MCQ- Public Revenue: Meaning, Tax Revenue, Non-Tax Revenue with Classification of Public Revenue

Public Revenue: Meaning, Tax Revenue, Non-Tax Revenue with Classification of Public Revenue

Meaning of Public Revenue:

The income of the government through all sources is called public income or public revenue.

According to Dalton, however, the term “Public Income” has two senses — wide and narrow. In its wider sense it includes all the incomes or receipts which a public authority may secure during any period of time. In its narrow sense, however, it includes only those sources of income of the public authority which are ordinarily known as “revenue resources.” To avoid ambiguity, thus, the former is termed “public receipts” and the latter “public revenue.”

As such, receipts from public borrowings (or public debt) and from the sale of public assets are mainly excluded from public revenue. For instance, the budget of the Government of India is classified into “revenue” and “capital.” “Heads of Revenue” include the heads of income under the capital budget are termed as “receipts.” Thus, the term “receipts” includes sources of public income which are excluded from “revenue.”

In a modern welfare state, public revenue is of two types, tax revenue and non-tax revenue.

Tax Revenue:

A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. As Taussig puts it, “the essence of a tax, as distinguished from other charges by government, is the absence of a direct quid pro quo between the tax payer and the public authority.”

Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred.

The main characteristic features of a tax are as follows:

1. A tax is a compulsory payment to be paid by the citizens who are liable to pay it. Hence, refusal to pay a tax is a punishable offence.

2. There is no direct, quid pro quo between the tax-payers and the public authority. In other words, the tax payer cannot claim reciprocal benefits against the taxes paid. However, as Seligman points out, the state has to do something for the community as a whole for what the tax payers have contributed in the form of taxes.

“But this reciprocal obligation on the part of the government is not towards the individual as such, but towards the individual as part of a greater whole.”

3. A tax is levied to meet public spending incurred by the government in the general interest of the nation. It is a payment for an indirect service to be made by the government to the community as a whole.

4. A tax is payable regularly and periodically as determined by the taxing authority.

Taxes constitute a significant part of public revenue in modern public finance. Taxes have macro-economic effects. Taxation can affect the size and mode of consumption, pattern of production and distribution of income and wealth.

Progressive taxes can help in reducing inequalities of income and wealth by lowering the high income group’s disposable income. By disposable income is meant the income left in the hands of the tax payer for disbursement after tax payment. Taxes imply a forced saving in a developing economy. Thus, taxes constitute an important source of development finance.

Non-Tax Revenue:

Public income received through the administration, commercial enterprises, gifts and grants are the source of non-tax revenues of the government.

Thus, non­tax revenue includes:

(i) Administrative revenue

(ii) Profit from state enterprises

(iii) Gifts and grants

Administrative Revenues:

Under public administration, public authorities can raise some funds in the form of fees, fines and penalties, and special assessments.

Fees:

Fees are charged by the government or public authorities for rendering a service to the beneficiaries. To quote Seligman, “A fee is a payment to defray the cost of each recurring service undertaken by the government, primarily in the public interest, but conferring a measurable advantage to the payer.”

Court fees, passport fees, etc., fall under this category. Similarly, licence fees are charged to confer a permission for something by the controlling authority, e.g., driving licence fee, import licence fee, liquor permit fee, etc. Fees are to be paid by those who receive some special advantages. Generally the amount of the fee depends upon the cost of services rendered.

Fees are a bye- product of the administrative activities of the government and not a payment for a business. Thus, fees are distinct from prices. Prices are always voluntary payments, but fees are compulsory contributions, though both are made for special services. Sometimes a fee contains an element of tax when it is charged high in order to bring revenue to the exchequer e.g., a licence fee.

Fines and Penalties:

Fines and penalties are levied and collected from offenders of laws as punishment. Here the main object of these levies is not so much to earn an income as to prevent the commission of offences and infringement of laws of the country. Fines and penalties are arbitrarily determined and have no relation to the cost of administration or activities of the government. Hence, collections from such levies are insignificant as a source of public revenue.

Special Assessments:

“A special assessment,” as Seligman points out, “is a compulsory contribution levied in proportion to the social benefits derived to defray the cost of a specific improvement to property undertaken in the public interest.” That is to say, sometimes when the government undertakes certain types of public improvements such as construction of roads, provision of drainage, street lighting etc., it may confer a special benefit to those possessing properties nearby.

As a result, values of rents of these properties may rise. The government, therefore, may impose some special levy to recover a part of the expenses so incurred. Such special assessment is levied generally in proportion to the increase in the value of the properties involved. In this respect, it differs from a tax.

In India, these special assessments are referred to as “betterment levy.” Betterment levy is imposed on land when its value is enhanced by the construction of social overhead capital such as roads, drainage, street- lighting, etc. by the public authority in an area.

Profits of State Enterprise:

Profits of state undertakings also are an important source of revenue these days, owing to the expansion of the public sector. For instance, the central government runs railways. Surplus from railway earnings can be normally contributed to the revenue budget of the central budget.

Likewise, profits from the state transport corporation and other public undertakings can be important sources of revenue for the budgets of state governments. Similarly, other commercial undertakings in the public sector such as Hindustan Machine Tools, Bokaro Steel Plant, State Trading Corporation etc. can make profits to support the central budget.

Earnings from state enterprises depend upon the prices charged by them for their goods and services and the surplus derived therefrom. Thus, the pricing policy of state undertakings should be self-supporting and reasonably profit-oriented. Again, prices are charged with an element of quid pro quo i.e., directly in proportion to the benefits conferred by the services rendered.

A price is a form of revenue derived by the government by selling goods and services of public enterprises. Thus, price is the revenue obtained from business activity undertaken by the public authorities. Many public enterprises like postal services run on cost-to-cost basis. The prices are charged just to cover the cost of rendering such services.

However, in certain cases, when the state has an absolute monopoly, prices having a high profit element are charged. Such monopoly profits of a state enterprise are in the nature of a tax. The difference between price and fee is this: the former usually can never be less than the cost of production or service, while the latter may not necessarily cover the cost of service.

Gifts and Grants:

These form generally a very small part of public revenue. Quite often, patriotic people or institutions may make gifts to the state. These are purely voluntary contributions. Gifts have some significance, especially during war time or an emergency.

In modern times, however, grants from one government to another have a greater importance. Local governments receive grants from state governments and state governments from the centre. The central government gives grants- in-aid to state governments in order to enable them to carry out their functions. When grants are made by one country’s government to another country’s government it is called foreign aid. Usually poor countries receive such aid from developed countries, which may be in the form of military aid, economic aid, food aid, technological aid, and so on.

Classification of Public Revenue:

Different economists have classified the sources of public revenue differently. A scientific classification enables us to know in what respects these various sources resemble one another and in what ways they differ. Of the various classifications of public revenue available in economic literature, we shall review a few important ones.

Seligman’s Classification:

Seligman classifies public revenue into three groups:

(i) Gratitious revenue

(ii) Contractual revenue

(iii) Compulsory revenue

Gratitious revenue comprises all revenues such as gifts, donations and grants received by the public authorities free of cost. They are entirely of a voluntary nature. Further, these are very insignificant in the total revenue.

Contractual revenue includes all those types of revenue which arise from the contractual relations between the public authority and the people. Fees and prices fall into this category. A direct quid pro quo is usually present in these types of revenue.

Compulsory revenue includes income derived by the state from administration, justice, and taxation. Taxes, fines and special assessments are regarded as compulsory revenue. These revenues express an element of state sovereignty. It is the most significant type of public revenue in modern times.

Dalton’s Classifications:

Dalton provides a very systematic, comprehensive and instructive classification of public revenue. In this opinion, there are two main sources of public revenue — taxes and prices. Taxes are paid compulsorily whereas prices are paid voluntarily by individuals, who enter into contracts with the public authority. Thus, prices are contractual payments.

Taxes are sub-divided into: (i) Taxes in the ordinary sense; (ii) Tributes and indemnities; (iii) Compulsory loans, and (iv) Pecuniary penalties for offences.

Prices are sub-divided into: (i) Receipts from public property passively held such as rents received from the tenants of public lands; (ii) Receipts from public enterprises charging competition rates; (iii) Fees or payments charged for rendering administration services, such as birth and death registration fees, and (iv) Voluntary public debt.

To these two groups must be added another group to make the classification exhaustive. Under this group, the following items are included: (i) receipts from public monopolies, charging higher prices; (ii) special assessments; (iii) issue of new paper money or deficit financing; and (iv) voluntary gifts.

Taylor’s Classification:

The most logical and scientifically based classification of public revenue is however provided by Taylor. He divides public revenue into four categories:

(i) Grants and gifts

(ii) Administrative revenues

(iii) Commercial revenues

(iv) Taxes

Grants and gifts:

Grants-in-aid are the means by which one government provides financial assistance to another to enable it to perform certain specified functions, for example, education and health grants made to the states by the central government.

Grants- in-aid are the cost payments made by the grantor government and revenue receipts to the grantee, and no obligation of repayment is involved. Gifts are voluntary contributions from individuals or institutions for specific purposes. Grants and gifts are voluntary in nature and there is absence of quid pro quo to the donor.

Administrative Revenues:

Under this group, fees, licenses, fines and special assessments are included. Most of these are voluntary in nature and based upon the direct benefits accruing to the payer. They generally arise as a by-product of the administrative or control function of the government.

Commercial Revenues:

These are the receipts by way of prices paid for government produced goods and services. Under this group, postal charges, tolls, interest on loans of state financial institutions or nationalised banks, tuition fees of public educational institutions are included.

Taxes:

These are compulsory payments made to government without expecting a direct return of benefits. The taxes involve varying degrees of coercive powers.

Canons of Taxation: Meaning, Types and Characteristics

Meaning of Canons of Taxation:

By canons of taxation we simply mean the characteristics or qualities which a good tax system should possess. In fact, canons of taxation are related to the administrative part of a tax. Adam Smith first devised the principles or canons of taxation in 1776.

Even in the 21st century, Smithian canons of taxation are applied by the modern governments while imposing and collecting taxes.

Types of Canons of Taxation:

In this sense, his canons of taxation are, indeed, ‘classic’. His four canons of taxation are:

(i) Canon of equality or equity

(ii) Canon of certainty

(iii) Canon of economy

(iv)  Canon of convenience.

Modern economists have added more in the list of canons of taxation.

These are:

(v) Canon of productivity

(vi) Canon of elasticity

(vii) Canon of simplicity

(viii) Canon of diversity.

Now we explain all these canons of taxation:

i. Canon of Equality:

Canon of equality states that the burden of taxation must be distributed equally or equitably among the taxpayers. However, this sort of equality robs of justice because not all taxpayers have the same ability to pay taxes. Rich people are capable of paying more taxes than poor people. Thus, justice demands that a person having greater ability to pay must pay large taxes.

If everyone is asked to pay taxes according to his ability, then sacrifices of all taxpayers become equal. This is the essence of canon of equality (of sacrifice). To establish equality in sacrifice, taxes are to be imposed in accordance with the principle of ability to pay. In view of this, canon of equality and canon of ability are the two sides of the same coin.

ii. Canon of Certainty:

The tax which an individual has to pay should be certain and not arbitrary. According to A. Smith, the time of payment, the manner of payment, the quantity to be paid, i.e., tax liability, ought all to be clear and plain to the contributor and to everyone. Thus, canon of certainty embraces a lot of things. It must be certain to the taxpayer as well as to the tax-levying authority.

Not only taxpayers should know when, where and how much taxes are to be paid. In other words, the certainty of liability must be known beforehand. Similarly, there must also be certainty of revenue that the government intends to collect over the given time period. Any amount of uncertainty in these respects may invite a lot of trouble.

iii. Canon of Economy:

This canon implies that the cost of collecting a tax should be as minimum as possible. Any tax that involves high administrative cost and unusual delay in assessment and high collection of taxes should be avoided altogether.

According to A. Smith: “Every tax ought to be contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the State.”

iv. Canon of Convenience:

Taxes should be levied and collected in such a manner that it provides the greatest convenience not only to the taxpayer but also to the government.

Thus, it should be painless and trouble-free as far as practicable. “Every tax”, stresses A. Smith: “ought to be levied at time or the manner in which it is most likely to be convenient for the contributor to pay it.” That is why, after the harvest, agricultural income tax is collected. Salaried people are taxed at source at the time of receiving salaries.

These canons of taxation are observed, of course, not always faithfully, by modern governments. Hence these are basic and classic canons of taxation.

We now present other canons of taxation:

i. Canon of Productivity:

According to a well-known classical economist in the field of public finance, Charles F. Bastable, taxes must be productive or cost-effective. This implies that the revenue yield from any tax must be a sizable one. Further, this canon states that only those taxes should be imposed that do not hamper productive effort of the community. A tax is said to be a productive one only when it acts as an incentive to production.

ii. Canon of Elasticity:

Modern econo­mists attach great importance to the canon of elasticity. This canon implies that a tax should be flexible or elastic in yield.

It should be levied in such a way that the rate of taxes can be changed according to exigencies of the situation. Whenever the government needs money, it must be able to extract as much income as possible without generating any harmful consequences through raising tax rates. Income tax satisfies this canon.

iii. Canon of Simplicity:

Every tax must be simple and intelligible to the people so that the taxpayer is able to calculate it without taking the help of tax consultants. A complex as well as a complicated tax is bound to yield undesirable side-effects. It may encourage taxpayers to evade taxes if the tax system is found to be complicated.

A complicated tax system is expensive in the sense that even the most honest educated taxpayers will have to seek advice of the tax consultants. Ultimately, such a tax system has the potentiality of breeding corruption in the society.

iv. Canon of Diversity:

Taxation must be dynamic. This means that a country’s tax structure ought to be dynamic or diverse in nature rather than having a single or two taxes. Diversification in a tax structure will demand involvement of the majority of the sectors of the population.

If a single tax system is introduced, only a particular sector will be asked to pay to the national exchequer leaving a large number of population untouched. Obviously, incidence of such a tax system will be greatest on certain taxpayers. A dynamic or a diversified tax structure will result in the allocation of burden of taxes among the vast population resulting in a low degree of incidence of a tax in the aggregate.

The above canons of taxation are considered to be essential requirements of a good tax policy. Unfortunately, such an ideal tax system is rarely observed in the real world. But a tax authority must go on maintaining relentlessly the above canons of taxation so that a near- ideal tax structure can be built-up.

Characteristics of Canons of Taxation:

A good (may be a near-ideal) tax system has to fulfil the following characteristics:

i. The distribution of tax burden should be equitable such that every person is made to pay his ‘fair share’.

This is known as the ‘fairness’ criterion which focuses on two principles:

Horizontal equity— equals should pay equal taxes; and vertical equity—un-equals should pay unequal taxes. That is to say, rich people should pay more taxes.

ii. But equity must not hamper productive efficiency such that burdens should be provided to correct inefficiencies. This ‘efficiency’ criterion says that it should raise revenue with the least costs to the taxpayers so that tax system can allocate resources without distortion.

iii. The two other criteria are: ‘flexibility’ and ‘transparency’.

A good tax system demands changes in tax rates whenever circumstances change the system. Further, a good tax must be transparent in the sense that taxpayers should know what they are paying for the services they are getting.

iv. A good tax system is expected to facilitate the use of fiscal policy to achieve the goals of

(a) stability

(b) economic growth.

For the attainment of these goals, there must be built-in-flexibility in the tax structure.

From the above discussion, it follows that taxation serves the following purposes:

(i) To raise revenue for the government

(ii) To redistribute income and wealth from the rich to the poor people

(iii) To protect domestic industries from foreign competition

(iv) To promote social welfare.

Important Characteristics of a Good Tax System!

To judge the merits of a tax system, it must be looked at as a whole. For, a tax system to be a good one just cannot have all good taxes but none bad at all. The state cannot raise sufficient revenue and, at the same time, please the tax payers.

As a noted philosopher Edmund Burke once remarked, “It is difficult to tax and to please as it is to love and to be wise.” In a tax system, therefore, different taxes, good and bad may be combined together which tend to correct and balance one another’s effects.

Hence, it should be noted that a good tax system does not mean a perfect tax system which contains only the good taxes based upon the canons of taxation, fetching adequate revenues and causing no hurt to the tax payer.

A good tax system is one which has predominantly good taxes and which fulfills most of the canons of taxation: it must yield sufficient revenue, but cause minimum aggregate sacrifice to the people and minimum obstruction to incentives for production.

A good tax system should possess the following characteristics:

1. It should ensure maximum social advantage. Taxation should be used to finance public services.

2. It should cause minimum aggregate sacrifice. In a good tax system, the allocation of taxes among tax payers is made according to the ability to pay. It falls more heavily on the rich and less on the poor. It should be reasonably progressive so as to minimise the gap of inequality of income and wealth in the community, thereby ensuring their better distribution.

3. In a good tax system, taxes are universally applicable in the sense that persons with same ability to pay are treated in the same way without any discrimination whatsoever. In the Indian tax system, however, this attribute is lacking to some extent. For instance, income tax is not universal in India, as no income tax is levied on agricultural incomes.

4. It should contain a predominance of good taxes satisfying most of the canons of taxation. That is to say, the taxes imposed should be more or less equitable, convenient to pay, economical, certain, productive, flexible and simple as far as possible.

5. The entire structure of the tax system should have built-in flexibility, so that changes are possible according to the changing conditions of a dynamic economy. It should be possible to add or withdraw a tax without destroying the entire system and its balancing effect. A rigid tax structure is very unsatisfactory. Taxation must cope with the changing needs of the modern government. The capacity to adjust itself to the dynamic conditions of an economy is a virtue of a good tax system.

6. A good tax system should be a balanced one.

It means there must exist not one kind of taxes but all types in the right proportion. In other words, it should not contain just progressive, regressive or proportional taxes only, but a healthy combination of all such taxes. Similarly, it should have a balance of direct and indirect taxes.

7. The tax system should be multiple, but then took a great multiplicity is not desirable. Dalton, however, suggests that a good tax system has to be also a reasonably efficient administrative system.

8. Further, in a good tax system there is simplicity, implying the absence of any unnecessary and avoidable complexities.

9. A good tax system should not hamper the development of trade and industry, but instead help the rapid economic development of the country. Taxation is designed to mobilise the surplus resources in the economy and not deprive the private sector of its resources.

Above all, the most fundamental characteristic of a good tax system is the appreciation of the rights and problems of the tax payer. A good tax system must contain the majority of such taxes which produce good effects on production and equitable distribution of national income and wealth. To achieve the socialistic goals of public policy a good tax system plays a very important role.

It should effectively balance the weight and burden of taxation. The weight refers to absolute sacrifice, in terms of purchasing power of real income surrendered by the tax-payer. The burden implies the relative capacity of the tax-payer to bear the tax.

Thus, the tax system should contain taxes which are strictly in relation to the tax payer’s ability to pay. In Dalton’s opinion, in a good tax system, there should be a double illusion that rich should pay more than what they think they should, so that the rich will be contented and the poor become virtuous; in this way, the incentive to work and save will be sustained.

Various factors have to be considered in determining the tax system of a country. The tax system of a country develops according to the tax ideals of the government and the goals of public policy, which the system has to incorporate in its structure. The practical shape of the tax system of a country depends on its historical background.

As such, the tax system of one country differs from that of another, depending on the institutional and historical differences. Nevertheless, as a guiding policy, a good tax system in any country with any background must seek the maxim of least aggregate sacrifice in its taxation policy.

In a less developed country, the tax system should be designed for the mobilisation of economic surpluses for economic development. Taxes should be such that they help in raising the incremental savings ratio. Taxes should work as a measure to prevent the flow of funds into undesired channels of production.

In the developing country, taxes have to serve as a means of curbing consumption and tapping the resources for development. The tax policy in an underdeveloped country should aim at stepping up capital formation and mobilising economic surpluses through the diversion of resources from private consumption to public investment.

Though a tax system may basically be designed to reduce inequalities of income and wealth, especially in a poor country, it should not conflict with the object of augmenting production and providing incentives to work hard and save more.

Thus, the test of a good tax system is its ability to inspire that confidence in the fiscal basis of the government which sustains public morale and promotes productive efforts, individual zeal and economic progress.

Incidence of Taxation

Taxes are not always borne by the people who pay them in the first instance.  They are often shifted to other people.  Tax incidence means the final placing of a tax.  Incidence is on the person who ultimately bears the money burden of tax.  According to the modern theory, incidence means the changes brought about in income distribution by changes in the budgetary policy.

Impact and Incidence: The impact of a tax is on the person who pays it in the first instance and the incidence is on the one who finally bears it.  Therefore, the incidence is on the final consumers.

Incidence and Effects: The effect of a tax refers incidental results of the tax.  There are several consequences of imposition of tax, for example, decreased demand.

Money Burden and the Real Burden: The money burden of a tax is represented by the total amount of money received by the treasury.  For example, the consumer has to spend Rs. 50 more on sugar monthly, it is the money burden that he has to bear.  But if he has to reduce his consumption of sugar it means there is a reduction in economic welfare.  This inconvenience, pinching, sacrifice or in short the loss of economic welfare is the real burden of tax.

Theories of Tax Shifting and Incidence

1. Earlier Theories: The earlier theories may be classified into:

(a)   Concentration or Surplus theory: According to concentration theory, each tax tends to concentrate on a particular class of people who happen to enjoy surplus from their products.

(b)   Diversion or Diffusion theory: The diffusion theory states that the tax eventually got diffused in the entire society.  That is, the final placing of tax is not one but multiple.  The process of diffusion took place through shifting or through process of exchange.

2. Modern Theory: According to modern theory, the concentration and diffusion theories are partially true.  Actually there are both concentration and diffusion of taxes according to the conditions present. The modern theory seeks to analyse the conditions which bring about concentration or diffusion.

Factors determining Tax Incidence

(a)   Elasticity: While considering incidence we consider both elasticity of demand and elasticity of supply.  If the demand for the commodity taxed is elastic, the tax will tend to be shifted to the producer but in case of inelastic demand, it will be largely borne by the consumer.  In case of elastic supply, the burden will tend to be on the purchaser and in the case of inelastic supply on the producer.

(b)   Price: Since shifting of the tax burden can only take place through a change in price, price is a very important factor.  If the tax leaves the price unchanged, the tax does not shift.

(c)    Time: In short run, the producer cannot make any adjustment in plant and equipment.  If, therefore, demand falls on account of price rise resulting from the tax, he may not be able to reduce supply and may have to bear the tax to some extent.  In the long run, however, full adjustment can be made and tax shifted to the consumer.

(d)   Cost: Tax raises the price; rise in price reduces demand and reduced demand results in the reduction of output.  A change in the scale of production affects cost and the effect will vary according as the industry is decreasing, increasing or constant costs industry.  For instance, if the industry is subject to decreasing cost, a reduction in the scale of production will raise the cost and hence price, shifting the burden of the tax to the consumer.

(e)   Nature of tax: The incidence of taxation will definitely depend on the nature of tax.  For example, an indirect tax’s burden is fall on the consumer.

(f)     Market form: Another factor determining the incidence of taxation is the market form.  Under perfect competition, no single producer or single purchaser can affect the price; hence shifting of tax in either direction is out of the question.  But under monopoly, a producer is in a position to influence price and hence shift the tax.

Distinction between Direct and Indirect Taxes

A direct tax is not intended to be shifted, whereas an indirect tax is so intended.

Taxes on commodities are generally called indirect taxes as they completely or partially shifted consumers. But it should be remembered that all the commodity taxes are not indirect taxes.  A tax is said to be indirect if its burden is shifted finally to the consumer.

Direct tax is the tax in which the commodity is taxed by the government, yet its price remains unaffected or changed.  In this case the tax

is not shifted to consumer and the tax will be called direct tax.  If the tax is shifted, the tax is indirect, otherwise indirect.

Merits and Demerits of Direct and Indirect Taxes

Merits of Direct Tax:

1. Equitable, i.e., the principle of progression is applied
2. Economical, i.e., the cost of collection is small
3. Certain, i.e., the direct tax can be calculated with a fair degree of precision
4. High degree of elasticity, i.e., the direct tax can be raised much easily
5. Civic consciousness, direct tax creates civic consciousness among tax-payers
6. Reduction of inequalities, i.e., the objective of direct tax is to reduce economic inequalities by taxing higher income earners at progressive tax rates.

Demerits of Direct Tax:

1. Inconvenient: for the tax payer to pay and file the income tax return
2. Unpopular tax system
3. Tax evasion is common
4. Unarbitrary tax rates

Merits of Indirect Tax:

1. Convenient: for the tax payer to pay and it requires no filing of returns
2. No tax evasion
3. Unified tax rate
4. Beneficial social effects (in case of harmful drugs and intoxicants)
5. Capital formation
6. Re-allocation of resources
7. Wide coverage

Demerits of Indirect Tax:

1. Uncertain
2. Regressive
3. No civic consciousness
4. Inflationary
5. Loss of economic welfare

Incidence of Some Taxes

Taxes on Personal Income:

1. Income tax, super tax and excess profit tax are all direct taxes and generally cannot be shifted.

2. However, the business is in a strong position and can shift a part of his tax burden to his customers.  But this situation is rarely present and the income tax payer must bear the burden of tax.

3. If the income tax is extremely heavy, it may discourage saving and investment.  However, it will mainly depend on whether the tax falls on average income or marginal income, the effects would be adverse. If the increase in tax is fall on marginal income, it will mean a positive discouragement to the earning of that income.

Corporate Tax:

1. Corporate tax discourages investment, level of national income and employment.

2. A corporation tax, by reducing the earnings of the existing firms, discourages the entry of new firms into the industry which may result in a monopoly or a semi-monopoly for the existing firms with all the attendant evils.

3. A part of corporate tax may be shifted to the buyers through a price rise.

Tax on Profits:

1. Some economists are not of the view that the tax on profit should be shifted to buyers.  It should be borne by the seller who pays it.

2. The second view does not subscribe with the above approach.  It is argued that normal profit is a part of the cost and when the entrepreneur is able to influence the price, the tax is generally shifted to the consumer.

3. However, the tax on profit in the form of a licence duty will be borne by the producer.

Wealth Tax:

1. Wealth tax is imposed on value of a person’s stock of wealth

2. By enabling the government not to raise the income tax rates too high, the wealth tax encourages investment in modern industries

3. Another obvious effect of wealth tax is the reduction of economic inequalities by reducing the size of inherited wealth

Property Tax:

1. The wealth tax is imposed on the net worth of the individual.  Whereas, the property tax is levied on the gross amount of assets’ value

There is no shifting of tax and the incidence is on the person on whom the tax is levied.  However, the tax on productive property

2. may be shifted to consumers.

Land Taxation:

1. The value of land depends on two sets of factors:

(a)    Natural factors like the fertility of the soil, the situation of the land, some other natural conditions, and

(b)   Investment of capital in drainage schemes, anti-erosion measures, irrigation facilities and other measures necessary to increase and sustain productivity

2. The tax on the first set is a tax on economic rent and has a tendency to fall on the owners

3. But when the owner can vary his investment when the tax increases, he can shift the tax burden to the consumer.

Tax on Buildings:

1. If the tax is imposed on the owner, he will try to raise the house rent and thus shift the tax to the occupier or tenant.  But he cannot do this during the currency of the lease.

2. A heavy tax will check building activity and the remuneration of the builder and of other people engaged in the trade may fall

3. The tax may fall partly on the owner, partly on the builder and partly on the occupier

Death Duty:

1. Death duty may take two forms, i.e., Estate Duty and Succession Duty

2. The Estate Duty is levied on the total value of the estate (i.e., movable and immovable property) left by the deceased irrespective of the relationship of the successor

3. The succession duty varies with the relationship of the beneficiary to the deceased.  It takes into consideration individual share of the successor and not the total value as in the estate duty.

1. Tax on Monopoly: The monopoly tax may be:

(a)    Independent of the output of the monopolised product, or

(b)   It may vary with the output, i.e., increase or decrease with the output

2. When the tax is independent of the quantity produced, it may either be lump sum tax on the monopolist or a percentage of the monopoly net revenue (profits).  In both cases it will be borne by the monopolist and he cannot shift the same to the consumer, because the monopolist is already on a price with maximum beyond which his profit will decline

3. In the second case, the price of the commodity or incidence of taxation will depend on the elasticities of supply and demand, and the influence of laws of returns.

4. Taxing of the commodity, therefore raises the price which will tend to reduce the demand

5. If, however, the demand is inelastic, it cannot be appreciably reduced and the tax will be borne by the consumer.

6. If the demand is elastic, the consumers may buy less when the tax has raised the price.  Instead of facing a decline in demand the monopolist may reduce the price and decide to bear the tax himself.

Commodity Tax:

1. Taxes on commodities may take several forms:

(a)    Tax on manufacture or production of a commodity called excise duties,

(b)   Tax on sale of a particular commodity known as sales tax, and

(c)    Import or export of commodities known as custom duties.

2. The commodity tax is tended to be shifted to the consumer and from consumer to the producer

3. Tax on production tends to raise the prise and will therefore be normally borne by the consumer

4. But the consumption tax is likely to check consumption and tends to be shifted backward to the producer.

5. Therefore, the tax on commodity will be partly borne by the producer and partly borne by the consumer

6. The portions of commodity tax to be borne by the producer and consumer depends on the degree of elasticity of demand and supply:

Elasticity	Incidence
Elastic demand	More tax burden on the supplier / producer
Inelastic demand	More tax burden on the buyer / consumer
Elastic supply	More tax burden on the buyer / consumer
Inelastic supply	More tax burden on the supplier / producer

7. As a rule, the consumer bears a smaller part of the tax when the demand is more elastic than the supply

8. This may happen that the price may not rise at all.  This is because the consumers have been able to discover an untaxed supply of the commodity or substitute.  In this case, the tax burden will fall on the producer.

 

DD and SS intersect at point P and MP is the price determined.  Now suppose a sales tax per unit is levied.  As a result the supply curve of the commodity will rise upward equal to the tax per unit.  The new supply curve will be S’S’.  The distance between the two supply curves represents the tax per unit of the commodity.  S’S’ cuts the demand curve DD at Q and, therefore, now TQ is the price determined which is higher than the old price PM by RQ.  Hence RQ is the burden of tax borne by the consumer even though the tax per unit is LQ.  Therefore, RL (LQ – QR) is the burden of the tax borne by the seller or he has RL price less than before (PM being the first price).

10. Therefore the commodity tax is distributed between the buyers and sellers according to the ratio of elasticities of demand and supply:

RL        =         Burden of the tax on the seller (producer)  .

RQ                   Burden of the tax on the buyer (consumer)

Ed        =         Proportionate decrease in quantity demanded

                        Proportionate increase in price

 ---------------------------------- (i)

Es        =         Proportionate decrease in quantity supplied

                        Proportionate decrease in price

 ------------------------------------- (ii)

=         Elasticity of Demand (Ed)

            Elasticity of Supply (Es)

11. In the above equation, RL is the burden of the tax on the seller and RQ is the burden of tax on the buyers.  Hence:

RL        =         Burden of tax on the seller

RQ       =         Burden of tax on the buyer            =         Elasticity of demand (Ed)

                      Elasticity of supply (Es)

Sales Tax:

1. The sales tax is levied on the turnover, profits or no profits.  It covers a wide variety of commodities.

2. The sales tax may make heavy inroads into profits which may lead to retrenchment in the staff and management, restrict enterprise and employment and hamper utilisation of resources.

3. Thus, its incidence may fall upon employees, management and landlords.

Import Duties and Export Duties:

1. Import Duties are generally borne by the home consumer

2. If the demand for the imported product is elastic and the supply is inelastic and the foreign producer has no alternative market, then in such a case the burden of tax may be shifted to foreign seller.  This situation is rarely present.

3. Export duty is borne by the exporter.  The price in the world market is fixed and no individual exporter is in a position to influence the world price.

4. There are certain exceptional situations in which the purchaser may bear the burden of export duty. For example, the supplier or the producer has the monopoly of the supply of a commodity.

Effects of Taxation on Production, Consumption and Distribution

Effects on Production:

1. Production is affected by taxes in two ways:

(a)    By affecting the ability to work, save and invest

(b)   By affecting the desire to work, save and invest

2. A tax on necessaries of life, will obviously affect the workers’ productivity and hence reduce production.  A heavy tax on income tends to reduce the ability to save and invest on part of individuals.  A decrease in investment is bound to affect adversely the level of output in the country

3. Normally taxation induces people to work harder, earn more, save more and invest more to increase their income and enjoy the same income after tax

4. Some taxes has no adverse effects, for e.g., import duties, tax on monopolists, etc.

5. High marginal rates of income tax are likely to affect adversely the tax payers’ desire to work, save and invest

6. The reaction varies from individual to individual.  It depends on the individual’s elasticity of demand for income.  When it is fairly elastic, the tax will lessen his desire to work and save

7. Entrepreneurs may avoid the production of goods which are taxed.  There is likely to be a diversion of resources from some sectors of economy to others

Effects on Income Distribution:

1. The effects of taxes on income distribution depends on the type of taxes and rates of taxes

2. Taxation of goods of mass consumption is regressive and redistributes incomes in favour of rich.

3. But if such commodities are exempted and luxuries are taxed, and the taxation is made progressive, then the income will be redistributed in favour of poor.

Effects on Consumption:

1. By imposing tax on a consumable good which is injurious to health, its consumption can be checked.

2. Similarly the tax on luxury goods can decrease their consumption and resources diverted to the production of mass consumption