Methods of Taxation

Tax: It is a compulsory financial charge imposed on the citizen by government organization to fund public expenditure.

Types of Taxes

  • Direct Tax: Direct tax is a tax where the incidence and impact fall on the same entity. For example, Income Tax, House Tax etc.
  • Indirect Tax: In Indirect Tax, the incidence and impact falls on the different entity. For example, GST, Service Tax etc.

Incidence of Tax: The point where tax looks as being imposed is known as incidence of tax.

Impact of Tax: The point where tax makes its effect felt is known as Impact of tax.

Methods of Taxation

A. Progressive Taxation: A progressive tax is one which charges different tax rates on different incomes. Under this system, the higher the income the higher the rate of taxes. In India, its best manifestation is Income Tax.

Advantages

  • It is equitable because individuals are taxed based on their earnings. Rich will pay more and poor will pay less.
  • Progressive taxes are based on the ability to pay principle; it tends to reduce disparities in the distribution of income and wealth.
  • It is elastic as a rise in income during prosperity is automatically taxed at a higher rate and a fall in income during recession is taxed at a lower rate.

Disadvantages

  • It is against the benefit principle i.e. those who get more benefit from the government must pay more tax.
  • Progressive taxation dampens incentive to work and save and, thus, it lowers capital formation.
  • There is a greater scope for tax evasion in the case of progressive tax. It is the higher rate of taxes that encourages taxpayers to evade their income by making false declarations of their incomes.

B. Regressive Taxation: It is just opposite to progressive tax system. Here, Tax rate decline with rise in incomes. It is not usually used as it punishes the less productive section of the Society. In pre-reform period India, regressive taxation method in excise duty was used to promote domestic production in some industries, whereby more production would give more rebate.

Direct Tax v/s Indirect Tax

Advantages

Disadvantages

Direct Taxation

1. Relatively easy to comprehend.

1. Discourages hard work and enterprise.

2. Equitable, as people on same income net pays same tax

2. Increases the time and resources spent on tax avoidance.

3. Gives the government direct control over people’s spending.

3. The tax on Company profit tends to reduce investment.

Indirect Taxation

1.Does not discourage efforts of enterprises.

1.They are regressive as irrespective of income, both rich and poor pay the same tax amount.

2. Can be used for specific social policy or cause like discouraging fat food items.

2. Can be difficult and costly to collect.

3. People have a degree of choice on whether to pay the tax or not by choosing to not buy the specific item or avail service.

3. It is usually volatile and unpredictable.

Advantages

  • It incentives productive section of the society. Thereby promoting more savings and capital formation.

Disadvantages

  • It punishes the less productive section of the Society. It is not used in modern-day democracies as it is not morally justifiable.

C. Proportional Taxation: Here the tax rate is fixed and that same rate is levied on every section of the society irrespective of their incomes or wealth. It is also morally wrong, as the rich and poor pay the same.

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