Classification of Taxes - Public Revenue, Public Finance | Public Finance - B Com PDF Download

What is Tax: Meaning and Classification of Tax –Explained!

Government Budget Constraint:

The Government has to finance its expenditure including interest payments on accumulated public debt by using taxation, borrowing from the market (i.e. sale of new bonds) and use of printed money.

Government’s budget constraint equation can be written as:

G = T+ ∆B + ∆M …(i)

Where G stands for Government expenditure, T for tax revenue, AB for new borrowing (i.e. issue of new bonds) and AM for new money created.

Rearranging government budget constraint

(i) we have

G – T= ∆B + ∆M …(ii)

When G exceeds T, we have a budget deficit. Budget constraint equation

(ii) says, that budget deficit must be financed either by new borrowing by the Government (∆B) pr by using printed money (AM).

What is Tax?

A tax is a compulsory payment levied on the persons or companies to meet the expenditure incurred on conferring common benefits upon the people of a country.

Two aspects of taxes follow from this definition:

1. A tax is a compulsory payment and no one can refuse to-pay it.
2. Proceeds from taxes are used for common benefits or general purposes of the State. In other words, there is no direct quid pro quo involved in the payment of a tax.

This implies that an individual cannot expect or demand that the Government should render him a specific service in return for the tax paid by him. However, this does not imply that Government does nothing for the people from whom it receives taxes.

In fact Government spends the tax money for the general or common benefits of all the people rather than conferring any special benefit on a particular tax payer. To quote Taussig, “The essence of a tax, as distinguished from the other charges by Government is the absence of any direct quid pro quo between the tax payer and the public authority.”

Tax should be carefully distinguished from a fee. Fee is also compulsory payment made by a person who receives in return a particular benefit or service from the Government. For paying fee on a television or radio, a person gets the benefits of programmes relayed by the Government on television or radio. Likewise, students who pay the education fee in schools and colleges, obtain the benefits of teaching arranged by the Government.

The amount of fee is always less than the cost of service rendered by the Government in return and therefore covers only a part of the cost of service rendered. Thus, even in case of fee, there is a general public interest or common benefit of the service rendered by the Government. In this case, the Government undertakes a service for the common benefits of the citizens and obtains a fee from those who avail of that service to cover a part of the cost of service rendered.

Classification of Taxes:

The taxes have been variously classified. Taxes can be direct or indirect, they can be progressive, proportional or regressive, and indirect taxes can be specific or ad-valorem. We spell out below the meanings of these different types of taxes.

Direct and Indirect Taxes:

The distinction between direct and indirect taxes is based on whether or not the burden of a tax can be shifted wholly or partly to others. If a tax is such that its burden cannot be shifted to others and the person who pays it to the Government has also to bear it, it is called a direct tax. Income tax, annual wealth tax, capital gains tax are examples of direct taxes. In case of a direct tax there is a direct contact between the tax payer and tax levying public authority.

On the other hand, indirect taxes are those whose burden can be shifted to others so that those who pay these taxes to the Government do not bear the whole burden but pass it on wholly or partly to others. For instance, excise duty on the production of sugar is an indirect tax because the manufactures of sugar include the excise duty in the price and pass it on to buyers. Ultimately, it is the consumers on whom the incidence of excise duty on sugar falls as they will pay higher price for sugar than before the imposition of the tax.

Thus, though excise duties are on the production of commodities but they can be shifted to the consumers. Likewise, sales tax on commodities can also be passed on to buyers or consumers in the form of higher prices charged for the commodities.

Therefore, excise duties and sales taxes on commodities are examples of indirect taxes. They are also known as commodity taxes. In the case of indirect taxes, there is an indirect relation, between the Government and those who ultimately bear the burden of the taxes.

Specific and Ad-Valorem Taxes:

Indirect taxes can be either specific or ad-valorem. A specific tax on a commodity is a tax per unit of the commodity, whatever its price. Thus the amount of total specific tax will vary in accordance with the changes in total output or sales of the commodity and not with the total value of output or sales.

On the other hand, an ad-valorem type of an indirect tax is levied according to the value of the commodity. For instance, sales tax in India is an ad-valorem tax as the rate of sales tax in case of several commodities is 10 per cent of the value of sales of the commodities. Ad-valorem taxes are progressive in their burden on consumers whereas specific taxes are regressive.

Progressive, Proportional and Regressive Taxes:

According to another classification, taxes can be progressive, proportional or regressive. In case of proportional tax, the same rate of the tax is charged, whatever be the magnitude of the base on which it is levied. For instance, if rate of income tax is 25 per cent whatever the size of income of a person, it will then be a proportional income tax. Likewise, if rate of wealth tax is 5 per cent, it will be proportional wealth tax.

Thus, in case of proportional tax it is the rate which is fixed and not the absolute amount of the tax. Thus with the rate of 25 per cent proportional income tax, a person with income of Rs. 25,000 will pay Rs. 6,250 as the tax, and a person with income of 50,000 will pay Rs. 12,500 as the tax. Thus, even under proportional income tax, a richer person has to pay greater amount of tax though rate of the tax is the same.

On the other hand, in case of a progressive tax, rate of the tax increases as the amount of the tax base (income, wealth or any other object) increases. The principle underlying a progressive tax is that greater the tax base, the higher the tax rate. In India income tax, an important direct tax levied by the Central Government, is progressive.

Its rate at present (1998-99) varies from 10 per cent in the slab of Rs. 40,000 to 60,000 to 30 per cent in the slab of income above Rs. 1,50,000. Under progressive income tax, the richer person pays not only absolutely more tax but also a higher rate of the tax. Thus, the burden of progressive tax falls more heavily on the richer persons as compared to proportional income tax.

A regressive tax is the opposite of a progressive tax. In case of a regressive income tax, the rate is lowered as the income rises. Thus, under regressive tax system, the burden of the tax is relatively more on the poor than on the rich. A regressive tax is therefore inequitable and no civilised Government in the world today will levy such a tax.