Public Finance : Taxation

Meaning :
It deals with the income & expenditure of the public authorities and with the adjustment of one to the other.
Scope of Public Finance :-
•  Public Revenue – Income of government.
•  Public Expenditure
•  Public Debt
•  Financial administration –It includes budget.
•  Economic stabilization & Fiscal Policy.
Importance of Public finance
•  Public finance helps us in understanding the functioning of the economy.
•  It helps in understanding the changed concept of the state
•  Useful in understanding the fiscal policy
Difference between Public & Private finance
•  Meaning
•  Scope Public finance has wide scope, private finance has narrow scope .
•  Public finance based on social welfare and private finance is based on the welfare of the private individuals only.
Public Revenue – The income of government from all sources is called public revenue or public income
Sources of Public Revenue:-
•  Taxes :- A Tax is a compulsory payment imposed on the people or company by government to meet the expenditure incurred on providing common welfares to the people
•  Commercial Revenue – Revenues which are derived by government from public enterprises by selling their goods & services are called commercial revenues. They are also known as prices as they come in the form of prices of goods & services provided by the government. They include the following.
•  Postage.
•  Railway faire
•  Irrigation charges
•  Prices paid for liquor in gov. stock etc .
It is not a very good source of the income of government
Sl. No.
1 It is not a compulsory payment it is paid by person who purchases goods and services sold by government.
It is a compulsory contribution to be paid by every tax payer upon whom at is imposed
2 It gives direct benefit to the person who pays it for buying goods services
It does not give a directly benefit to tax payer
3 Price is paid for goods & services which are purchased by the consumer.
It is used for the common benefit of all people whether they pay tax or not
(iii) Administrative Revenue:- It includes fee, fines. Special assessment and escheat
•  Fees :- It is a payment which is paid to you for special services rendered by them it sis only paid by those people who receive special benefits from the services rendered by government com.
•  License Fee : - It is a payment not to perform a service but to grant a permission by a government. The registration fee for motorcycle, license for keeping guns are some example of license fee.
•  Fines & Penalties :- They are not important source of revenue. A fine refers to the punishment imposed for the violation of law Example – Motorists are charged for violating traffic rules & regulation
•  Special Assessment : - Some times government undertake certain improvements such as construction of road, provision of drainage, Street lightning etc. they offer common benefits to society as a result of such improvements the values of these properties rise and imposition of changer in proportion to increase wealth is called special assessment .
It may be termed as special tax but it is not same as tax . It is levied after the benefits have been conferred upon the payers while tax has no guarantee of benefit. It is diff from fees, fees are the payments for certain services rendered by government while special assessment lived for unrest in one's property from some particular Services of government.

•  Forfeiture :- It refers to penalties imposed by courts for the failures of individual to appear in the courts, to complete contracts as stipulated.
•  Escheat – Under the right of escheat the govt. May acquire the property, bank balances etc. of a person without having any legal successor or without writing a will this is also not an important source of revenue.
•  Taxes :- A tax is a compulsory payment imposed on the person or the companies by the govt. to meet the expenditure incurred on providing common benefits to the people
Characteristics of Taxes:-
•  Compulsory contribution: - Tax is a compulsory payment made by the people to govt. no one can refuse the payment of tax to the government.
•  Personal obligation : - Tax is a personal obligation on the tax payer. It becomes his duty. To pay the tax if he comes under the taxable capacity
•  General welfare : - Tax is a payment made by taxpayer which is used by the government for the benefit of all the citizen.
•  No Quid pro Quo: A tax is not levied for any specific services rendered by the govt. to the taxpayer and individual cannot ask for special benefit from the state in return for the tax payer by them thus the tax payer cannot claim something equivalent to the tax paid from govt. Which means there is no quid or quo in case of taxes ?
•  Regular Payment : - Tax is payable regularly by the tax payer as determined by the tax department.
•  Collection of Revenue : - The modern government performs a large no. of functions for the welfare of societies for which they need income this income can be earned by the government only through taxes which are considered as the main source of revenues. Of government.
•  Regulation of consumption & Production : - Taxation policy regulates consumption and production of country. They are used to discourage production and consumption like require, pan masala etc. they are also effective in diverting the resources from production of non-essential commodities to essential commodities.
•  Protection to domestic industry : - custom duties are used to reduce the imports of those goods which are domestically available and thereby encourage the domestic industry. These taxes protect the domestic industry from cut-throat foreign competition, this will also have favorable effect on the countries balance of revenue.
•  Reducing income inequalities :- Taxes are used for reducing inequalities of income and wealth in a country by the following ways.
1.Progressive taxation on income would be great help in this regard it means imposing heavy taxes on rich and low taxes on poor.
2. Inequality of income can also be reduced by imposing heavy taxes of luxury goods and by giving tax concision on essentials goods which are purchased by the people.
•  Increasing the rate of capital formation :- The mains purpose of taxation in poor country is go promote capital formation and economic development. The revenue collected through taxes by govt. can be utilized for the development of agriculture and industry and it can be used for providing infrastructural facilities like transport & communication power etc. on this entrepreneur can be motivated to set up industry in backward regions of the country thus investment level goes up.
•  Price stability :- It is the prerequisite for economic development to take place taxes play a very important role for maundering price stability in the times of inflation taxes reduced the purchasing power of people which result to fall in aggregate demand in economy and thereby helps in controlling prices. On the other hand taxes can be reduced during deflection increase the aggregate remand.
•  Development of backward region: - For the development of backward region govt. gives tax concessions to the entrepreneur for setting up industries in these regions.
•  Economic growth : - Tax collected by govt. can be used in promoting economic development of country. It can also be used for increasing the productive capacity of diff. sectors of economy. Which with definitely improve the growth rate of economy also.
•  Proportional tax: - In this type of tax all incomes are taxed at the uniform rate. and it is not linked with the income of tax payer it is a simple tax system and dose not have any harmful effects on willingness to work and save but it is not based on principle of equality and revenue collected through this tax is very less.
•  Progressive tax : - Tax is said to be progressive when the rate of tax increases as the taxpayers' income increases. Acc. to Dalton in progressive taxes the higher the income the tax payer has higher proportionate tax to pay. Progressive tax is based on principle of equity and it reduces the inequality of income & health in helps in controlling inflation also. On the other hand it has some disadvantages like there is an harmful effect on willingness to work and save. On case of progressive taxation tax evasion is common this case.
•  Regressive Tax : - It is one in which the rate of tax decreases as the tax payers' income increases. It is just opposite of progressive taxes regressive tax are adjust and inequitable. They do not the principle or equity and they promote inequalities of income in the surety.
•  Digressive Taxation : - Under this system the rate of tax increases up to action limit but after that a uniform rate is charged. It is formulate on slab system in this case higher income group people have to make will sacrifice as compared to lower income grow up people this is the case of income tax in India as well.
Now the question arises out of above stated categories of tax systems which is the best the answer would be we have to select the tax system which will distribute tax system most equitably Regressive & digressive taxation can not be accepted on the ground of equity but there has been heated. Controversies regarding proportional and progressive taxation however most of the economists are in favor of progressive taxation system.
Direct Taxes are those under which burden falls on the same person on whom it is imposed, i.e. impact and incidence falls on the same person. eg:- income tax, wealth Tax, Property Tax etc.
Merits of Direct Taxes:-
•  Equitable: - Direct Taxes are based on the principle of equity or ability to pay. The burden of a direct tax is equitably distributed on different people & institutions as they are progressive in nature. Which means as income increases the rate of income tax also increases
•  Certainty: - Direct taxes are certain the tax payer knows how much tax is due from him and when and how can he adjust his income and expenditure. The govt. also knows fairly well the amount of revenue coming to it
•  Economical: - Direct Taxes are economical in the sense that the cost of collection of these taxes is relatively low in the case of income tax it is deducted at the source from salary of people. No separate staff is needed for tax collection .
•  Elasticity: - Direct Taxes are flexible and thus satisfy the canon of elasticity. The govt. can increase or decrease rate of direct taxes according to the requirement of economy. In case of war natural calamities or emergency the state can raise the rate of these taxes in order to have larger tax revenue and during depression rate of tax can be decreased.
•  Civic consciousness: - Direct Taxes inculcate the spirit of civic responsibilities among tax payers. Since tax payers provide funds from their own pockets to the govt. they take been interest in seeing that these funds are properly utilized. This public awareness plays an important tool in checking the wastage of public expenditure .
•  Simplicity: - Direct Taxes are very simple on nature it is easy to calculate and understand these taxes.
•  Reducing inflationary pressure: - Direct taxes are anti inflationary in nature they help in controlling inflation by moping up the excessive purchasing power of community.
•  Reduces inequalities As we know the direct taxes are progressive in nature and therefore rich people are subjected to higher rates of taxation, while poor people are exempted from direct tax obligation. Hence these taxes help to reduce inequalities in income
Demerits of Direct Taxes:-
•  Unpopular: - Direct Taxes pinch to the tax payer because they have to pay them directly out of their income or salaries they can not be shifted on to others thus they are very much unpopular among tax payers and are generally opposed by the tax payers.
•  Inconvenient: These taxes .are also inconvenient in nature because the tax payer has to submit the statement of his income along with the source of income from which it is derived, which is generally subject to complications. Moreover the payment of these taxes in lump sum is not as convenient to the tax payers as the frequent payment of small amount of indirect taxes. Hence these are said to be inconvenient to the tax payers .
•  Possibility of injustice: - In practice it is difficult to asses the income of all the classes accurately. Hence the direct taxes may not fall with equal weight on all classes, Moreover the rates of direct taxes are arbitrarily fixed by the govt. and they may not be determined on the basis of ability to pay.
•  Evasion: - A direct tax is said to be a tax on honesty, it is not evaded only when the tax payer is honest, otherwise it can be evaded through fraudulent practices. Hence it is found that it can be evaded if the taxpayer decides to become dishonest.
•  Discourages Saving & investment: – Direct Taxes adversely affect saving & taxes when people know that with increase in income & wealth they will have to pay a large portion of their income in the form of taxes. They all be reluctant to save & invest more this way direct taxes adversely affect the will to work save & invest.
•  Narrow in Scope: - Direct taxes or generally imposed on rich people low income group cannot be approached through these taxes. In this way direct taxes have their limited applicability .
The tax which is initially imposed on one person and paid by another. In case of indirect taxes impact and incidence fall on 2 different people for eg- custom duty Sale Tax, Vat, etc.
Merits of Indirect Taxes:-
•  Connivance :- Indirect Taxes are more convenient than direct taxes they are paid in small amount and at some intervals. they are generally included in price of the commodity & hence not much burden is felt by tax payer.
•  Wide coverage :- These taxes reach to the all income groups low, middle, high they are imposed on all type of commodities thus they have a wide coverage & every consumer pays to the state. Ex-checker acc. to his ability to pay thus they are equitable also to some extent.
•  Elastic: - Indirect taxes are also elastic in nature the govt. Can reduce or increase the rate of taxes, acc. to the requirements. The govt. can obtain adequate tax revenue by increasing tax rate on those commodities which are highly in demand & they have inelastic demand however, this will go against common of equality .
•  No evasion :- Indirect Taxes are difficult to be evaded as they are in included in price of the commodity as a person can evade an indirect taxes only when he decides not to purchase a taxed commodity
•  Diversity : - Indirect Taxes satisfy the canon of diversity. They can be imposed on verity of commodities and services. Thus govt. can earn continuous and sufficient revenue from indirect taxes
•  Direct the consumption of commodities :- Indirect taxes check the consumption of harmful goods like wine tobacco & other such substances. The state imposes heavy duties on such articles of consumption which are injurious to health & efficiency of people as a result, their price rise & consumption is reduced.
De-merits of indirect Taxes :-
•  Regressive & unjust :- Indirect Taxes on necessities, which are consumed by poor are regressive in nature. The rich & poor are required to pay the same amount of tax on such commodities like matchbox, soap, toothpaste, blades etc. but the burden is heavy on poor than on the rich, thus they do not satisfy the canon of equity.
•  Inflationary Impact :- Another demerit of indirect taxes is that they feed inflation. Imposition of these taxes tends to raise the price of commodities there by leading to higher cost to higher wages and again to higher prices, thus price wage cost spiral sets in the economy.
•  Uneconomical :- These taxes are uneconomical because the cost of collection is very high the state has to appoint many tax collectors to check the accounts and stock of producer, wholesalers & retailers in order to find out whether they are paying taxes or not.
•  Uncertain: - The Revenue from indirect taxes is uncertain because it is not possible to estimate accurately the effect of such taxes on demand for products. When the commodity is taxed its market price rises which results in lower demand so it is quite difficult to anticipate the income from indirect taxes.
•  Discourages Saving: - Indirect Taxes discourage saving as they are included in price so people will spend more on consumption expenditure, hence saving reduces.
•  Lack of civic consciousness: - A person who purchase a commodity does not know that he is paying a tax to government in price of commodity, therefore such taxes do not inculcate civic consciousness among majority of tax payers who are ignorant of the fact that they are contributing something the state treasury .
Difference between Direct & indirect taxes

1 Meaning Direct Taxes are those under which burden falls on the same person on whom it is imposed, i.e. impact and incidence falls on the same person The tax which is initially imposed on one person and paid by another. In case of indirect taxes impact and incidence fall on 2 different people
2 Shifting of tax The can't be shifted They can be shifted
3 Impact &incidence They fall on the same person It falls on two different people.
4 Civic consciousness It inculcates civic consciousness It does not inculcate civic consciousness
5 Income & expenditure They are imposed on income of the taxpayer They are imposed on expenditure of tax payer
6 Nature of Tax They are compulsory in nature They are not compulsory.
7 Examples Wealth tax , income tax & Property tax etc. Sales Tax, VAT, custom duty etc.
Canons of Taxation / Principles of Taxation / Characteristics of good tax system :
A good tax system should follow certain principles which become its characteristics thus a good tax system is based on certain principles which are known as canons of taxation. Adam Smith was probably the first economist who stated the general principles of taxation or rules of taxation. They are even now considered as the Characteristics of taxation of good tax system. According to Adam Smith father of economics there are 4 main cannons of taxation which are as fallows
•  Canon of Equality: - The cannon of equality equity or justice is most important cannon of taxation. It means that every person should pay tax according to his ability and not the same amount. it also means that every body should not pay at the same rate rather every tax payer should pay the tax in proportion to his income. The rich should pay more than the poor whose income is less.
•  Canon of Certainty : - Acc to smith there should be certainty in taxation because uncertainty breeds corruption. The certainty aspects of a tax are
•  Certainty of effective incidence i.e. who shall bear the tax burden.
•  Certainty of tax amount payable in a certain time period
•  Certainty of Revenue to the government how much govt. shall have estimated collection of revenue during a given time period.
3. Canon of economy -: every tax should satisfy the canon of economy in two ways
•  It should be economical for the state to collect it
•  It should be economical for the tax payer it means he should have sufficient money left with him after paying the tax
4.Canon of convenience: - According to Adam Smith every tax ought to be levied at the time or in the manner in which it is more likely to be convenient for the contributor to pay it .it implies that taxes should be imposed in such a manner and at the time which is the most convenient for the tax payer,e.g. the best time for the collection of land revenue is the time of harvest.
Some other writer like Bastable added a few more canons of taxation to the Adam Smith's four canons of Taxation these are
• Canon of productivity: - The productivity of a tax may be observed in two easy ,in the first place ,a tax must yield a sufficient revenue for the maintenance of the government. Secondly, the taxes should obstruct and discourage production in the short as well as in the long run.
Canon of Elasticity: Taxation should be elastic in nature this canon implied that the yields of the taxes may be increased or decreased according to the changing needs of the govt. The govt. resources can be raised in emergencies like war floods droughts etc quickly only when the tax system is elastic. Taxes on property and commodities are not so elastic as income tax .
Canon of Simplicity :- this canon suggest that tax system should be easily understandable to tax payer i.e its nature, its aim, time of payment, methods and basis of estimation should all be easily followed by the each tax payer. However it is not very easy to observe this canon in the modern tax system, which has become quite complex in nature.
•  Canon of expediency : - Acc to this cannon a tax should be based on sound principles so that it requires no justification from the side of government. the possibility of imposition of taxes should be taken from different angles, i.e. its reaction upon tax payers .some times it may be desirable and may have most of the characteristics of a good tax system but the govt. may not find it expedient to impose it,e.g. progressive agriculture income tax is very much desirable in India, but it has not been imposed so far in the manner it should have been imposed.
•  Canon of diversity: - There should be variety of taxes a single tax. Would neither meet the revenue requirement of state nor satisfy the canon of equity thus there should be a variety of taxes so that all citizens should contribute towards state revenue acc to their ability to pay.
•  Canon of co-ordination : In a democratic country taxes are imposed by central, state and local govts. It is therefore very much desirable that there is vo-ordination between different taxes that are imposed by different taxing authorities. it is very much needed considering the interest of tax payer and the govt. both .
Main Sources of Revenue of central govt .
Tax Revenue
•  Income Tax(on income of the individual as well as joint Hindu families)
•  Corporation Tax (on income of the companies both domestic and foreign companies operating in India )
•  Interest Tax (on the gross interest income of the financial institutions like Bank)
•  Expenditure Tax(expenditure incurred in luxury hotels and restaurants)
•  Wealth Tax(total wealth of individuals and Hindu undivided families)
•  Custom Duty.(import and export duty)
•  Central excusive Duty.(duties on industrial products)
•  Service Tax.(on services provided by hotels,telephones,port services etc.)
2. Not Tax Revenue
(i) Interest received(on loans given by central govt. to other govts.)
(ii) Dividends & Profits
•  Barrowing both from internal & extra source.
•  Income from Railways
•  Post & Telegram
•  Commercial & non-commercial under
•  Grants in Aid(from foreign countries as well as from international organizations)
Sources of Revenue of State government
Tax Revenue.
•  Land Revenue
•  Tax on agriculture resources.
•  Estate duty.
•  Excise duty on liquors, OPM and other nonce
•  Motor Vehicle Tax
•  Entertainment Tax
•  Electric city Duties
•  Taxes on profession,
•  Toll Tax
•  Taxes on income
•  Non Tax Revenue
•  Borrowing within country and loans from govt. of India .
•  Incomes from govt. undertaking, owned by State govt.
•  Royalties from mines, forest, etc.
•  Grant in Aid from central govt.
•  Interest received.
•  Dividends from public sector undertaking
•  Administrative receipts
VAT :-
The value added Tax is a Tax on the Value added to a commodity or service at each stage from production to retail stage
The modified value added scheme allows the manufacturer to obtain instant and complete reinvestment of the excise duty paid on the components of the commodity.
Specific Tax :-
Taxes which are levied on the basis of specific qualities or attributes such as Weight, size, volume etc are called specific taxes.
Ad. Valorem Tax :-
Taxes which are imposed. Acc to the value of commodity are known as advalorem taxes. For eg. - import duty.
Central Value added Tax was introduced in 2000-2001 and 20001 2002 budgets by replacing. The 3 advalorem rates with a single rate of 16%
Impact of a Tax :- The impact of a tax is upon the person who pays it in the first instance in other words the person who pays the tax to govt. in first instance bears its impact.
Shifting of a Tax :-
The process of passing on the money burden of a tax to another person is called shifting of a tax.
Incidence of a Tax :-
It refers to the money of tax on the person who ultimately pays it. In the words of Dalton . The incidence of a tax is upon those who bear the direct money burden of tax.
Difference between impact and incidence

Impact of Tax
Incidence of Tax
1. It refers to the initial burden of the tax
It refers to the ultimate burden of a tax
2. It is upon the person who pays it in the first instance
It is felt by the person who actually bears the burden of tax.
3. It can be easily shifted.
It cannot be shifted


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