7.5 Taxation

      Taxation is a term for when a taxing authority, usually a government, levies or imposes a tax. The term “taxation” applies to all types of involuntary levies, from income to capital gains to estate taxes.

• Taxation occurs when a government or other authority requires that a fee be paid by citizens and corporations, to that authority.
• The fee is involuntary, and as opposed to other payments, not linked to any specific services that have been or will be provided.
• Tax occurs on physical assets, including property and transactions, such as a sale of stock, or a home. 
• Types of taxes include income, corporate, capital gains, property, inheritance, and sales.

The purpose of taxation is income redistribution and creation of welfare of its citizens. In modern economies taxes are the most important source of governmental revenue. Taxes differ from other sources of revenue in that they are compulsory levies and are unrequited—i.e., they are generally not paid in exchange for some specific thing, such as a particular public service, the sale of public property, or the issuance of public debt While taxes are presumably collected for the welfare of taxpayers as a whole, the individual taxpayer’s liability is independent of any specific benefit received.

7.6 Proportional, progressive, and regressive taxes

Taxes can be distinguished by the effect they have on the distribution of income and wealth. A proportional tax is one that imposes the same relative burden on all taxpayers—i.e., where tax liability and income grow in equal proportion. A progressive tax is characterized by a more than proportional rise in the tax liability relative to the increase in income, and a regressive tax is characterized by a less than proportional rise in the relative burden.

Thus, progressive taxes are seen as reducing inequalities in income distribution, whereas regressive taxes can have the effect of increasing these inequalities.

The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so in the upper-income categories—especially if a taxpayer is allowed to reduce his tax base by declaring deductions or by excluding certain income components from his taxable income. Proportional tax rates that are applied to lower-income categories will also be more progressive if personal exemptions are declared.

Income measured over the course of a given year does not necessarily provide the best measure of taxpaying ability. For example, transitory increases in income may be saved, and during temporary declines in income a taxpayer may choose to finance consumption by reducing savings. Thus, if taxation is compared with “permanent income,” it will be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (except those on luxuries) tend to be regressive, because the share of personal income consumed or spent on a specific good decline as the level of personal income rises. Poll taxes (also known as head taxes), levied as a fixed amount per capita, obviously are regressive.

It is difficult to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being considered

Characteristics of Taxation

Taxes can be categorized as

        (i)  Regressive

        (ii) Proportional

        (iii) Progressive

(i)     Regressive Tax

        It is a tax under which the income of a person goes up, the rate of tax goes down so that the tax burden on higher incomes is relatively lower.

           Eg: indirect tax such as sales tax, service tax (as rich and poor pay the same tax for purchasing everyday products and services)

(ii)    Proportional Tax

        It is a tax under which as the income of a person increases (or) decreases, the rate of tax is same for all income groups.

        So that tax burden for an income group is same

        E.g.: Income slab:     2.5 – 5 Lakh      –      5%

                                        5 – 10 Lakh                  –   5%

                                         10 Lakh above          –      5%

(iii)   Progressive Tax     

        It means as the income of a person goes up, the rate of tax imposed on his income goes up so that the tax is more for higher incomes. It reduces inequalities and statistics “Principle of equality in taxes”.

        For eg.:

        Salary               2.5- 5 Lakh     –       5%

                               5 – 10 Lakh       –       10%

                               Above 10 Lakh   –      20%

Incidence of tax vs impact of tax

The point where the tax looks as being imposed is known as the incidence of tax- the event of tax imposition. The point where the tax makes an effect is known as impact of tax – the after effect of tax imposition. This distinction can be seen in the type of taxes such as direct tax and indirect tax.

7.7 Different types of Taxation:

1. i) Direct & Indirect taxes
2. ii) Specific & Ad Valorem taxes

1. Direct Tax

                If impact and incidence of the tax lies on the same person. A direct tax is paid directly by an individual or organization to the imposing entity. Direct taxes are progressive in nature in India.

        E.g.: Income Tax, Corporate Tax, Property tax & wealth tax, etc.

1. Indirect Tax

                 An Indirect tax is a tax which is imposed on someone but is paid by someone else. E.g., excise duty – levied on producer, but ultimately paid by consumer along with price.

        It means burden falls on someone else (or) its burden can be shifted

E.g.: Taxes on goods & Services (GST) like VAT, service Tax, Entertainment tax Excise duty.

1. ii) Specific & Ad Valorem taxes
2. Specific Tax

        When any good is taxed on the basis of its measure, size and weight such tax is known as specific tax.

        E.g.: Tax on Cigarette – basis of length

1. Ad Valorem Tax

        It is a tax which is imposed on a commodity on the basis of the total value of good regardless of number of units produced or sold or price of the commodity.

The distinction between specific & Ad Valorem tax is explained by the following example.

E.g.: If a shirt manufacturer produces 1000 shirts and fix Rs.1lakh as their worth he have to pay Rs.10000 as tax (taking Ad Valorem as 10%). But if he chooses to raise the worth of the same 1000 shirts to Rs.2lakhs he has to pay extra Rs.10000 and totally Rs.20000 as Ad Valorem tax.

When tax is imposed on the manufactures based on number of shirts, it is known as specific tax.

        When tax is imposed based on total value of the goods, it is known as Ad Valorem tax.

Surcharge

        A surcharge is tax on tax which is imposed on incomes above a certain level with a view to reduce inequalities and make the tax structure progressive. It is also called super tax.

E.g.: In India, surcharge of 15% on those individuals whose annual income exceeds Rs.1crore.

CESS

A cess is a levy which is imposed to achieve a specific objective. It may be withdrawn once the objective has been achieved.

        E.g.: Education & Health cess, Swachh Bharath Cess