Tax System in INDIA

Tax System in India, Budget & Fiscal Deficits in

India

General Economics

General Economics: Tax System in India,Budget & Fiscal Deficits in India

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TAX • Important Source of Revenue of the

Government. • Compulsory Contribution from a

Person to the Expenses incurred by the State in common Interest of all without reference to Specific benefits conferred on any Individual.


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Tax

Direct Taxes e.g. Income Tax, Wealth

Tax

Indirect Taxes e.g. Custom Duty, Excise

Duty, etc.


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Tax • Direct Taxes are the Taxes which are not

shifted i.e., the Incidence of which falls on Persons who pay them to the Government. For Example, Income Tax and Wealth Tax.

• Indirect Taxes are the Taxes in which the burden of paying Tax is shifted through a Change in Price. For Example, Custom Duty, Excise Duty, etc.


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Merits of Direct Taxes • Imposed according to the Ability of the

Person to Pay. (Termed as Progressive Taxation)

• Revenue is Income Elastic as Progressive Character Revenue increases faster than the increase in Income.

• Create better Civic Consciousness.

• Serves the purpose of Transference of Income from the Rich to the Poor.


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Demerits of Direct Taxes • The Ability to Pay is difficult to determine; only

a rough idea can be formed. • Because of Undeclared Sources of Income or

Evasion, the actual payment may not be strictly according to Pay.

• Necessitate Proper Maintenance of Accounts which some of the Tax Payers may not be able to do.

• Cumbersome Assessment Procedure requiring Expert Assistance.


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Merits of Indirect Taxes • Convenience in Assessment & relative

Difficulty in Evasion.

• Inclusion of Tax in the Price.

• May not be Regressive if levied on ad valorem basis.

• Difficult to Evade.

• Taxes on drinks, narcotics, & tobacco, serve a Social purpose by discouraging their consumption.


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Demerits of Indirect Taxes • Regressive Character

• Do not create Social Consciousness as Payment of Tax is not felt by the Payer.

• Government is not certain about the Proceeds of these Taxes.

• Burden of Indirect Taxes can be shifted Forward or Backward as such Consumers have to bear the ultimate burden of Tax.

• Can be Evaded by methods as Smuggling, Falsification of Accounts, etc.


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Indian Taxation System • Indian Tax System is characterized

by: –A High Dependence on Indirect Taxes.

–Low Average Effective Tax Rates & Tax Productivity.

–High Marginal Effective Tax Rates & large Tax-induced Distortions on Investments & Financing Decisions.


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Indian Taxation System

Tax

Direct Tax

Income Tax

Wealth Tax

Gift Tax

Indirect Tax

Custom Duties

Excise Duties

Sales Tax

Service Tax


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Income Tax • Income Tax is a Tax on the Income

of an Individual or an Entity.

• Introduced in India in the year 1860.

• Discontinued in the year 1873.

• Reintroduced in the year 1886.


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Income Tax • Levied on the Income of

Individuals, Hindu Undivided Family (HUF), Unregistered Firms & other Association of People (AOP).

Personal Income Tax

• Levied on the Income of Registered Companies & Corporations.

Corporate Income

Tax


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Personal Income Tax • Incomes from all the Sources are added.

• Certain Rebates, Deductions, Expenditure etc., on account of Life Insurance, Medical Insurance, Savings in PPF, etc. are allowed.

• Whole Income is divided into Different Slabs and Taxed on the basis of Slab into which it Falls.

• Progressive Income Taxation i.e., as Income Increases, the Rate of Tax also Increases.


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Personal Income Tax Income Tax Slab (in Rs.) Tax

0 to 1,50,000 No Tax

1,50,001 to 3,00,000 10%

3,00,001 to 5,00,000 20%

Above 5,00,000 30%

• Tax Slabs are different for Men, Women & Senior Citizen.

• For Women there is no Tax for Income below Rs.1.80 Lakh.

• Senior Citizens need not pay Tax for Income below Rs 2.25 lakh.


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Corporate Income Tax • Rationale for the Corporation Tax is that a

Joint Stock Company has a Separate Entity & thus should be Taxed separately.

• Until 1960-61, Corporations were Taxed in a Partial sense.

• A Corporation was required to Pay Income Tax on behalf of Shareholders on Dividends paid to them, & each Shareholder got a Credit to this effect.


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Corporate Income Tax • Since 1960-61, Corporations are being

treated as Independent Entities & Shareholders are not given any Credit.

• Corporations are Taxed at a Flat Rate, but certain Rebates & Exemptions are also provided.

• Tax Rates are different for Indian Companies & Foreign Companies.


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Taxes on Wealth - Estate Duty • Taxes which are levied on Wealth & Capital

are mainly Estate Duty, Annual Tax on Wealth & Gift Tax.

• Estate Duty was First Introduced in the year 1953.

• Estate Duty is levied on the Total Property passing to the heirs on the Death of a Person.

• Estate Duty was abolished in the year 1985.


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Annual Tax on Wealth • Annual Tax on Wealth was introduced in 1957. • Annual Tax was levied on the Wealth such as

Land, Bonds, Shares, etc. of the People. • Certain Types of Properties such as Agricultural

Land & funds in Provident Account were exempt.

• Wealth Tax was abolished in 1993 on all assets except certain specified assets such as Resident Houses, Farm Houses, Urban Land, Jewellery, Bullion, Motor Car, etc.


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Gift Tax • Gift Tax was introduced in 1958.

• Gift Tax was leviable on all Donations to Recognized Charitable Institutions, Gifts to Women Dependents & Gifts to Wife.

• Gift Tax was abolished in 1998.


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Custom Duties • Custom Duties are levied on Exports & Imports.

• From the point of View of Revenue, Importance of Export Duty is Limited.

• Import Duties are levied on the basis of ad valorem.

• In Pre-Tax Reform Period, India had become a country with one of the highest levels of Custom Tariffs in the World.

• Since 1991, the Custom Duty Structure was pruned.

• Maximum Rate of Custom Duty is 10% now.


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Excise Duties • An Excise Duty is levied on Production & has

absolutely on Connection with its Actual Sales.

• These are levied by the Central Government in a number of forms.

• Taxation on Inputs, such as Raw Materials, Components has a number of Limitations.

• To remove these, Government introduced Modified Value Added Tax (MODVAT) in 1986-87.


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Excise Duties • Value Added is the difference between a

Firm’s Revenues & its Payments to other Firms i.e., it is the Value Difference between Sales & Purchased Items.

• Under MODVAT, a Manufacturer can take Credit of Excise Duty paid on Raw Materials and Components used by him in his Manufacture.


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Excise Duties • Since it amounts to Excise Duty only on

Additions in Value by each Manufacturer at each stage, it is called Value-Added-Tax (VAT).

• MODVAT differs from VAT.

• VAT covers the entire value of Inputs where as under MODVAT Duty paid Inputs only.


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Excise Duties • To Overcome the Limitations of MODVAT,

the Budget 2000-01 introduced the Central Value-Added Tax [CENVAT].

• CENVAT is applicable on the Excisable Goods made in India.

• Basic Excise Duty is 16% & some Special Excise Duties which are levied in addition to CENVAT.


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Excise Duties • The basic Excise paid on Excisable Goods

can be deducted from the Excise collected on the Output so that only Tax on Value Added is paid.

• CENVAT reduces Cascading effect of Input Taxation.

• System has certain shortcomings such as Cumbersome Procedures, Inadequate Coverage of CENVAT, scope of Tax-Evasion.


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Sales Tax • Sales Tax is a Tax on Business Transactions. • In India, many Commodities are not covered by

Sales Tax. • Sales Tax is more in case of Luxury Items & Less or

almost nil in case of Necessities. • Registered Trading Concerns are required to pay the

Sales Tax to the Government who shift the Burden to the Customers.

• Problems: Cascading Effect, Lack of Transparency, Narrow Base, different Procedures followed by different States, etc.


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Value Added Tax (VAT) • VAT is a multistage Sales Tax with credit for

Taxes paid on Business purchases.

• VAT is non-cascading.

• Tax is levied on Value Addition at each stage of Transaction in the Production/Distribution Chain.

• VAT was introduced in 1999 & was Implemented in April, 2005 in some States.


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Value Added Tax (VAT) Benefits of VAT:

• A set off will be given for Input Tax as well as Tax paid on Previous Purchases.

• Other Taxes such as Turnover Tax, Surcharge, etc. will be abolished.

• Overall Tax Burden will be Rationalized.

• Price will in general Fall.


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Service Tax • Service Tax is a form of Indirect Tax

imposed on Specified Services called Taxable Services.

• It was introduced in the year 1994-95.

• Service Tax Network has expanded to cover many Services over the Years.


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Features of Tax Structure in India

• Tax Revenues (on account of the Centre, State & Union Territories) form about 20% of the Total National Income of India (2005-06).

• Among the Third World Countries, India is one of the Highest Taxed Countries. Reasons Being: – Spectacular Rise in Expenditure on Defense &

Other Non-Developmental activities.

– Increase in Expenditure on Development Planning.

– Violation of the Canon of Economy.


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Features of Tax Structure in India

• Tax Revenue collected by the Central & State Governments has increased from Rs.460 crore in 1951-51 to Rs.6,89,000 crore in 2006-07.

• The Ratio of Direct to Indirect Taxes has declined from 40:60 in 1950-51 to 20:80 in 1990-91.

• Share of Direct Taxes in the Gross Tax Revenue was 35% in 2005-06 & Indirect Taxes was 65%.


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Features of Tax Structure in India • Among the Working Population of 40%, only

2.5% is liable to pay Income Tax in India. As such, Indian Tax Structure relies on a very Narrow Population Base.

• Total Tax Revenue is highly Insufficient to meet the Expenditure requirements of the Economy.

• Direct Taxes are Progressive, Indirect Taxes are Differential in Nature.

• Agriculture Income is wholly exempt from the Income-Tax despite the fact that a new class of Rich Farmers has emerged in the Country which can easily pay Taxes.


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Evaluation of Indian Tax System • The system of Taxation does not conform to

Canon of Equity as – The Indirect Taxes form a big percentage of Total Tax

Receipts which generally fall heavily on the Poorer Section of Population.

– People with Higher Incomes are Evading Tax with the consequent Increase in the Tax Burden on people with Lower Income.

• Inflexible Taxation System as it largely depends on Urban Incomes & leaves out Agricultural Income.


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Evaluation of Indian Tax System

• Service Sector which accounts for more than 50% of GDP contributes just 7.8% towards Tax Revenues & 0.8% towards GDP.

• The Booth Lingam Committee & Chelliah Committee recommended Simplification & Rationalization of Tax System in India.

• The Cost of Tax Collection has increased from Rs.543 crores in 1990-91 to more than Rs.3,663 crores in 2006-07.


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Evaluation of Indian Tax System

• Evasion & Tax Avoidance are reported to be very High.

• Black Money is generated at the Rate of 50% of the country’s GDP.

• Indian Tax System is also accused of – Discouraging Employment.

– Distorting Prices.

– Adversely Affecting Savings.


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Budget Deficit • Budget is prepared by the Government of

India showing the Expected Receipts & Expenditures in the coming Financial Year.

• Receipts of the Government come from Taxes (both Direct and Indirect), Profits form various Financial Institutions, Government Commercial Undertakings, Interest from Loans given to Other Governments, Local Bodies, etc.


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Budget Deficit • The Expenditure of the Government are on

Developmental Projects such as Construction of Roads, Railways, Production of Energy & Non-Developmental Expenditure on a Large Number of Activities such as Defense, Subsidies, Police, Law & Order, etc.

• If Receipts are equal to Expenditure, the Budget is said to be Balanced. If Receipts are higher than the Expenditure, the Budget is said to be Surplus & if Receipts are lower than the Expenditure, the Budget is said to be Deficit.


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Budget Deficit • Budget Deficit is thus the

Difference between Total Receipts and Total Expenditure (Revenue plus Capital).

• If Borrowings and other Liabilities are added to the Budget Deficit, we get Fiscal Deficit.


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Fiscal Deficit • Fiscal Deficit, measures that part of

Government which is Financed by Borrowings.

• Fiscal Deficit in India is a more Comprehensive Measure of the Imbalances.

• It is the measures of Excess Expenditure over the Government’s own Income.


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Calculation of Budget & Fiscal Deficit 1990-91 Rs.

(Crore) 2004-05 Rs.

(Crore)

1. Revenue Receipts 54,950 3,51,200

2. Capital Receipts of which a) Loan Recoveries + Other Receipts b) Borrowings & Other Liabilities

39,010 5,710

33,300

1,63,144 12,000

1,51,144

3. Total Receipts (1+2) 93,960 5,14,344

4. Revenue Expenditure 73,510 1,15,982

5. Capital Expenditure 31,800 67,832

6. Total Expenditure (4+5) 1,05,310 5,14,344

7. Budgetary Deficit (3-6) 11,350 Nil

8. Fiscal Deficit [1 + 2(a) – 6 = 7 + 2(b)]

44,650 1,51,144


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Trends in India’s Budget & Fiscal Deficit

• Budget Deficit does not show the True picture of Government Liabilities & hence a True Picture of the Financial Health of the Economy, the Practice of showing Budget Deficit in the Budget was given up in 1997.

• Government now taps 91 days Treasury Bills from the Market and shows it as part of the Capital Receipts under the heading ‘Borrowing and other Liabilities”.

• Budget now show Fiscal Deficits to show the Overall Shortfalls in the Public Revenues.


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• Fiscal Deficit focuses on/measures the Total Resource Gap & as such fully reflects the impact of the Fiscal Operations of the Indebtedness of Government.

• It is the measure of Excess Expenditure over the Government’s Own Income.

• Over the Years, Fiscal Deficits have grown rapidly & have become the Cause of Concern.


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• In the fifteen year period of 1975-90, the Fiscal Deficit of the Central Government rose alarmingly from 4.1% of GDP to 7.9% of GDP.

• Non plan Revenue Expenditure particularly on Defense, Interest Payments, Food & Fertilizer Subsidies rose sharply during 1980s.

• Reforms were taken up from the year 1991 to restore the Fiscal Discipline.


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• As such Fiscal Deficit was reduced to 4.1% in 1996-97.

• Rose again in 2000-01 & stood at 5.6%.

• Fiscal Responsibility & Budget Management (FRBM) Bill was introduced in 2000 & FRBM Act was passed in 2003.

• As a result, the Fiscal Deficit has been reduced & stands at 3.6% (2006-07).


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Q 1 Which of the following is not the Merit of

Direct Taxes. Find it.

a) They are imposed according to the Ability of the Person to Pay.

b) These Taxes create Civil Consciousness.

c) The Revenue is Income Elastic.

d) They do not require maintenance of Accounts.


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Q 2 Find the Tax which is Direct Tax

among the following:

a) Personal Income Tax.

b)Excise Duty.

c) Sales Tax.

d)Service tax.


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Q 3 Indian Taxation System is characterized by:

a) A High Dependence on Indirect Taxes.

b) Low Average Effective Tax Rates & Tax Productivity.

c) High Marginal Effective Tax Rates & large Tax-induced Distortions on Investments & Financing Decisions.

d) All of the Above.


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Q 4 Among the following types of

Taxes, find the one which is Indirect?

a) Gift Tax

b) Corporate Income Tax

c) VAT

d) Wealth Tax


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Q 5 Which of the following statements is

Correct? a) Income Tax was abolished in India in

1991.

b) Gift Tax was abolished in India in 1998.

c) All the States have adopted VAT System of Indirect Taxation.

d) Estate Duty was abolished in 1995.


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Q 6 Which of the following statements is

Correct? a) Excise Duty is levied on Sales Volume.

b) Custom Duties have been drastically cut down since 1991.

c) VAT has been adopted by all the States in India.

d) Agriculture contributes the Maximum to the Direct Tax Revenues in India.


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Q 7 When the Government tries to meet the

Gap of Public Expenditure & Public Revenue through Borrowing from the Banking System, it is called ___________

a) Deficit Financing.

b) Debt Financing.

c) Credit Financing.

d) None of the Above.


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Q 8 _________ is the difference

between Total Receipts & Total Expenditure.

a) Fiscal Deficit.

b) Budget Deficit.

c) Revenue Deficit.

d) Capital Deficit.


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Q 9 If Borrowing & Other Liabilities are

added to the Budget Deficit we get

a) Revenue Deficit.

b) Capital Deficit.

c) Primary Deficit.

d) Fiscal Deficit.


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Q 10 FRBM Act stands for a) Fiscal Revenue & Budget Management.

b) Foreign Revenue & Business Management.

c) Fiscal Responsibility & Budget Management.

d) Foreign Responsibility & Budget Management.


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Q 11 On which of the Following, Income Tax

is not imposed in India? a) Income from Salary.

b) Income from House Property.

c) Interest on Fixed Deposits.



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Q 12 PPF stands for: a) Private Provident Fund.

b)Personal Provident Fund.

c) Public Provident Fund.

d)Public Presidency Fund.


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Q 13 Income Tax was introduced first time

in India in 1860 & then discontinued in1873. It was re-introduced in the year:

a) 1885

b) 1886

c) 1887

d) 1890


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Q 14 Which of the following is not

the example of Direct Tax? a) VAT

b)Wealth Tax

c) Corporate Tax

d)Income Tax


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Q 15 Excise Duty is imposed on a) Goods Imported in India.

b)Goods Sold in India.

c) Goods Manufactured in India.

d)Goods Exported from India.


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Q 16 Wealth Tax was abolished in: a) 1985

b)1998

c) 2005

d)False it is still continuing


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Q 17 CENVAT was introduced in the

year: a) 2001-02

b)2000-01

c) 2002-03

d)2004-05


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Q 18 The Basic Rate of Excise Duty is: a) 6%

b)16%

c) 24%

d)None of the Above.


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Q 19 Ad Valorem Duty means Duty

imposed on the basis of: a) Percentage of Price of Commodity.

b) Per unit of the Commodity.

c) Both (a) & (b).



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Q 20 Under which of the following Tax

System, more Tax is imposed on the Lower Income Group?

a) Regressive

b) Progressive

c) Value Added Tax

d) Proportional Tax

THE END

Tax System in India, Budget & Fiscal Deficits in India

Tax System in INDIA

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