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Income tax

Income tax is a form of tax levied on money you earn, either in form of wages for
individuals and the profits from your business for the self employed. Income tax is
generally used to finance government expenditure, and pay for services provided by
the state, such as education and healthcare.

Tax is a contribution exacted by the state. It is a non penal but compulsory and
unrequited transfer of resources from the private to the public sector, levied on the
basis of predetermined criteria.

The classical economic were in view that the only objective of taxation was to raise
government revenue. But with the changes in circumstances and ideologies, the
aim of taxes has also been changed. These days apart from the object 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. For economic development of a country, tax can be used as an important
tool in the following manner:

1. Optimum allocation of available resources:

Taxis the most important source of public revenue. The imposition of tax leads to
diversion of resources from the taxed to the non-taxed sector. The revenue is
allocated on various productive sectors in the country with a view to increasing the
overall growth of the country. Tax revenues may be used to encourage development
activities in the less developments areas of the country where normal investors are
not willing to invest.

2. Raising government revenue:

In modern times, the aim of public finance is not merely to raise sufficient financial
resources for meeting administrative expense, for maintenance of low and order
and to protect the country from foreign aggression. Now the main object is to
ensure the social welfare. The increase in the collection of tax increases the

government revenue. It is safer for the government to avoid borrowings by

increasing tax revenue.

3. Encouraging savings and investment:

Since developing countries has mixed economy, care has also to be taken to
promote capital formation and investment both in the private and public sectors.
Taxation policy is to be directed to raising the ratio of savings to national income.

4. Reduction of inequalities in income and wealth:

Through reducing inequalities in income and wealth by using a efficient tax system,
government can encourage people to save and invest in productive sectors.

5. Acceleration of Economic Growth:

Tax policy may be used to handle critical economic situation like depression and
inflation. In depression, tax is set to increase the consumption and reduce the
savings to increase the aggregate demand and vice verse. Thus the tax policy may
be used to strengthen incentives to savings and investment.

6. Price Stability:

In under developed countries, there is another role to maintain price stability to

ensure growth with stability.

7. Control mechanism:

Tax policy is also used as a control mechanism to check inflation, consumption of

liquor and luxury goods and to protect the local poor industries from the uneven
competition. Taxation is the only effective weapon by which private consumption
can be curbed and thus resources transferred to the state. Thus the economy can
ensure sustainable development.

Thus it can be said that the economic development of a country depends various
reasons one of them are on the presence of an effective and efficient taxation

a compulsory contribution to state revenue, levied by the government on workers'
income and business profits, or added to the cost of some goods, services, and
A means by which governments finance their expenditure by imposing charges on
citizens and corporate entities.
Governments use taxation to encourage or discourage certain economic decisions.
For example, reduction in taxable personal (or household) income by the amount
paid as interest on home mortgage loans results in greater construction activity,
and generates more jobs. See also taxation principles.

Objectives Of Taxation

The basic objective of taxation is to raise resources for the State. Different
objectives of taxation may be summed up as under:

Objective of raising revenue: The basic and primary objective of taxation is raising
revenue. Enormous amount needed by modern governments for National defence,
creation of infrastructure and social upliftment schemes make regular and
systematic resource mobilization compulsory.
Regulatory objectives: Taxation performs an important regulatory role in different
socio economic aspects.
Regulatory consumption: State can discourage consumption of harmful and
undesirable goods by levying prohibitive rates of tax.

Regulatory production: Production may be encourages by exempting new industries

from tax for someone, reducing tax on capital goods, increasing tax on imported
goods to encourage local production, etc.
Regulating imports and exports: Imports of undesirable products can be curbed by
imposing prohibitively high import duties. Exports can be encourages by cutting
duties and taxes on exports.
Regulating effects of inflation, depression etc: Raising tax rates can reduce
consumption of goods and the demand in general. High levels of taxation can
reduce the purchasing power of people and the funds collected can be used by the
state for productive purposes to increase supply of goods, thus stablising supply
and demand equation.
Developmental objectives: Taxation can be used as an effective tool to achieve
higher levels of economic development and employment.
Economic development: Economic development is measured in terms of Gross
National Product i.e. the output achieved in all the major sections of the economy
i.e. Agriculture, Industry and Services. Taxation can be used as a stimulant to any
one or all the three sectors by judicious changes in the tax rates.
Capital formation: Indian household savings rate is around 26%, one of the highest
in the world. Savings can be channeled into Investment Avenue through
appropriate policy measures. Taxation plays a major role in high level of savings by
providing different kinds of exemptions from tax on contribution to provident funds,
insurance premium, etc.
Increasing employment opportunities: Small and medium enterprise usually have
maximum potential for employment, industrial estates, special economic zones,
export oriented parks, etc., have high employment potential.
Objectives of reducing inequalities: inequalities are common in several aspects.
Inequalities in economic disparities: Income levels of individuals very wildly in
India. It is claimed that rich are becoming richer and the poor are becoming poorer
year by year. Taxation can be a powerful weapon in tackling income disparities.
Reduction in regional imbalances: Some regions may become well developed
compared to others in a country. Tax incentives and exemptions to start industries
in the backward regions can be a good method of dealing with the problem.
Different objectives of taxation, each one of them desirable by itself, can pull in
different directions. The state should formulate a comprehensive and cohesive tax
system which can balance the different objectives in view of its own requirements
and goals.

A good system of taxation must satisfy certain general principles. Adam Smith laid down the
following four canons of taxation.
Canon Of Equality:
This is the most important canon of taxation. Equality or equity means that every ax payer
should contribute towards the support of the government according to his ability to pay. This
does not mean that all people rich or poor should pay equal tax or at equal rate. Equality means
equality of sacrifice. The equality of sacrifice can only be maintained when the rich are required
to pay tax at a greater rate than the poor people.
Canon of certainty:
This canon says that every thing about a tax should be definite and certain. According to this
canon there must be certainty about the time of payment, the manner of payment and the quantity
to be paid. It will give greater confidence to the government about its estimates and that the tax
payer will also feel certain about his budget. Uncertainty encourages corruption.
Canon of convenience:
This canon implies that every tax ought to be levied at the time or in the manner in which it is
likely to be most convenient for the contributor to pay it. If a tax is convenience, the payer will
pay it at the proper time without reminder. For example a person drawing a monthly salary likes
to pay at the time of receiving his salary every month.

Canon of economy:
This canon implies two things. Firstly, the cost of collection of a tax should be small in
proportion to yield. Secondly, the tax must not obstruct in any manner the economic
development of the country. If a tax is contrary to these two principles it is regarded as costly and

Besides these canons of taxation , there are four other important principles of taxation. They
have been added by later economists. They are as follows:
Canon of Productivity:
It means that taxes should yield sufficient revenue to the government. A few tax which are fairly
productive are much better than a large number of taxes which not so productive.
Canon of elasticity:
This principles means that tax system should be capable of expansion and reduction according to
the requirements of the state. Taxes which in case of need can be conveniently increase in

amount without any additional cost of collection are considered to be good taxes. Income tax is a
very good example of an elastic tax.
Canon of simplicity:
The system of taxation should not be complicated and difficult to be understood by an average
person. The basis of tax and method of calculation should be simple, plain and intelligible.
Canon Of Diversity:
This principle says that a large variety taxes is always preferable to a small number. Every tax
has some defects. In a varied tax system, different taxes tends to cancel to each other. Variety is
also desirable from the point of view of yield, stability and justice.

Advantages and disadvantages of Direct Taxes

Advantages of Direct Taxes

Direct and indirect taxes have advantages of their own. Direct taxes have some
merits and so have the indirect taxes. Direct taxes have the following advantages in
their favor:

1. Equitable. The burden of direct taxes cannot be shifted. Hence, equality of

sacrifice can be attained through progression. Of course, the very low incomes can
be exempted. This cannot be achieved by taxes on commodities which fall with
equal force on the rich and the poor. The tax raises the price of the commodity and
the price of a commodity is the same for every person, rich or poor.

2. Economical. Their cost of collection is low. They are mostly collected "at the
source". For instance, the income tax is deducted from an officer's pay every month.
This saves expense. The employer acts as an honorary tax collector. This means
great economy.

3. Certain. In the case of a direct tax, the payers know how much is due from them
and when. The authorities also know the amount of revenue they can expect. There
is certainty on both sides. Certainty minimizes corruption on the part of the
collecting officials.

4. Elastic. If the State suddenly stands in need of more funds in an emergency,

direct taxes can well serve the purpose. The yield from income tax or death duties
can be easily increased by raising their rate. People cannot stop dying for fear of
paying death duties.

5. Productive. Another virtue of direct taxes is that they are very productive. As a
community grows in numbers and prosperity, the return from direct taxes expands
automatically. The direct taxes yield large revenue to the State.

6. A Means of Developing Civic Sense. In the case of a direct tax, a person knows
that he is paying a tax; he feels conscious of his rights. He claims the right to know
how the Government uses his money and approves or criticizes it. Civic sense is
thus developed. He behaves as a responsible citizen.

Disadvantages of Direct Taxes

1 .Inconvenient. The great disadvantage of a direct tax is that it pinches the payer.
He 'squeaks' when a lump sum is taken out of his pocket. The direct taxes are thus
very inconvenient to pay. Nobody can help feeling the pinch.

2. Evadable. The assessee can submit a false return of income and thus evade the
tax. That is why a direct tax is "a tax on honesty". There is a lot of evasion. Many of
those who should be paying taxes go scot-free by concealing their incomes.

3.Arbitrary. If taxes are progressive, the rate of progression has to be fixed

arbitrarily; and if proportional, 4hey fall more heavily on the poor. Thus, both are
bad. The rate of taxes depends upon the whim of the Finance Minister. This is

4. If the taxes are too heavy, they discourage saving and investment. In that, case
the country will suffer economically.

DIRECT TAX :When the impact and incidence of a tax are on the one and the same person, it is
said to be the direct tax. For example, as the income of the people increases, the
rate of taxes also increases and it lowers the purchasing power and prices. Income
Tax is direct tax.

Disadvantages of Direct Tax

1. Chances of Dishonesty :To avoid from direct tax, the tax payer submits false statements of his income and
revenue of state reduces.

2. Inconvenient :The tax payer has to prepare lengthy statements of his income and expenditure. It
is very laborious for the tax payer to prepare and keep these records.

3. Painful for the Tax Payer :It pinches the tax payer that hid hard earning money is being taken by the

4. Lump sum Payment :Direct tax is to be paid in lump sum every year so it becomes very difficult for the
tax payer to pay large amount in one installment.

5. Reduction in Savings :-

Direct tax discourages the rate of saving because the major portion of the income is
paid to the government.

6. Protest and Procession :When the prices level rises, the tax payer protests against the rise in taxes.

INDIRECT TAX :If the impact of the tax falls on one person and the incidence on another, the tax is
called indirect tax. For example the sales tax and custom duty is paid obviously by
the trader but it is included in price and consumer bears the burden of this tax.

Advantages of Indirect Taxes

1. Convenient in Payment :It is very easy to pay because they are included in prices. The consumer often does
not know that he is paying the tax.

2. No One can Evade the Tax :Any one who will purchase the taxed commodity, will pay the tax. So it is not
possible to evade indirect tax.

3. Contribution from Every Citizen :Indirect tax is very useful because every member of the society contributes
something towards the revenue of the state.

4. Elastic :Indirect tax is also elastic to a certain extent. The state can increase its revenue
within limits by increasing the rate of taxes.

5. Control on Harmful Goods :If the state wishes to discourage the consumption of harmful drugs, it can raise their
prices by increasing the taxes on them.

6. Tax on Luxury Items :The indirect tax satisfied the canon of equality. If it is imposed on luxury goods, then
rich people will pay more taxes and poor will not pay because they do not purchase

Demerits of Indirect Tax

1. Unfair Profit :The traders increase the prices more than the rate of taxes and they earn abnormal
profits. A consumer suffers a loss.

2. Not an Economical :Indirect tax is uneconomical. The government spends a large amount of money on
the collection of taxes.

3. Uncertain :The revenue from indirect tax is uncertain. The government can not correctly
estimate as how much money will it receive from this tax.

4. Civic Consciousness can not Create :It does not create the civic consciousness because the tax is wrapped up in prices.

5. Does not Satisfy the Canon of Equality :This tax is imposed on all the classes according the same ratio. The burden of tax
falls more on poor people than on the rich.

6. Low Standard of Living :When the tax is imposed on the consumption of goods, it increases the prices and
lowers the standard of living in the country.

7. Cause of Unemployment :If the goods are taxed at higher rates, it lowers the effective demand, production of
goods and employment.

Keeping in view the merits and demerits of both taxes, we can say a country should
employ both these forms of taxes in a proper manner.