What is Tax?

A tax is a compulsory payment levied on the persons or companies to meet the expenditure
incurred on conferring common benefits upon the people of a country.

Two aspects of taxes follow from this definition:

(1) A tax is a compulsory payment and no one can refuse to-pay it.

(2) Proceeds from taxes are used for common benefits or general purposes of the State. In other
words, there is no direct quid pro quo involved in the payment of a tax.

This implies that an individual cannot expect or demand that the Government should render him
a specific service in return for the tax paid by him. However, this does not imply that
Government does nothing for the people from whom it receives taxes.

In fact Government spends the tax money for the general or common benefits of all the people
rather than conferring any special benefit on a particular tax payer. To quote Taussig, “The
essence of a tax, as distinguished from the other charges by Government is the absence of any
direct quid pro quo between the tax payer and the public authority.”

Tax should be carefully distinguished from a fee. Fee is also compulsory payment made by a
person who receives in return a particular benefit or service from the Government. For paying
fee on a television or radio, a person gets the benefits of programmes relayed by the Government
on television or radio. Likewise, students who pay the education fee in schools and colleges,
obtain the benefits of teaching arranged by the Government.

The amount of fee is always less than the cost of service rendered by the Government in return
and therefore covers only a part of the cost of service rendered. Thus, even in case of fee, there is
a general public interest or common benefit of the service rendered by the Government. In this
case, the Government undertakes a service for the common benefits of the citizens and obtains a
fee from those who avail of that service to cover a part of the cost of service rendered.

Classification of Taxes:

The taxes have been variously classified. Taxes can be direct or indirect, they can be
progressive, proportional or regressive, and indirect taxes can be specific or ad-valorem.
We spell out below the meanings of these different types of taxes.

Direct and Indirect Taxes:

The distinction between direct and indirect taxes is based on whether or not the burden of a
tax can be shifted wholly or partly to others. If a tax is such that its burden cannot be shifted
to others and the person who pays it to the Government has also to bear it, it is called a direct tax.
Income tax, annual wealth tax, capital gains tax are examples of direct taxes.
In case of a direct tax there is a direct contact between the tax payer and tax levying public
authority.

Important direct taxes are listed below:

Income Tax

This is most important type of direct tax and almost everyone is familiar with it. TDS is its famous
synonym and whosoever is earning above a minimum amount (tax exemption limit) has to pay income
tax.
 
Wealth Tax

This is in addition to the income tax and is levied if your net wealth exceeds Rs 30 Lakh at the rate of 1%
on the amount exceeding Rs 30 Lakh.

*Note – In Budget 2013-2014 Finance Minister Mr P. Chidambaram introduced a surcharge of 10

This is levied on the capital gains arrived by selling property and stocks. Tax rates are different for long
term and short term capital gains.
 
Gift Tax/ Inheritance or Estate Tax

Amount exceeding Rs. 50000 received without consideration by an individual/HUF from any person is
subjected to gift tax as income under “other sources”. There are exemptions like money received from
relatives is not taxable. Marriage gifts and money received through inheritance are also exempt from gift
tax. Inheritance tax was earlier in practice but has been repealed by the government.
 
Corporate Tax

Companies operating in India are taxed as per the corporate tax rate on their income. This tax is one of
the major sources of revenue for government.
 
Indirect Tax

Impact and incidence of indirect Taxes fall on different persons as opposed to direct taxes where impact
and incidence is on the same person. These taxes are recovered from different groups of people but the
liability remains with the person who collects it. Tax payer recovers the indirect taxes paid from their
consumers and clients and finally pays it to government.

For example, when we purchase any product we pay VAT, when we eat in restaurants we pay service tax
which are ultimately deposited in government’s kitty by the service providers. Brief about various types
of indirect taxes is given below:

Service Tax
Service providers in India are subject to service tax, which is charged on the aggregate amount received
by the service provider. Services like leasing, internet/voice, transport, etc are subject to service tax.
 
Custom Duty

Custom duties are indirect taxes which are levied on goods imported to/exported from India. There are
different rules for different types of goods and sectors. Government keeps on changing these rates so as
to promote import/export of specific goods.
 
Excise Duty

Excise duties are indirect taxes which are levied on goods manufactured in India for domestic
consumption. Like custom duty, there are a number of rules which keep on changing as per government
discretion.

Sales Tax and VAT

Sales tax is levied by the government on sale and purchase of products in Indian market. As customers,
whatever you buy from the market, you pay sales tax on it. Now, sales tax is supplemented with new
Value Added Tax so as to make it uniform across country.

The VAT is a consumption tax that taxes the value added by businesses at each point in the
production chain. It applies to both manufactured goods. A business pays VAT on its purchase of
inputs and collects it on its sales, whether those sales are to another business or the final
consumer. VAT is also applicable on resale of goods.

It is also known as consumption tax. It is a multi point sales tax with set off for tax paid on
purchases.

It is basically a tax on the value addition on the product. It is not charge on companies. It is
charged as a percentage of its price.

Advantages:

1.As compared to other taxes, there is a less chance of tax evasion. VAT minimizes tax evasion
due to its catch-up effect.

2. VAT is simple to administer as compared to other indirect tax.

3. VAT is transparent and has minimum burden to consumers as it is collected in small

4. VAT is based on value added not on total price. So, price does not increases as a result of
VAT.

5. There is mass participation of taxpayers.

1. VAT is costly to implement as it is based on full billing system.

2. VAT is relatively complex to understand. The calculation of value added in every stage is not
an easy task.

3. To implement the VAT successfully, customers, need to be conscious, otherwise tax evasion
will be widespread.

Security Transaction Tax (STT)

STT is levied on transactions (sale/purchase) done through the stock exchanges. STT is applicable on
purchase or sale of various financial products like stocks, derivatives, mutual funds etc.

On the other hand, indirect taxes are those whose burden can be shifted to others so that those
who pay these taxes to the Government do not bear the whole burden but pass it on wholly or
partly to others. For instance, excise duty on the production of sugar is an indirect tax because
the manufactures of sugar include the excise duty in the price and pass it on to buyers.
Ultimately, it is the consumers on whom the incidence of excise duty on sugar falls as they will
pay higher price for sugar than before the imposition of the tax.

Thus, though excise duties are on the production of commodities but they can be shifted to the
consumers. Likewise, sales tax on commodities can also be passed on to buyers or consumers in
the form of higher prices charged for the commodities.

Therefore, excise duties and sales taxes on commodities are examples of indirect taxes. They are
also known as commodity taxes. In the case of indirect taxes, there is an indirect relation,
between the Government and those who ultimately bear the burden of the taxes.

Specific and Ad-Valorem Taxes:

Indirect taxes can be either specific or ad-valorem. A specific tax on a commodity is a tax per
unit of the commodity, whatever its price. Thus the amount of total specific tax will vary in
accordance with the changes in total output or sales of the commodity and not with the total
value of output or sales.

On the other hand, an ad-valorem type of an indirect tax is levied according to the value of the
commodity. For instance, sales tax in India is an ad-valorem tax as the rate of sales tax in case of
several commodities is 10 per cent of the value of sales of the commodities. Ad-valorem taxes
are progressive in their burden on consumers whereas specific taxes are regressive.

Progressive, Proportional and Regressive Taxes:

Thus, in case of proportional tax it is the rate which is fixed and not the absolute amount of the
tax. Thus with the rate of 25 per cent proportional income tax, a person with income of Rs.
25,000 will pay Rs. 6,250 as the tax, and a person with income of 50,000 will pay Rs. 12,500 as
the tax. Thus, even under proportional income tax, a richer person has to pay greater amount of
tax though rate of the tax is the same.

On the other hand, in case of a progressive tax, rate of the tax increases as the amount of the tax
base (income, wealth or any other object) increases. The principle underlying a progressive tax
is that greater the tax base, the higher the tax rate. In India income tax, an important direct tax
levied by the Central Government, is progressive.

Its rate at present (1998-99) varies from 10 per cent in the slab of Rs. 40,000 to 60,000 to 30 per
cent in the slab of income above Rs. 1,50,000. Under progressive income tax, the richer person
pays not only absolutely more tax but also a higher rate of the tax. Thus, the burden of
progressive tax falls more heavily on the richer persons as compared to proportional income tax.

A regressive tax is the opposite of a progressive tax. In case of a regressive income tax, the rate
is lowered as the income rises. Thus, under regressive tax system, the burden of the tax is
relatively more on the poor than on the rich. A regressive tax is therefore inequitable and no
civilised Government in the world today will levy such a tax.

Adjusted Gross Income

The amount of taxable income that remains after certain allowed business-related deductions—
such as alimony payments, contributions to a Keogh retirement plan, and in some cases,
contributions to an IRA—are subtracted from an individual's gross income. Adjusted gross
income and gross income will be the same for many taxpayers.