UNIT 2

Taxation

2.2 Taxation

Taxation referred as imposing of tax on individual or entities by a taxing authority, usually a government. To raise the revenue for government expenditures (education, health, infrastructure, etc), tax are levied in almost every country of the world.  The government levy tax to enhance the country economy and to lift up the standard of living of the nationals.

Definition

Tax is defined as a compulsory contribution from individuals and or business organizations for the purpose of financing the expenditure of the government. Taxation is therefore the process of levying and collection of tax from taxable persons.

Types of tax

1. Direct tax

The government imposes such taxes directly on the individual or entity and it cannot be transferred to any other person or entity.  In other words, direct taxes collected directly from the income of the individual or company. The incidence and burden is on individuals or companies that pay the tax to the government.

Direct taxes are income tax, capital gains tax, securities transaction tax, perquisite tax, corporate tax.

• Income tax:
  • Income tax act is a tax imposed on earned income( wages, salary, commission) and unearned income(dividends, interest and rent)
  • Levied by the federal, state and local government
  • Direct taxes are imposed every year on your income
  • The government has fixed various tax slabs for different groups of people.

Tax slab for general tax payers

Tax slab for senior citizens (age between 60 to 80 years)

Tax slab for senior citizens (age above 80 years)

• Capital gains tax:
  • Such tax is paid when you receive a large sum of money
  • It could be from an investment or large sum of money.
  • Capital gains tax are of two types – long term capital gains and short term capital gains
  • Long term capital gains refer to investmnet made for more than 36 months
  • Short term capital gains refer to investment made within 36 month
  • Long term capital gain tax is 20%. On the other hand short term gain tax is caculated on the basis of income bracket you fall in.
• Securities transaction tax
  • Securities transaction tax refers to tax payable on income received from trading on stock market or exchange securities.
  • This tax is imposed by combining the share price and the tax
  • Under this tax is paid every time on the purchase and sell of share

• Perquisite tax
  • Perquisite are the fringe benefits received by the employees oner and above the salary
  • The fringe benefits can be taxable or non taxable depending upon the nature
  • Perquisite tax are 30% of the value of fringe benefit
  • It can be a company or association of person or individual
  • Taxable perquisites are rent free accomodation, water, electricity, medical expenses
  • Non taxable fringe benefits are travel allowances, health club, sport club, telephone lines, etc
• Corporate tax
  • Corporate tax refers to tax paid by the company from its revenue earned.
  • Corporate tax has its own tax slab which depends on the revenue earned by the companies
  • Domestic firm which do not earn more than 1 crore per annum will not have to pay corporate tax
  • International firm will have to pay tax rate of  41.2% of the revenue earned.
  • There are four types of corporate tax

Minimum alternate tax – MAT refers to companies to make minimum payment of tax that is 18.5% presently to the income tax department

Fringe benefit tax – it refers to tax applied on all the fringe benefits that the employee received from the employer

Dividend distribution tax- tax imposes on the gross income of the investor received from the investment made by them on the companies. Presently, the DDT rate is 15%

Banking cash transaction tax – this tax has been scrapped by the government of India.  Under this tax, 0.1% of tax imposed on every bank transaction

2.     Indirect Tax

Indirect tax refers to taxes imposes on goods and services. This is different from direct tax as the tax is not levied directly on the individual, its imposed on the products which the individual sell and collect the tax.

Example – sales tax, value added tax

Such tax are imposed by summating them with the price of the product.

Types of indirect tax

• Sales tax
  • Tax imposed on the sale of the product is called sales tax
  • Sales tax imposed on the products seller which goes to the individual who buys the product.
  • Tax is imposed on the particular product means if the product is resold, seller cannot apply sales tax on it
• Service tax
  • Tax imposed on the service offered by the company is called service tax.
  • The rate of service tax is 14%
  • Payment of service tax is made on the bills paid by the customer
• Value added tax
  • VAT are known as commercial tax, not charged on the goods and services
  • VAT ia imposed at all strp of supply chain, from manufacturers to dealers to distibutors to end user
• Custom duty and octroi
  • Tax charged on importing anuthing from abroad is called custom tax
  • Custom duty means goods from different countries are levied taxes
  • Octroi means goods from different state within India are taxed
• Excise duty
  • Such tax imposed on all goods manufactured in India
  • Governement collect tax from the producer of goods and also from the receiver of manufactured goods
  • Excise taxes are taxes required on specific goods or services like fuel, tobacco, and alcohol.
  • Excise taxes are primarily taxes that must be paid by businesses, usually increasing prices for consumers indirectly.

2.3 Progressive taxes and proportional taxes

Progressive tax

Progressive tax refers to individual have to pay higher tax as the income increases. In other words, as the taxable income increases, the tax rate gets progressively higher. The income tax bracket mentioned above are the example of progressive tax.  It also referred as graduated income tax.

The progressive tax is based on the tax payer’s ability to pay, low income group pay low tax rate compared to high income group.

The advantage of progressive tax is

• That it reduces the burden of low income earners to maintain the standard of living.
• Ability to collect more tax than flat taxes or regressive taxes

Regressive tax

It is opposite of progressive tax. Such tax takes the large percentage of income from the low income group than those with high income eaner. Regressive tax effect low income group severely because its applied uniformly to all situations.

Example – sales tax are imposed on the product and services . Tax is uniform for higher and lower income groups. Property tax are set at flat percentage regardless who ever purchase.

Proportional tax

Regardless to the income of the people, same percentage of tax is imposed on all taxpayers is called as proportional tax.  It applies same tax to lowern middle and higher imcome group. It is also called flat tax. Proprtional tax carries higher burden on low income individual.

Example – sales tax because all consumer pay fixed rate regardless of their income.

2.3 Theories of taxation

1. Benefit theories

• According to this theory, the government should impose taxes on individual in relation to the benefits provided by the government. The more benefits a person get from the activities of state, the more he should pay to the government.  In other words, those who receive more benefit from government goods should pay more than others.
• The main advantage of this theory is imposition of taxes is justified by the benefits involved in public goods.

Drawbacks

• Difficulty in measuring the benefit enjoyed by the people from government goods and services
• It is against the principle of tax. Tax is compulsorily payable to the public authorities, so that government can meet their expenses. There is no direct quid pro quo in the case of a tax.
• This theory will cause great injustice. A poor gets more benefits from low cost product. Thus the theory suggests impose more tax on poor because he derives more benefit from low cost.

2.     Cost of service principle

This theory implies that the cost incurred by the government in providing public goods to satisfy social wants should be regarded as the basis of taxation. This means state is the manufacturer of the good and taxes are price of the goods.

Drawbacks

• It is against the principle of tax. There is no direct quid pro quo in the case of a tax.
• It’s difficult to estimate the government services or social goods made available to each individual tax payer.
• It’s against the welfare norms. Government cannot provide free education, medical to poor if cost is the base of taxation

3.     Ability to pay

This is the acceptable theory in taxation, that citizen should pay taxes to the public authorities in accordance with their ability to pay.

For example, if person X taxable capacity is more than person Y, the former should pay more tax than the latter.

On implication of this theory, justice can be achieved. The theory does not give accurate measure of a person’s ability to pay.

The main viewpoints advanced in this connection are as follows:

• Ownership of Property:

Some economist suggested ownership of a property is a way to measure person’s ability to pay. But this was rejected, as person who earns more do not spend on buying property will escape from paying tax. On the other hand, person who earn less and buy a property will end up paying more tax.

• Tax on basis of expenditure

The person’s ability to pay is calculated by the expenditure a person incurs. The greater the expenditure, the higher should be the tax and vice versa. This was also rejected, because person with large family will spend more than small family

• Income as a basics

Most of the economists are of the opinion that income should be the basis of measuring a man's ability to pay. The viewpoint is sound and fair in every aspect. The more income of an individual, more tax he should pay.

2.4 Impact and incidence of tax

The concept of impact and incidence of tax

Impact of taxation refers to immediate burden of the tax. It implies on the person who pays the tax in the first instances.

Incidence of the tax is the one who finally bears it. Therefore incidence is on the final consumers. The incidence tax remains on the person who cannot shift the burden to other person.

Impact of taxation is the producer while incidence of tax is the consumer. The impact of tax can be shifted while incidence of tax cannot be shifted.

Dalton classifies incidence of tax in two categories

1. Money burden : money burden is classified into direct money burden and indirect money burden

Direct money burden means the person who pays the tax also bears the burden

Indirect money burden means incidence of tax involves shifting. For example, government imposes tax on sugar manufacturing. The tax is imposed on manufacturer directly. The manufacturer shift money burden to the wholesaler. Wholesaler shifts it to the final consumer. Thus the final consumer bears the tax.

2.     Real burden:

Direct real burden is the sacrifice of economic welfare made by the tax payer as a result of payment of tax

Indirect real burden is the reduction of consumption of good due to imposition of tax.

Effect of the tax

Effect of tax is the consequence of imposition of tax on individual and on community.

For example, if the government impose a tax on necessary goods. The seller will increase the price of the goods as a result consumer has to spend more to buy the same product or reduce the consumption because their income is limited and their standard of living is decreased.

The effects also depends on demand and supply of goods

1. Perfect inelastic – the effect of tax burden fully on the consumer. As whatever is the price, consumer will buy same quantity
2. Relative inelastic – the burden of tax is on the buyer than seller. The price changes in price will increase or decrease the demand
3. Perfect elastic – the burden of tax is on the producer. The consumer will reduce the consumption as the price increases.
4. Unit elastic – the effect of tax are equal for both consumer and producer.

Sources

1. Public finance in theory Baltic - Musgrave

2. Public Finance Department and Developing countries - Dr. S.K. SINGH