Taxation is the process by which the Government collects money from people to use for public purposes.
Tax es are generally an involuntary fee levied on individuals or corporations that is enforced by a Government entity, whether local, regional or national in order to finance Government activities.
Purpose of taxation
Taxes are mainly used to finance the expenses incurred by Government to manage an economy. These expenses include: health care, education, transportation and operating Government business entities etc. Taxation is also used by Government for several other purposes such asâ€”
a. Expenses related to building and technology infrastructure.
b. To reduce pollution by taxing offending firms.
c. To discourage unhealthy lifestyle e.g, a tax on cigarettes, other tobacco products, liquor etc.
d. To protect local and infant industries by taxing imports.
e. To achieve greater equality of wealth and income. Revenue from taxation is used to help the very poor e.g. providing food stamps.
f. To improve the balance of payments (BOP) by increasing the duties charged on imported goods.
g. To control spending in an economy thus reduce inflation
h. Prevent Concentration of Wealth in a few handsâ€“Tax is imposed on persons according to their income level.
Importance of taxation
" … but in this world nothing can be said to be certain, except death and taxes."
– Benjamin Franklin
Taxation is important to society because the Government use the tax collected to fund projects related to health care systems, education systems, and public transports. Also, the money collected can also be used to give unemployment benefits, pensions, and other matters that can benefit the society as a whole. Without tax, the Government would not be able to fund the essential projects and services that people need. The Government allocates the money collected from the taxpayers to different areas of the country. For example: Some areas of our country are rich in natural resources (like minerals, fuels etc) that if utilised properly are beneficial for the development of nation and its economy. The Government needs to allocate part of the tax money towards development of such areas. Such allocation of finances generated by taxes by the Government not only helps the nation's economic growth but also helps the local habitants of such places by raising their standards of living (which is consequentially positively affected by the development programmes undertaken by the Government). Similarly, expenses made by the Government on maintenance of historic monuments, archaeological sites etc. not only improves the standards of such places but also helps in generating more revenues using tourism as a tool.
Moreover, another tax benefit on society is it discourages certain undesirable activities such as; liquor, tobacco and gambling. On such activities the Government imposes excise tax, discouraging individuals from selling such commodities.
Economic growth and taxation
Economic growth is the basis of increased prosperity. Growth comes from the accumulation of capital and from innovations which lead to technical progress. Accumulation and innovation raise the productivity of inputs into production and increase the potential level of output. The rate of growth can be affected by policy through the effect that taxation has upon economic decisions. An increase in taxation reduces the returns to investment (in both physical and human capital) and Research and Development (R&D). Lower returns mean less accumulation and innovation and hence a lower rate of growth. This is the negative aspect of taxation. Taxation also has a positive aspect. Some public expenditure can enhance productivity, such as the provision of infrastructure, public education, and health care. Taxation provides the means to finance these expenditures and indirectly can contribute to an increase in the growth rate. Taxation can have both a negative and a positive effect on growth. The negative effect arises from the distortions to choice and the disincentive effects. The positive effect arises indirectly through the expenditures financed by taxation.
The classical view of economics is that the only objective of taxation is 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
Taxation is 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 developed 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 law and order and to protect the country from foreign aggression but 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 an 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 versa. Thus the tax policy may be used to strengthen incentives to savings and investment.
6. Price stability
In underdeveloped countries, there is another role to maintain price stability to ensure growth with stability which can be handled by a smart tax policy.
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 transfer of resources to the State. Thus, the economy can ensure sustainable development.
Therefore, it can be said that the economic development of a country depends on various reasons one of them are on the presence of an effective and efficient taxation policy.
Tax revolution: tax reforms
The first comprehensive attempt at reforming the tax system was by the
Tax Reform Committee in 1953. This provided the backdrop for the generation of resources for the Second Five-Year Plan (1956-60), and was required to fulfil a variety of objectives such as raising the level of savings and investment, effecting resource transfer from the private to the public sector and achieving a desired state of redistribution. Since then, there have been a number of attempts, most of them partial, to remedy various aspects of the tax system. The expenditure tax levied on the recommendation of the
Kaldor Committee in 1957-58 had to be withdrawn after three years as it did not generate the expected revenues. The attempt to achieve the desired state of redistribution caused the policy makers to design the income tax system with confiscatory marginal rates. The consequent moral hazard problems led the Direct Taxes Enquiry Committee in 1971 to recommend a significant reduction in marginal tax rates. On the indirect taxes side, a major simplification exercise was attempted by the
Indirect Taxes Enquiry Committee in 1972. At the State and local level, there were a number of tax reform committees in different states that went into the issue of rationalization and simplification of the tax system. The motivation for almost all these committees was to raise more revenues to finance ever-increasing public consumption and investment requirements.
The Tax Reforms Commiitee 1991 (TRC) laid out a framework and a roadmap for the reform of direct and indirect taxes as a part of the structural reform process. The paradigm shift in tax reforms adopted by the TRC was in keeping with the best practice approach of broadening the base, lowering marginal tax rates, reducing rate differentiation, simplifying the tax structure, and adopting measures to make the administration and enforcement more effective.
The important proposals put forward by the TRC included reduction in the rates of all major taxes, i.e., customs, individual, and corporate income and excise taxes to reasonable levels, maintain progressivity but not such as to induce evasion. The TRC recommended a number of measures to broaden the base of all the taxes by minimising exemptions and concessions, drastic simplification of laws and procedures, building a proper information system and computerisation of tax returns, and revamping and modernisation of administrative and enforcement machinery.
It also recommended that the taxes on domestic production should be fully converted into a value added tax, and it should be extended to the wholesale level, in agreement with the States, with additional revenues beyond post-manufacturing stage passed on to the State Governments. The tax reforms witnessed thereafter sought to follow the directions spelt out in this report.
While the TRC laid down the analytical foundations for the reform of the tax system in a liberalised environment, subsequent reports extended the roadmap for reforms to meet the demands of the emerging economic environment in the new millennium.
India's biggest indirect tax reform has finally arrivedâ€“the Goods and Service Tax (GST)
From its first official mention in 2009 when a discussion paper was introduced by the previous United Progressive Alliance Government to the point when the current Government tabled the Constitutional Amendment Bill in the Parliament, building consensus on the GST hasn't been easy, Its current status is that it has been passed by both the Houses, of Parliament and is now being ratified by the State Assemblies gradually.
Why does India need the GST?
The GST is being introduced not only to get rid of the current patchwork of indirect taxes that are partial and suffer from infirmities, mainly exemptions and multiple rates, but also to improve tax compliances.
The spread of GST in different countries has been one of the most important developments in taxation over the last six decades. Owing to its capacity to raise revenue in the most transparent and neutral manner, more than 150 countries have adopted the GST. With the increase of international trade in services, the GST has become a preferred global standard. All OECD countries, except the US, follow this taxation structure.
What is GST?
It has been long pending issue to streamline all the different types of indirect taxes and implement a "single taxation" system. This system is called as GST (GST is the abbreviated form of Goods & Services Tax). The main expectation from this system is to abolish all indirect taxes and only GST would be levied. As the name suggests, the GST will be levied both on Goods and Services.
GST was first introduced during 2007-08 budget session. On 17th December 2014. It is defined as any tax on the supply of goods or services that will subsume CENV AT, service tax, Central Excise duty, additional excise duties, excise duties levied under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955, service tax, additional customs duty (countervailing duty or CVD), special additional duty of customs (SAD), central surcharges and cesses, State VAT, State Sales Tax, entertainment tax not levied by local bodies, luxury tax, taxes on lottery, betting, and gambling, tax on advertisements, State cesses and surcharges related to supply of goods and services and entry tax not levied by local bodies.
The primary reason for introducing the Bill is to pave the way for the Centre to tax sale of goods and the States to tax provision of services. The Bill further proposes that the Central Government will have the exclusive power to levy GST on imports and interstate trade.
The bill has also recognised the need to have a GST council. The Union Finance Minister, the union minister of State in charge of revenue or finance, and the minister in charge of Finance or Taxation or any other Minister nominated by each State Government would constitute the council to ensure that both the Centre and the States are on equal footings.
In addition, the Bill proposes to set up a Dispute Settlement Authority that would look into disputes between the States and the Centre. Appeals from the authority would directly lie with the Supreme Court.
How is GST applied?
GST is a consumption based tax/levy. It is based on the "Destination principle." GST is applied on goods and services at the place where final/actual consumption happens. GST is collected on value-added goods and services at each stage of sale or purchase in the supply chain. GST paid on the procurement of goods and services can be set off against that payable on the supply of goods or services. The manufacturer or wholesaler or retailer will pay the applicable GST rate but will claim back through tax credit mechanism.
But being the last person in the supply chain, the end consumer has to bear this tax and so, in many respects, GST is like a last-point retail tax. GST is going to be collected at point of Sale.
The GST is an indirect tax which means that the tax is passed on till the last stage wherein it is the customer of the goods and services who bears the tax. This is the case even today for all indirect taxes but the difference under the GST is that with streamlining of the multiple taxes the final cost to the customer will corne out to be lower on the elimination of double charging in the system.
Benefits of CST Bill implementation
• The tax structure will be made lean and simple
• The entire Indian market will be a unified market which may translate into lower business costs. It can facilitate seamless movement of goods across states and reduce the transaction costs of businesses.
• It is good for export oriented businesses. Because it is not applied for goods/services which are exported out of India.
• In the long run, the lower "tax burden could translate into lower prices on goods for consumers.
• The suppliers, manufacturers, wholesalers and retailers are able to recover GST incurred on input costs as tax credits. This reduces the cost of doing business, thus enabling fairer prices for consumers.
• It can bring more transparency and better compliance.
• Number of departments (tax departments) will reduce which in turn may lead to less corruption.
• More business entities will come under the tax system thus widening the tax base. This may lead to better and more tax revenue collections.
• Companies which are under unorganised sector will come under tax regime.
Role of tax professionals
Throughout the world, Tax Professionals including Gaffed Accountants and lawyers who practice majorly in the field of taxâ€“with their technical expertise and professional and ethical training-play a key role in assisting client and employer taxpayers regarding tax obligations. At one extreme, it is clear that tax evasionâ€“which is illegalâ€“should be condemned by all parties and no professional accountant should ever be associated with it. At the other, leveraging tax incentives in the way they are intended by Governments is certainly appropriate. Between the two extremes lies the complex question of "tax avoidance", which is by definition legal. This poses a difficult dilemma for taxpayers and, thus, for the accountancy profession.
The tax professionals
• Help employers and clients understand their fiscal and regulatory obligations in relation to taxation and advise them on how to comply;
• Ensure that their employers and clients understand the options available to them and assist them to be as tax-competitive as possible (thus creating economic wealth and employment), but should also ensure that they understand the consequences of each option (including potential reputational consequences);
• Are obliged to comply with strict ethical principles (e.g., the international
Code of Ethics or the codes of national professional and regulatory organisations), and are guided by the fundamental principles of integrity and professional behaviour; and
• Play an important role in combating tax evasion. For example, accountants in public practice help clients comply with their legal obligations. If a client is unwilling, an accountant considers options, such as resigning from the account; in some circumstances, accountants may have a reporting obligation to revenue or regulatory authorities.
Clearly, accountants play an important role-in effective tax systems, employer and client education, business advisory, ethics, and more.
[Source: Speech delivered at the 6th Five Years
Law Course Competition on 3rd September, 2016 at Jaipur]