Taxation

1. Nature, purposes and principles of taxation

A tax is a compulsory payment imposed by a public authority under law, without a direct quid pro quo. Tax revenue finances public goods, infrastructure, welfare and administration. Unlike borrowing, it does not create a repayment liability for government. Fees are associated with particular services or regulatory functions, although an exact equivalence between the amount paid and the benefit received is not always necessary.

Taxation serves allocation, redistribution and stabilisation objectives. Taxes on tobacco can discourage consumption with adverse health effects; progressive income taxation can reduce post-tax inequality. During an economic slowdown, income-tax receipts ordinarily decline as incomes fall, cushioning disposable income. This automatic stabiliser operates without a fresh policy decision, unlike a discretionary tax-rate reduction.

Adam Smith’s classical canons are equality, certainty, convenience and economy. Modern tax design also emphasises simplicity, neutrality, transparency and revenue productivity. Horizontal equity requires similar treatment of people with comparable ability to pay; vertical equity permits different treatment of taxpayers with different capacities. A sound system balances these goals because stronger redistribution, administrative simplicity and economic efficiency do not always coincide.

• Tax base: the income, transaction, consumption, wealth or property on which tax is imposed.
• Tax rate: the liability applicable to a unit of the tax base.
• Tax expenditure: revenue forgone through exemptions, deductions, concessions or preferential rates relative to a benchmark tax structure.

2. Classification, burden and behavioural effects

Direct taxes are imposed on income, profits or assets, with statutory liability resting on the assessed person. Indian examples include personal income tax and corporation tax. Indirect taxes are imposed on supplies, production or transactions and may be passed through prices; GST, customs duties and Union excise duties are examples. This classification does not establish who ultimately bears the economic burden: even a corporate tax can affect shareholders, workers and consumers.

A progressive tax has an average tax rate that rises with the tax base; a proportional tax maintains a constant average rate; a regressive tax takes a declining proportion as the base rises. Consumption taxes may be regressive relative to income because poorer households consume a larger share of their income. Exemptions for essentials and targeted public transfers can moderate this effect. A higher tax payment in rupees alone does not prove progressivity.

Ad valorem taxes are calculated as a percentage of value, whereas specific taxes are charged per physical unit. The division of a tax burden between buyers and sellers depends on relative elasticities: the less elastic side generally bears more. Taxation can also produce deadweight loss by discouraging mutually beneficial transactions. Corrective taxes may instead improve efficiency where market prices fail to reflect pollution or other external costs.

• Marginal tax rate applies to an additional unit of taxable income; average tax rate is total tax divided by the relevant income base.
• Tax evasion is illegal concealment or misreporting. Tax avoidance exploits legal arrangements, but abusive arrangements may be challenged through anti-avoidance provisions.

3. Constitutional powers and fiscal federalism

Article 265 requires legal authority for taxation. Legislative competence is distributed through the Constitution and its Seventh Schedule. Parliament taxes income other than agricultural income, while states have competence over agricultural income. Parliament levies customs duties; states levy taxes such as those on vehicles and electricity within constitutional limits. Municipal property taxation depends on authority conferred through state legislation.

GST introduced a special arrangement. Article 246A gives Parliament and state legislatures power to legislate on GST, while Parliament has exclusive power over GST on inter-State supplies. Article 269A governs the levy and collection of inter-State GST and its apportionment. Article 279A establishes the GST Council. In Union of India v. Mohit Minerals, 2022, the Supreme Court held that Council recommendations are not binding, emphasising cooperative federalism.

The Finance Commission, constituted under Article 280, recommends the distribution of shareable Union taxes between the Union and states and among states. Gross Union tax revenue is not identical to the divisible pool. Cesses levied for specific purposes and Union surcharges are excluded from this pool. Consequently, an increase in their share can limit states’ automatic access to growing Union tax receipts.

• A cess is imposed for a specified purpose; a surcharge is an additional charge on an existing tax.
• In GST Council voting, the Union carries one-third of the total weighted votes and states collectively carry two-thirds; a decision requires at least three-fourths of weighted votes cast.

4. GST: operation, coverage and limitations

GST is a value-added tax operating through successive stages of supply. Eligible input tax credit allows a registered business to offset tax paid on inputs against output tax liability, subject to statutory conditions. This reduces cascading, or tax on tax. On an intra-State taxable supply, CGST and SGST generally apply; UTGST applies instead of SGST in specified Union territories. Inter-State supplies and imports attract IGST under the applicable framework.

As a destination-based tax, GST assigns revenue to the jurisdiction of consumption rather than production. Exports and qualifying supplies to Special Economic Zone units or developers are zero-rated. Zero-rating is not the same as exemption: zero-rated supplies can preserve eligible input-credit and refund benefits, whereas credit attributable to exempt supplies is generally unavailable or reversed.

GST did not subsume every indirect tax. Alcoholic liquor for human consumption is constitutionally outside GST. GST levy on petroleum crude, high-speed diesel, petrol, natural gas and aviation turbine fuel awaits the prescribed notification following a Council recommendation. Electricity duty, stamp duties and basic customs duty remain outside the GST framework. Composition arrangements simplify compliance for eligible small taxpayers but generally deny input tax credit.

• Common exam trap: GST is levied on supply, not merely on manufacture or sale.
• GST on imports does not eliminate basic customs duty.
• Tobacco can attract both GST and Union excise duty.

5. Revenue indicators and reform priorities

The tax-to-GDP ratio measures tax collections relative to economic output. Comparisons must specify whether they cover the Union alone or general government, including states. Tax buoyancy is the percentage change in tax revenue divided by the percentage change in nominal GDP. A value above one indicates faster revenue growth than nominal GDP. Tax elasticity attempts to isolate responsiveness after removing discretionary tax-policy changes.

A broader base, fewer unjustified exemptions and predictable administration can improve collections without repeatedly raising rates. Digital returns, information matching and invoice trails can deter evasion, but compliance costs, refund delays and litigation can burden firms. Tax deducted at source and tax collected at source are collection mechanisms, not separate taxes. Effective reform combines enforcement with taxpayer services, privacy protection and accessible dispute resolution.

• Interpret rising revenue carefully: inflation, economic recovery, policy changes and improved compliance can all contribute.
• The Laffer curve illustrates that very high rates may erode the tax base; it does not establish that every tax cut raises revenue.

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