and plugging the tax evasion might increase the revenues further.
'ome postulate that an economyJs tax9to9&"7 ratio is, or should be, a function of its per capita &"7, and hence it is misleading to compare ndiaJs with those much wealthier. !he theoretical basis for such an assertion is debatable, and empirical evidence for this is also lac$ing. +hile ndiaJs own tax9to9&"7 has increased over :; years with increasing per capita &"7, superficially supporting the theory, this fact hides more than it reveals, if one brea$s the time period of study into two quarter9century periods. n the :9year period from 1D: to 1DD;, ndiaJs tax9to9 &"7 increased steadily from 1;K to 1K while &"7 increased .F9fold. n the subsequent :9year period from 1DD1 to ;1-, ndiaJs tax9to9&"7 stayed roughly
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constant between 1K and 1EK while &"7 increased -.:9fold :. t is puling to us that #ust as ndia bro$e away from its clichMd *indu rate of growth post the 1DD1 economic reforms to grow much more rapidly, its tax9to9&"7 ratio stayed constant, belying those who would have predicted an increase. !hat, curiously, ndiaJs rate of tax revenues did not grow commensurate with its &"7 growth post the 1DD1 reforms are inexplicable. !he second and perhaps the more important deviation in ndiaJs tax structure from other ma#or economies is in terms of the split of the total tax ta$e between direct and indirect taxes. "irect taxes are taxes on income, wealth, property and capital gains. ndirect taxes are taxes on goods, services and excise taxes. ndirect taxes are considered regressive since its marginal impact on the economically wea$er sections of society is far greater. ndiaJs direct to indirect tax ratio is roughly =:>:. !his is in contrast to most G/" economies where the ratio is the exact opposite, E>== in favour of direct taxes. n the :;9year period analysis, ndiaJs direct9to9 indirect tax ratio has swung from a low of 1=>FE to its current high of =:>:. 8or the G/" nations, throughout this :;9year period, the direct9to9indirect tax ratio has remained roughly constant in the range of :>=:. Although it is widely accepted that indirect taxes have become an important source of development funds in developing countries. 2any developing economies that have adopted economic planning use indirect taxes as important source of funds. !hese taxes are found to be better suited in developing countries because they have much wider coverage as compared to direct taxes. 6oth rich and poor pay indirect taxes in form of commodity price. *igh rate of taxes on luxury goods will ta$e away resources from the rich and such resources re9distributed among the poor in the form of subsidies besides taxes on product li$e alcohol, cigarettes can have beneficial effect on consumption pattern. ndirect taxes are used to divert resources from less desired use to more desired one in developing countries. !axes on goods considered to be luxuries will ma$e them 5
7raveen ha$ravarthy, ndia is an outlier in its tax policy, Livemint ( 8ebruary ;1), http>??www.livemint.com?Gpinion?brb"!w1a$p&'=um;t=a2?ndia9is9an9outlier9in9its9tax9policy.html
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more expensive, lower their demand and profitability. !his will divert their resources from the production of these goods to more essential ones. !axes on imported goods have been used by developing countries for reducing imports and promoting domestic industries. Gn other hand in developing economies collection of direct taxes is believed to be very significant. Gnly a small proportion of population pays such taxes. "irect taxes are primary used in such economies to reduce inequalities of income distribution. *igh degree of progression is used in case of direct taxes in developing countries. !his discourages savings done by high income group and adversely effects investment and capital formation. *ighly progressive taxation leads to tax evasion and blac$ money. !hus direct taxes have been postulated to have a limited role to play in developing countries and indirect taxes have become an important source of development funds in developing countries. 6ut still, the question arises, that whether there should be a desirable balance between direct and indirect tax contribution. /conomic literature lays down two principal views. !he first view, which was popular in the 1Dth century and into the middle of the ;th century, is the 4desirable balance5 view N roughly, the idea that there should be something li$e a half9and9 half split. !he great 1Dth century liberal prime minister of &reat 6ritain, +illiam &ladstone, subscribed to this view, for instance, suggesting that direct and indirect taxes were a$in to 4two attractive sisters each with an ample fortune5. /ventually, however, with the advent of mathematical optimiation techniques in economics, the consensus view shifted to what is now the mainstream view, what economist Anthony At$inson calls 4superiority of direct taxes5. According to the modern view, direct taxesNsuch as income or wealth taxesN function better both in terms of efficiency and equity, while indirect taxes are inferior. +hat is more, ideologically, both left and right should prefer direct taxes to indirect taxes, for different reasonsNthe left for reasons of progressivity, the right for reasons of minimiing inefficiency. f indirect taxes must be used, perhaps because of some constitutional or political economy constraint on the level of
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income or wealth taxes that a government may levy, then ideally they should be minimally distortingNin effect, by mimic$ing the effects of a direct tax. An example of a 4good5 indirect tax is a single rate goods and services tax (&'!) with no exemptions. 'uch a tax distorts individualsJ labour supply and savings choices, li$e direct income and wealth taxes, but does not distort the economyJs structure of production or consumption, as most indirect taxes, such as trade tariffs, do. !he 4worst5 taxes are sector9specific excise taxes with high tax ratesNsuch as taxes on petroleum, alcohol and tobaccoNwhich are maximally distorting to the economy and maximally regressive. !hey are also among the most popular for governments the world over, because they are good ways to grab a lot of revenue, although not good for the economy or its citiens.
6oth direct and indirect taxes are essential to bring adequate revenue to the state for meeting the increasing public expenditure. 6oth taxes are essential to promote economic growth, fill employment and economic stability. "irect and indirect taxes should side by side H balance each other. t is debatable as to which carries more importance or is there a need of more than a desirable balance and a significant importance to one than the other in a developing country li$e ndia. !hus, both are an important contribution to the prosperity of the ndian economy which is still developing and with changing times and tax reforms, the economy will flourish.
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'. I$IO-RAH Articles &areth ". 2yles, Taxation and Economic Growth , 8iscal 'tudies (;;;) vol. 1, no. 1, pp. 1-11F !.B. Bustagi, ndirect !ax Beforms in the ndian /conomy, %ol. =, 0o. 1, 3anuary 9 2arch 1DDF 'han$ar Acharya, !hirty Oears of !ax Beform in ndia, /conomic and 7olitical +ee$ly, %ol. -;, 0o. ; (2ay 1-9;, ;;:), pp. ;1, ;=9 ;E; +ebsites !axation in ndia, +i$ipedia, ( August ;1), https>[email protected]@ndia &aurav A$rani, Bole of !axation in "eveloping ountries li$e ndia, 6logspot, (=; "ec. ;1;), http>??$alyan9city.blogspot.in?;1;?1?role9of9taxation9in9developing.html 7raveen ha$ravarthy, ndia is an outlier in its tax policy, Livemint, ( 8ebruary ;1),