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CHAPTER; 1

NATURE. SCOPE . HISTORY and TAX POLICY

SYNOPSIS

Nature and Scope


The Problem
Objectives
Research Methodology
Significance of the Study
Historical Perspective (The 1886 Act - The 1918 Act - The 1922 Act
- The 1961 Act - Ancient Period - Early Hindu Period - The Moghul
Period - Later Hindu Period - The British Period) -
Tax Policy and its Implications - Objectives of Socio-economic
Policy - Outline of Tax Policy - Foundations of a Tax Structure -
Objectives of Personal Taxation
Some Characteristics of a Good Tax System.
NATURE AND SCOPE:
Income-tax in India is one of the important sources of revenue for the
government. But the major contribution comes from the business class
whereas the contribution from Salaried class is negligible. Salaried class
have a fixed income and they hardly have an “opportunity” to evade tax.
Middle-aged salaried people are extremely worried about their future and
try to save as much as possible but it becomes difficult due to changing
provisions from year to year. It seems that the acute problems
encountered by the salaried class have received the scant attention of the
government.
The present study seeks to discuss the various aspects of salary taxation.
It will focus on the historical background of taxation. It will include the
basic considerations for tax policy and structure for taxation for India. It
will also include the objectives of personal taxation, and characteristics
of a good tax system ; in the process it will reflect on the reform of
personal taxation. It will throw light on the three major considerations in
framing an effective tax system.
The study will embrace the present status of salary taxation in India
analysing the available statistics on it. It will also discuss the issues like
discrepancy between salaried class and business class.
The study is directed to include the attitudes and opinions of various tax
payers ( salaried assessees only). The survey will focus on the tax
awareness, tax behaviour and problems faced by them.

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It will take the view of other countries with respect to salary taxation.
The countries like US, UK, Newzealand, Mauratius, etc. will be included
for the purpose. Nevertheless, it will focus on the present provisions in
Indian Income-tax and how to rationalise the present method of
collection of ST. Lastly, the discussion on the above-mentioned aspects
will generate possible and feasible suggestions with respect to ST.

THE PROBLEM:
The last day of February every year carries a special significance in
India. Everyone is keen to know how country’s Budget is going to affect
his/her family budget. This is especially true for the salaried people
belonging to the middle class, for in these days of inflation they have to
match their depleted income with rising expenditure.
Every year on the occasion of budget session several groups in our
society hold high expectations from the government in respect to tax
relief. Such a desire on the part of people can be easily understood as
they are hard pressed due to rising inflation. Political parties in their
manifesto declare some relief to acquire the patronage of the electorate.
The middle class people which is largely composed of salary group have
to pull on with limited income. Therefore it is inevitable that they should
be provided some relief on permanent basis. So the problem is what type
of reforms are necessary to help the salaried class.

OBJECTIVES:
1. Income-tax on salary should be revised in such a ijianner so that it
causes least expenditure to the government.

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2. The government should not lose this institutionalized source of

revenue.
3. Salary tax payers face least inconvenience with the proposed reform.
4. Tax calculation becomes easy and simplified.
5. The procedure of tax collection should be changed in a way that it
saves time, money and energy both to the government and tax payers.
6. The proposed reform should restore the well-claimed characteristics of
a good tax system.

RESEARCH METHODOLOGY:
The research methodology shall be exploratory in nature. The study shall
be based on the secondary literature and data with respect to historical
perspective, tax policy and its structure, present status, and international
comparison.
To study the attitudes and opinions of tax payers an interview schedule
will be constructed containing questions on tax awareness, tax behaviour
and problems & suggestions. I intend to undertake a survey of about 250
respondents for the said study. A purposive sample will be selected for
the purpose.

SIGNIFICANCE OF THE STUDY :


In modem inflation-oriented society, taxes constitute major component
of one’s expenditure and they take away a big slice of one’s income. It
demands great attention when cost of living is increasing by leaps and
bounds.

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The present study seeks to reveal the current weaknesses of the system
and its status in the society and economy. This would unfold the often -
preached rationale on the basis of statistical tables. It will take into
account tax payers’ agony and their demand which will help the
government “user friendly”, tax policy. The study will generate
qualitative material for the use of the government so as to improve the
system and benefit the tax payers.

HISTORICAL PERSPECTIVE
When man started living as a civilized member of the state he also
started exchanging his rights and duties. The state has to carry on
administration and to enable citizen to pursue his all kinds of activities to
earn his livelihood. It has to maintain peace and order within the state.
Moreover it has to protect him from outside invasion. For all these,
required money was raised by means of taxation.
Though taxes are as old as states and state governments, tax on “income”
in the present form is of recent origin. In the U.K., it was levied for the
first time in 1799 by William Pitt to provide for the Napoleonic war and
in the then British India in the year 1860.
In India, between 1860 and 1886, 23 Acts dealing with taxes on income
were passed with one object or the other. To start with, in the year 1860
tax was levied at 2% on income between Rs. 200 and Rs. 500 and at 4%
on income above Rs. 500. At no time the maximum rate was more than
4%. The tax imposed in 1860 was abolished in 1865. It again came in
1868 and was abolished for the second time in the year 1873. It is
interesting to note that Bengal, Madras, and Bombay passed their own

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Acts, while Northern India was lead by Imperial Legislature. The Act VI
of 1880 raised the limit of non-taxable income to Rs. 500 p.a. all over
India, but the rate continued to be still 2% only. This Act remained in
force till 1886. But still it was an unjust system where the richer a man
was the less he had to pay. So a fresh legislation was passed in the year
1886 and it was the 24th attempt to impose tax on Income in India.

THE 1886 ACT:


The Act is very much important as it has become the “foundation stone”
of free India. Even the Act of 1961 contains germs of the Act of 1886. In
the Act, Income was divided into four classes :
(a) Salaries & Pensions (b) Profits of companies (c) Interest on
Securities and (d) Other sources of Income which included Income from
House Property. Income falling in each head was assessed separately and
without reference to any income falling in other parts. Agricultural
income was exempted totally.
The tax rate was 5 pies in the rupee of 192 pies (approx. 2.6%) on the
income over Rs. 2000. On salaries between Rs. 500 and Rs. 2000,
income - tax was 4 pies per rupee. The Act remained in operation for
many years. However in 1916 First World War necessitated the
Government to increase taxation.

THE 1918 ACT:


Several terms were defined in this Act like -- “Assessee”, “firm”, “HUF”,
“Company”, “previous year”, etc. Income was divided into six classes :
(a) Salaries (b) Interest on Securities (c) Income from House Property

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(d) Income from Business (e) Professional Earnings (f) Income from
Other Sources. The maximum rate was 1 anna in a rupee (6.25%) and it
applied to individual income of over Rs. 24999.

THE 1922 ACT:


This Act was based on recommendations of the All-India Committee,
1921. According to the preamble of the Indian Income Tax Act, 1922, it
was “an Act to consolidate and amend the law relating to Income-tax and
Super tax” and it received assent on 5th March, 1922 came into force
from 1-4-1922.
However, the Act was amended 19 times upto the end of 1934.
Afterwards so many committees were formed to review the statutes —
The Experts’ Committee, 1935 ; The Investigation Commission, 1947 ;
The Taxation Enquiry Commission, 1953 ; Indian Tax Reform, 1956 (by
Mr. Kaldor), The Law Commission of India, 1958 and Direct Taxes
Administration Enquiry Committee, 1958.

THE 1961 ACT:


It came into force with effect from 1-4-1962. On the very following day,
i.e., on 2-4-1962 it had to be amended. Since then it had been amended
several times through Finance Acts every year.

CONCEPT OF “INCOME”
It is very interesting to note that the term “income” itself was not defined
in the 1922 Act till 1939, Since then it has been expanded from time to
time.

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In the case of C.I.T. Vs. Shaw Wallace and Co., 61.T.C. 178 the privy
council pointed out that there must be “coming in” before there could be
any taxable income. That was the principle laid down in the English
case of Tennant V.Smth, 3 T.C. 158 that case, an employee of a bank
had to reside in the bank premises which was rent free. It was held that
in such circumstances what was saved by way of rent of the residence
could not be added as “income” to his salary. In other words, a “benefit”
in kind was not “income” as nothing “came in”. However, gradually
this principle was discarded and now all kinds of perquisites are
taxable. So this is the brief history of taxation of recent past. If we refer
to the Maurya period and arthshastra of Chanakya it will be clear to us
that “salary tax” is a gift presented by the Britishers.

ANCIENT PERIOD:
In the Mauryan period the importance of land revenue as the basic source
of the state was recognised. The collection of revenue from various
sources, particularly from the land, meant the appointment of a series of
officials to administer the various stages of collection. A complex
bureaucratic system emerged where salaries were paid to the officials.
The salaries had been extremely high in the upper class of officials.

There were three principal sources of income.......... (a) Land revenue


(b) taxes from traders, artisans (c) fines imposed on criminals.
Eventhough the principal means of filling the treasury was taxation, the
kings could not levy and tax which was not sanctioned by the smriti tests
except in a calamity, such as foreign invasion.

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Gautam, Vasistha and Manu permit the kind to take a maximum of one
sixth of the crop as his revenue. But Manu allows the King to take even
one fourth in case of calamity, Manu has poetically described the
taxation system as “just as the leech, the calf and the bee take their
substances little by little, so must the king draw from his kingdom
annual taxes little by little. Let the king not cut up his own root (by
levying no taxes), nor the root of others by excessive greed.”1

Apastamba merely mentions that king should collect taxes, and then
proceeds to give a list of persons who are exempt from taxes.... which
includes a learned brahmana, women of all castes, minors, sanyasinis,
etc. Manu has said that the king may take from mechanics, artisans as
well as from Sudras who subsist by manual labour one day’s free labour
per month, Chanakya has mentioned seven heads of income, viz,
Mulya (price), Bhaga (share), Vyaji (commission), Parigha (royalty),
Klpta ( a fixed tax to be paid collectively by a village), Rupika (a
manufacturing charge like mintage), Atyaya (penalty for negligence of
duty).

No where tax on salary is mentioned but Chanakya has suggested to


impose emergency taxes on almost all professions including actors and
prostitutes who are to pay half their wages. Thus there was no tax on
salary except in case of emergency.

In the Early Hindu Period. the term “assessed taxes”, presumably


borrowed from the English fiscal practice of the eighteenth century, was

1 Majmudar A. K., 1980, PP 33

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used until 1914, in the Finance and Revenue accounts of the
Government of India to designate and variety of taxes. By April 1903,
however, all such taxes were either repealed or abolished with the
exception of the income tax, which was first introduced in 1860 and
lasted only for five years. The permanent income tax, with which we
are mainly concerned in this monograph dates from April 1886.

Probably there is no part of India where taxes on arts, trades and


professions are as new to the people as the income tax was in England,
when first proposed by Pitt as a regular part of his financial system.
These Indians imposts are known to us as the SAYAR or transit or
octroi duties, the Moturpha taxes or license duties, and the thathameda
or capitation tax in Burma. The beginnings of these taxes are buried in
the past and all we can do here is to trace, at least some of them as far
back as possible.

As per the famous Hindu Law Code, the Manava- Dharma, a perennial
source for savants and scholars of Hindu culture in all its aspects.
According to the author of this code we understand that the kind is
justified in levying direct taxes on land, merchants, artisand, and
mechanics. Revenue was collected both in kind and in coin.

Briefly stated the tax system consisted of the following: (a) a tax on the
produce of land (b), a series of taxes on personal property of every
description, (c) a tax on sales (d) a kind of poll tax like the Roman and
French corvees, and finally (e) succession duties.

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During the Moghul period, the following is a somewhat partial list of
the imposts levied by the Moghul Emperors , beside the ancient land
revenue’ (1) the Jiziah or the capitation tax levied on non-
Mohammedans according to their ability at Rs. 40, 20 and 10 each. (2)
the port duties, similar probably to our customs duties, (3) a tax per
head on pilgrims; (4) a tax on timber out from the State or Private
forests, with a view to conserve forests; (5) presents to be given to the
Emperor (6) a tax on the various classes of artificers; (7) Tahsildars’
fees, the money given to the tax gatherer; (8) Complimentary offerings
on receiving a lease and the like; (9) a fee for testing and exchanging
coins, that is , a mint charge; and (10) market tolls.

Besides these exactions there were the taxes on sales of cattle, on hemp,
blankets, oil, raw hides, weights and measures; there were the special
license duties on butchers, fishermen, brokers, tanners, gamblers,
passports, and turbans, on the purchase and sale of a house, on salt made
from nitrous earth, on the manufacture of lime, spirituous liquors, and
dy-stuffs from plants. All these imposts must have almost choked Indian
industries and commerced for many years to come.

The Emperor, Akbar one of the most enlightened Mohammedan


Emperors, and contemporary of Queen Elizabeth, took away most of
these imposts and built himself an everlasting name. In order to
compensate for the loss of revenue, he, with the help of his famous
Hindu finance minister, Rajah Todar Mull introduced a ten year

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settlement in the case of the land tax and substituted money payments
for payments in kind. It was one of the minutest surveys ever carried out
and became the basis of Modem surveys and settlements, at least in
Bengal.

The effect of the abolition of the various vexatious exactions was


naturally felt in the country’s commerce and industry. Never before or
long after this period does India seem to have enjoyed such material
prosperity, so much so that it is estimated that at the time of Akabar’s
death there were no less than 35 millions of treasure in the Agra fort
alone, and that the total gross treasure in all the treasuries of Akbar’s
empire may be given at 70 to 80 millions sterling of modem money.

Probably this treasure was the greatest inducement for the Emperor Shah
Jahan, the grandson of Akbar, to hand down his name to posterity as
the builder of the most exquisite Taj Mahal and other artistic public
buildings, together with canals, the latter to insure continued
agricultural and commercial prosperity. He, however, does not seem to
have exhausted this huge treasure left by Akbar.

It was left for Aurangzib, to squander the remainder of this treasure in


fighting the wars of succession and in suppressing smaller nationalities,
in order to bring the whole of India under one empire and thus to realise
the dream of the universal peace. But all this meant more money.
Akbar’s treasure was exhausted. Some of the old imposts were resorted
to among them the humiliating Jiziah, which created more trouble than

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Aurangzib had ever anticipated. The Jiziah, not the amount of the tax
as such, but the method by which it was assessed and collected, was at
any rate one of the causes that finally led to the downfall of the Moghul
Empire in India.

During the later Hindu period, besides the land revenue, there were
other taxes, the revenue from which was termed as Nukta-bab or the
extraordinary revenue as distinguished from the land revenue. These
taxes may be briefly stated as follows:- (1) the Mohtrupha, a tax on
merchants, manufacturers, professions and houses, which came down
to modem times and was not abolished until after the Mutiny, atleast in
Southern India (2) a tax on certain rent-free lands; (3) a tax on profits of
grass lands; (4) the Pandhari tax levied on the offerings of pligrims at
religious fairs, which was later converted into a license tax on petty
artisans, and was onlyh abolished in 1903 in the Central Provinces; (5)
the costoms duties and finally (6) tributes from the conquered regions,
known as the Mahratha chauth or the fourth.

During the British period taking the year 1765 as the starting point, land
revenue still formed the bulk of the revenue; even as late as 1853 this
source contributed more than half of the total gross receipts. Indirect
taxation such as salt, opium, customs, transit duties, stamps, registration,
excise on spirituous liquors, and tobacco contributed not less than one-
third, if not more. Thus the British Government always tried to keep an
impartial equilibrium between direct and indirect taxation.

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Among the direct taxes besides the land tax under the Company, some
of which were also levied under former Governments, may be
mentioned the following important imposts: SAYAR, an Arabic word
meaning universal, included many irregular receipts mainly collected by
provincial officers from cultivators especially, in Bengal. It also
included thown duties, duties at bazzars and collections from Gaya and
other places of Pilgrimage, all of which now form part of minicipal

revenues.

In Madras, on the other hands, the term SAYAR was used to designate
transit duties. In the Deccan again SAYAR was divided into two
branches (a) the Moturpha, a tax on profesisons, and implements
collected by village officers, and (b) the Bullooteh, a tax upon the fees
in kind received by the village artisans from the cultivators. All these
were later commuted for a money tax or cess on the land revenue and are
known today as the provincial rates.

There was again a tax known as the wheel tax, levied on buggys, carts,
and chariots, confined to Bombay only. Collections were farmed to the
highest bidder and the tax was very' oppressive in amount. At present
this tax is entirely handed over to municipalities.

The group of taxes known as P.T. (Pligrim Taxes) coming down from
remote times, consisted of a number of imposts; (a) a poll tax upon all
pilgrims resorting not only to the great temples, but to many of the
smaller pagodas and shrines of fame; (b) a toll on all the offerings

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brought by the devotees with them. The government usually farmed out
these to a renter for a lump sum; (c) fixed sums to perform the various
penances; and finally (d) license fees for shops, booths, and stalls during
religious festivals.

These various taxes were recognised to be a great hindrance to trade and


commerce. Accordingly Lord Cornwallis, the then Governor General of
India under the Company consolidated the SAYAR into the transit and
town duties. This was the beginning of that monstrous inland tariff wall
extending over 1,500 miles from Attock in the north to Cuttack in the
southeast, which was abolished only in 1878 by Lord Lytton with the
aid of Sir J.Strachey, regular sea-customs being substituted for them. It
is astonishing that a free trading England should have tolerated such a
thing for nearly a century.

The Moturpha, levied on trades, industries, and occupations, and


chiefly found in Madras after 1833, formed part of the provincial
revenues since 1843 on account of the increase in the salt duty for the
Central Government. This tax in Madras, bringing an annual revenue
of over 100,000 was not abolished until after the Mutiny.

In summing up for the preceeding three periods one frankly admits that
the trading and the professional classes, Pandits and Shastrees, Maulvis
and Kazis contributed little or next to nothing to the public treasury.

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TAX POLICY : BASIC CONSIDERATIONS
Diverse routes to economic development have been charted out from
time to time. Basically, economic development is marked by a high rate
of capital formation, rapid improvements in technology, and a rising
level of productivity. At any point in time, we may think of an
economy as possessing a labour force with given education and skills,
a stock of productive capital, and a specific set of institutional economic
arrangements. Other things remaining the same, productivity can be
improved by providing the labour force with more capital. The output
per man-hour can be related to the amount of productive capital in terms
of a production function. As capital increases, the production function
moves upwards to the right denoting increased output per man-hour.
But as education and technology and other factors improve, the quality
of work by labour force also improves, as existing capital is used more
effectively. The production function, therefore, shifts from one point to
another. Thus, the process of economic development in advanced
industrialised countries has been characterized both the shifts in the
production function and by substantial increases in the quantity of capital
available per worker.

The chief feature which distinguishes a developed from an


underdeveloped country is that the former has the larger volume of
aggregate productive capacity (HCA and HMPL) compared to its labour
force, than the later. There is a huge labour force in the
underdeveloped countries whose marginal productivity is zero, or near
zero, or above zero, yet below the minimum cost of living level. The

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stage of “full employment” in Keynesian terms is, therefore, reached
much earlier while huge labour still remains involuntarily unemployed.
Pushing aggregate demand through public policy beyond this point
leads to inflation, while, at the same time, unemployment prevails. This
is a phenomenon which characterises underdeveloped regions and marks
them off from the developed ones. Borkar, therefore, defines an
underdeveloped region as one” in which productive capacity is
underdeveloped, relatively to the needs of population. More precisely,
it can be defined as a system where the aggregate marginal productivity
of all labour is less than the cost of living.” This implies capital scarcity
and inefficient technology. It is thus that a high rate of capital formation
and improvements in productivity are the principal instruments of
economic development. Simultaneously, growth in population needs to
be controlled as a complementary measure to promote growth. India is a
typical example of an overpopulated, “ under-capitalised”,
underdeveloped economy.

OBJECTIVES OF SOCIO ECONOMIC POLICY


The first few years after independence were characterised by absence of
socio-economic policy. The industrial Policy Resolution of 1948
marked the dawn of mixed economy in the country. The distinguishing
feature of the Constitution, adopted on January 26, 1950, is the
incorporation within it of the “Directive Principles of State Policy”
(DPSP) which cast an obligation upon the state to establish a welfare
state distinguished by a just social order. The First Year Plan (1951-56)
was the first step in that direction. It aimed at correcting the

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disequillibrium in the economy caused by the War and the partition of
the country, and proposed to initiate a process of balanced economic
development. In December, 1954, the Parliament adopted the “Socialist
Pattern of Society” (SPS) as the objective of social and economic policy.
Within this framework, the Second Five-Year Plan (1956-61) set for
itself the principal objectives of a sizeable increase in national income so
as to raise the level of living in the country, rapid industrialisation, a
large expansion of employment opportunities, reduction of inequalities
in income and wealth, and a more even distribution of economic power.
The Third-Five-Year Plan (1961-66) sought to further these objectives
by assuring a substantial expansion of employment opportunities,
establishing progressively greater equality of opportunity and bringing
about reduction in disparities in income and wealth and a more even
distribution of economic power. The Fourth Five Year Plan (1969-74),
in view of the failures of the past few years, proposes to step up the
tempo of activity in agriculture and industry to the extent compatible
with maintaining economic stability and elimination of dependence upon
foreign aid.

The socio-economic objectives of national policy are, thus, to secure


rapid economic development along egalitarian lines implying fair
distribution of economic gains and enlargement of economic
opportunities for all.

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IMPLICATIONS OF THE BASIC CONSIDERATIONS FOR TAX
POLICY
What tasks do the basic considerations set for tax policy ? The ends of a
rising standard of living (economic development) and social justice in
India will be achieved if all manifestations of the basic under
development which characterize the Indian economy are removed. The
central problem in the theory of economic growth a W. ARTHUR LEWIS
puts it is to understand the process by which a community is converted
from being a 5 % saver to a 12 % saver. For this,unnecessary
consumption and wasteful, non-productive and non-essential
investments must be discouraged. Another requirement is to being about
a transfer of savings into sectors which require them most and which
can use them most productively and efficiently. The propensity to
consume being very high among the low-income household sector, it is
important that the incremental incomes in this sector are siphoned off
into the government as well as corporate sectors through the instrument
of government policy. Even the requirements of finance of the business
sector could be channeled through state-run sepcialized financial
institutions.

Another requirement for economic development is accumulation of


knowledge which, interpreted in wider sense, calls for the provision of
social and economic overheads, of which education, both technical and
general, is obviously of outstanding importance. In a study to measure
the contribution of various factors to economic growth in U.S.A.,
EDWARD DENISON calculated that increase in education contributed

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0.7 % (most important source) to the average annual growth in output
per man-hour of 2.3 % in that country during the period 1929-57.

The social objective in India consists in the attainment of social justice,


which calls for equality of opportunity and reduction/elimination of
income and wealth inequalities. The system of inheritance of property
and the accompanying hereditary economic advantages of birth and
environment which are the principal causes of unequal opportunities
need to be limited, if not completely eliminated. Free access to
education for all and full employment are the other steps towards the
attainment of this goal. Reduction of inequality between the employed
and the unemployed calls for provision of employment opportunities.
Broadly, employment is a function of economic development. As
aggregate demand of the economy is pushed up, output rises to meet it
and more employment opportunities are opened up. But due to low
marginal productivity which, as observed earlier, falls below the
minimum cost of living level, the KEYNESIAN “ full employment” is
reached much before all the available manpower is actually employed.
Merely pushing aggregate demand at this stage will lead to inflation.
The problem, therefore, boils down to raising productivity in the
economy to promote economic development and, therefore,
employment opportunities.

Inequalities between the rural sector and the urban sector can be
removed if the primary sector (agriculture), which is a particularly
depressed sector in underdeveloped countries, is quickly developed. It

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involves promoting complete changes in traditional attitudes and
institutions associated with rural India. Agriculture needs to be
transformed through the provision of essential inputs like hybrid seeds,
chemical fertilizers, and sufficient irrigation and storage facilities.
Though not so significant as the other inequalities, concentration of
income and wealth in comparatively few hands hits the eye most and has
drawn close attention in the Five-Year-Plans. It is felt that we need to
distinguish functional inequalities from non-functional inequalities and
eliminate the latter. It is the undesirable consequences of inequalities-
disparities in the standards of consumption, concentration of economic
power, the coming into being of a class of rentiers- which have to be
attacked and prevented from assuming dangerous proportions.

It remains to underline the need to maintain economic stability, short­


term and long-term ,to ensure economic development of the country on
an egalitarian basis. The commonly-held belief that economic
development is spurred by rising prices has now been punctured, and it
has been firmly proved that price stability and economic development
are not incompatible. Studies in the International Monetary Fund have
come out with the conclusion that, besides the social inequity caused by
them, inflationary devices cannot be expected to leave a favourable
effect on savings for any length of time; rather; savings tend to fall.

The objective of rapid economic development must get the primary


attention. If this objective is achieved, the objectives of economic
stability and of economic equality are also promoted substantially. As

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the State is accorded an important role in hastening economic growth,
its need for financial resources has to be fulfilled to the extent that it
does not affect optimum growth possibilities. Of course, the State
forfeits its right to claim a big segment of the economy’s financial
resources if it fails to make the most productive use of them.

OUTLINE OF TAX POLICY


It seems that the State’s expenditure and transfer policies should be
extensively used to promote equality of opportunity and to reduce
income and wealth inequalities, while the tax policy should be used to
promote savings in approved forms and productive investment, and
discourage wasteful and ostentatious consumption. However, as the
State can spend mostly what it collects, it becomes obvious that the tax
policy is perhaps, the most important instrument to achieve a country’s
socio-economic objectives. The Indian tax policy should, therefore,
aim to fulfill the following objectives, in that order: -
(I) To promote optimum savings, direct investment into
priority channels, and discourage wasteful consumption;
(II) To transfer, to the maximum extent possible in consonance
with the preceding objective, financial resources from the
public to the State; &
(III) To promote equality of opportunity, reduce inequalities
of income and wealth, and prevent concentration of
economic power.
These objectives have to be achieved consistent with the objective of
maintaining short-term as well as long- term economic stability.

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The primary task of tax policy is to wrest from the low- income low-
output economy the maximum possible resources for economic
development. The first objective involves favourable treatment of
savings and high taxation of wasteful consumption, dissavings and
unproductive, non-essential investments. Taxation can help secure
equality of opportunity through adequate transfer of resources to the
State to enable it to make commensurate investment in human material,
and rapid promotion of agriculture and industry. The last measure, of
course, merges into the first objective. Taxation is a useful instrument
in ensuring economic stability. Appropriate taxes can be raised to
siphon off excessive demand. This, of course, involves proper choice of
tax devices as some of them might rather assist than prevent rising
prices. Taxation to secure large resources for the State and to reduce
inequalities is usually translated into levy of highly progressive taxes.
At the same time, promotion of rapid economic development, it is said,
calls for low taxation. These tax policy objectives, therefore, seem to
be conflicting. However, to the extent, resources mobilized by the State
are used for productive and priority investment, high taxation and
economic development are complementary. Moreover, if taxes which
are introduced to reduce inequalities are such as do not significantly
impair or affect incentives to work, save and invest, the objectives may
be said to be complementary. Even if growth, stability and equality clash
at a point, attempt should be made to achieve the optimum mix. In a
federal set-up such as India’s, it need hardly be pointed out that only
closely coordinated and uniform tax policy between the Central and the

23
State Governments can help secure these objectives. There are
possibilities that the two levels of Government might, be at logger-heads
politically, economically, and ideologically, and might, therefore, defeat
each other’s objectives.

Although it is virtually axiomatic that high and progressive taxation


impairs incentives to work, save and invest, it must be conceded that we
are on very uncertain ground in discussing the possible effects of
taxation. It must, however, be accepted that there is a persistent allergy
to taxation. Whatever its physical effects, the psychological effects of
taxation as reflected in the behaviour of the stock exchanges, reactions
of businessmen and others seem to be strong. As has been remarked,
“tax rates bark more than they bite”. In order to secure optimum rate of
development, there is need to attempt to minimize such adverse
reactions by careful choice of tax devices and rational, efficient
administration.

FOUNDATIONS OF A TAX STRUCTURE


A tax structure must be built up on a strong foundation so that it can
subserve the tax policy objectives adequately. To be strong, the
foundation must come up to certain standards. Those standards are the
maxims of taxation which were laid down by Adam Smith almost 200
years ago. Those maxims are: equality ( equity ) , certainty,
convenience, and economy. These pre-requisites of a tax system are
accepted by all.

24
Equity implies a fair distribution of the tax burden among all taxpayers,
and is essential to inspire that confidence in the fiscal basis of
Government which sustains public morale and promotes productive
effort and economic progress. Fair distribution is secured by achieving
both horizontal equity as well as vertical equity. The former means
equal treatment of equals and implies construction of a fair tax base.
This is universally accepted, although its implementation does create
some problems. Vertical equity means unequal treatment of unequals
and is secured through the tax rate structure. How unequal should the
treatment of unequals be? This involves subjective measurement and
has been translated into several ‘sacrifice’ theories. Generally, it is
believed to lead to a progressive rate structure, although it involves
value judgment and is often disputed.

Simplicity and clarity of tax law is another maxim which may be added.
It is true that tax laws which aim to provide for equity and certainty and
prevention of tax avoidance cannot be very simple; but these should not
be very complicated either, for laws which are difficult to interpret and
hard to administer defeat the very objectives they seek to achieve in the
first place.

OBJECTIVES OF PERSONAL TAXATION


Owing to the ridiculously low levels of income and consumption,
personal taxes embrace only a small section of the Indian population.
This does not mean, however, that these taxes are unimportant. As
personal taxation applies to those individuals and HUFs who are quite

25
well-to-do, who are the principal savers and also conspicuous
consumers, it can be used as an exclusive instrument to reduce
inequalities of income and wealth and to promote equality of opportunity
(through progressive income-tax, wealth tax and estate and gift taxes)
and to promote savings and curb ostentatious consumption (through an
income-tax favouring savings and an expenditure tax). In the process,
it cam also be made to yield a handsome amount of revenue for the
State. Furthermore, as the process of economic growth gathers,
momentum, and more and more people climb up the income-ladder, the
significance of these taxes is bound to increase. Personal taxation is
judged by the common man principally on the criterion of fairness.
Again, the tax administrator comes face to face with most taxpayers
only in the case of taxes comprised in personal taxation; therefore, tax
complications and administrative angularities come to light most
frequently in this area. These two considerations- equity and
administrative ease- thus become two very important criteria in
constructing and, subsequently, reviewing personal taxes.

The evaluation of personal taxation should, therefore, be based on the


following criteria:
1. Whether it is equitable and fair;
2. Whether it is easy to adminster;
3. Whether it promotes persoanl savings, preferably through
approved channels, and productive investment, and restrains unn­
ecessary consumption;
4. Whether it promotes equality of opportunity and restrains

26
inequalities of income and wealth.
5. Whether it promotes economic stability ; and,
6. Whether it provides adequate revenue to the State.

SOME CHARACTERISTICS OF A GOOD TAX SYSTEM:

1. Any system of public finance must be looked at as a whole, before


any final judgment can be passed upon its merits or demerits. So too,
any tax system must be looked at as a whole. For different taxes may, in
some of their effects, correct and balance one another.

If in a given year a given revenue is to raised by taxation, alternative


tax systems will result in alternative distributions of the total burden of
taxation, which will itself be greater under some systems than others,
and in other alternative effects on the economic welfare of the
community. These matters will be discussed in the next seven chapters.
But in this chapter a few preliminary points will first be noticed.

2. The comparative advantages of single tax and multiple tax


systems have been much argued Various types of single tax have been
proposed. The Physiocrats proposed a single tax on the economic rent
of land, because they thought that this was where all taxes ultimately
fell, and that it would, therefore, save trouble and misunderstanding to
put them there straight away. But this idea involved a false theory of
incidence. Henry George made a similar proposal, partly because he
thought that a tax on rent did not check industry, whereas all other taxes

27
did, in which opinion there is a grain of truth, and partly for reasons of
a supposedly ethical character, which carry less weight. But there are
two grave objections to a single tax of this kind. The first is that it
would not, in most modem communities, bring in enough revenue. The
second is that it would lead to a very bad distribution of the burden of
taxation. For a millionaire, who owned no land, would pay no taxes,
while a poor man, who had invested all his savings in the purchase of
his house, might pay in taxation, in respect of the land on which it
stood, a considerable proportion of his income. A single tax on land has
no relation to individual “ability to pay” (ATP).

There is much stronger case for a single tax assessed on income. This
could be made to yield all the tax revenue normally required and, by
means of graduation, differentiation and other devices, could be made
to distribute the burden of taxation between individuals in whatever way
was thought best. There are, however, in addition to arguments against
any single tax, three objections to exclusive reliance upon an income
tax. The first is that such a tax imposed on small incomes is relatively
difficult and expensive to collect. The second is that is secures no
special contribution from inheritors of wealth, a pre-eminently taxable
class. The third is that it tends to check saving more than most other
taxes do. The first objection might be overcome to some extent by
administrative improvements, and indeed would not arise at all, if it
were decided to distribute the burden of taxation in such a way as to
exempt small incomes altogether. The second could be overcome by
treating wealth acquired by inheritance or gift as taxable income at the

VVlELft,
time of its acquisition. There is something to be said for doing this and it
was done in the United States income tax of 1861. The third could be
overcome by exempting savings from taxable income, and imposing a
single tax, not upon personal income, but upon personal expenditure.

Such a tax has great attractions. It would also fall upon dis-savings, i.e.
on personal expenditure financed by selling securities or other assets and
“living on capital” ; also on capital gains, if these were spent, though
not if they were saved. In principle, there is a strong case for making
such an expenditure tax, not indeed a single tax, but one of the more
important revenue raisers, graduated and differentiated, as with an
income tax, so as to give the desired distribution of the tax burden. But,
in practice, there are great administrative difficulties, much greater than
with income tax, and it is not yet clear that these could be effectively
surmounted.

3. Arguments against particular forms of single tax are reinforced by


certain general arguments against any form of single tax. Anomalies as
between persons, which are liable to arise under a single tax, are liable
to be corrected under a multiplicity of taxes. And evasions, which may
be comparatively easy under a single tax, are more readily detected
under the check and counter- check which a multiple tax system may
provide. Thus valuations for death duties and the previous income tax
returns of the deceased may be checked against one another. Again,
the land value duties of the British budget of 1909, though they never
brought in any appreciable revenue., necessitated a land valuation which,

29
though never completed, is said to have more than paid for itself by the
additions which it indirectly brought to the death duty revenue.

In general, the weight of argument is against a single tax. In the case of


local authorities, exercising comparatively few functions over a
comparatively small area, there is something to be said, on ground of
convenience, for a single tax on “ Immobilia” or immovable property.
Local rates in Britian are a tax of this sort, based on the annual value of
land plus buildings, though some classes of land and buildings are
subject to exemption or abatements by way of “derating”, and there are
great complications both of law and fact, increased by the wide range of
rent control, in the valuation of various classes of property. It is often
argued, with some force, that rates would be better based on the
capital, or even the annual, value of land only, as is done in many parts
of the world. For British local rates are in great measure, tax on houses,
which are not a good object of taxation. But these local rates are not, in
reality, a single tax, for British local authorities derive a large part of
their revenue from grants-in-aid out of the proceeds of national
taxation, and from the ownership of public property and the conduct of
public enterprises in their own areas. And local rates are only in part a
genuine tax. In part they represent prices paid by ratepayers for specific
services rendered to them by local authorities.

An interesting case is the State of Nevada, which raises nearly all its
revenue by the taxation of legal gambling. “It has no state income tax,
no retail sales tax and no state inheritance tax.”

30
4. But though a multiple tax system is generally preferable to a single
tax system, too great a multiplicity is not desirable. Advocates of
“broadcasting the basis of taxation” are to be distrusted. Of this
fellowship was Arthur Young who said, “if I were to define a good
system of taxation, it should be that of bearing lightly on an infinite
number of points, heavily on non”. But there is not necessarily any less
total pressure under such a system, for, as mathematicians know, the
sum of an infinitely large number of infinitely small weights may be
greater than a single moderate weight. Moreover, a large number of
taxes, however small, usually involves a large cost and a large amount
of vexation in collection.

The path of wisdom in this matter, for a modem community with a well
developed economic life and a reasonably efficient administrative
system, is fairly clear. It is best to rely on a few substantial taxes for the
bulk of the tax revenue. In so far as it is desired to tax the rich, income
and inheritance taxes are the best means; in so far as it is desired to tax
the poor, taxes on a few commodities of wide consumption, preferably
commodities not necessary to health and efficiency. Some commodities,
such as alcohol and tobacco, may indeed be taxed on their merits, or, as
some would say, on their demerits, apart from any question of the
distribution of the burden of taxation between different sections of the
community. Other taxes on luxuries have their legitimate place and
some taxes with special objects may be added, but it is desirable to keep
their number within bounds.

31
Almost everywhere, and even in Great Britain, whose tax system is
simpler and more efficient than that of any other important modem
community, so-called “historical causes” have led to a needless
multiplicity of taxes and to needless complexity in methods of
assessment. But, especially where multiplicity is reduced, particular
taxes may need to be complex— the British income tax for example - if
the tax system as a whole is to be satisfactory.

5. A further point of occasional controversy may be noticed here. Is


it a characteristic of a good tax system that taxes would be “felt” as
much, or as little, as possible ? The plain man will be inclined to think
that the best tax is that which is least felt, that is to say which causes the
least inconvenience and conscious sacrifice to those who pay it. But
some austere thinkers take the view that mankind can only learn through
suffering, and that political responsibility can only be brought home to
us through conscious payment of the price of greatness- or of folly, as
the case may be. Thus after the first world was a Scottish Professor of
Economics thought that we might be tempted to go to war again, if we
rashly destroyed, by means of a capital levy, the Great War Debt,
which would otherwise be one of the most impressive of our national
war memorials. It used also to be maintained that, if income tax were
resolutely imposed upon all, however, poor, all would eagerly co­
operate in checking wasteful expenditure, while the poor would also
gain in moral stature. Men take sides in this controversy according to
opinions not exclusively economic. And experience after the second
world was has now shown that, in a modem democratic state, the

32
reaction to a nearly universal income tax, newly imposed, is not that
imagined by the austere. The public mind is less preoccupied with
checking public expenditure than with redistributing the burden of
taxation, so as to relieve the poorer sections of the community of their
recently acquired income tax. On the other hand, an increase in a well-
established tax, such as local rates, tends to create a somewhat
undiscriminating demand for ‘economy’.

6. The practical application of a decision, in either sense, of the


main controversy is not wholly clear. Thus it is commonly supposed that
an income tax is more keenly felt than taxes which, being levied on
commodities, are wrapped up in their prices, as some of the medicines
of our childhood were wrapped up in jam. But on the other hand, it is
sometimes said, an income tax hits only marginal expenditure and
marginal savings all round, whereas a tax on a particular commodity hits
expenditure, including non-marginal expenditure, on that commodity
only, and is thus apt to cause a greater loss of satisfaction. Moreover,
when income tax is ‘deducted at the source’, that is to say intercepted
before his money income actually reaches the tax payer, it is apt to be
less keenly felt, than if he first receives his income in full and then at a
later date, when he has already spent most of it, receives a demand note
from the tax collector. An inheritance tax, again, is often less keenly
felt than might be supposed, since its payment is generally made
through the agency of executors, before the inheritors receive the
balance of the property, and since the payment coincides both with a
positive accretion of personal wealth to the inheritors and with other

33
events, which often force considerations of tax payments into the
background of their minds.

7. An ingenious formula, of Cambridge origin, is that the rich


should pay more taxation than they think, while the poor should think
they pay more than they do. This double illusion, it is argued, will
keep the rich contented and the poor virtuous, and will tend to maximize
work and saving by all classes. But it would be hard to create , and still
harder to maintain, such an unstable equilibrium of errors.

A distinction may, indeed, be drawn between the subjective and the


objective burden of taxation. Corresponding to the same objective
burden, as seen by the statesman, there may be a different subjective
burden on two different taxpayers, due to differences of taste and
temperament, even if their economic situation as regards income and
other factors, is the same. Corresponding to a given objective burden,
taxes which are ‘much felt’ impose a heavier, and taxes which are ‘little
felt’ a lighter, subjective burden. But, in general, this distinction is
only of secondary importance. The primary consideration is the
objective burden, as measured by a given loss of resources to a taxpayer
in a given economic situation. To this there corresponds what may be
called a normal subjective burden. Deviations on either side from this
normal are mainly due either to personal peculiarities of taxpayers,
which cancel out in the average, or to transitory conditions, such as the
novelty of a particular tax, which pass with time. The objective burden
will vary only with variations in the loss of resources imposed by

34
taxation, or in the economic situation of the taxpayer, as measured by
his income, number of dependents, etc.

Thus it is seen that tax as sources of revenue has taken different streams
from the ancient period. In the Ancient period, Moghul period and later
Hindu period, there were several heads of tax revenue. Among all, of
course, land revenue formed a major part of revenue. It is also important
to note that any taxation system has to have some good characteristics
like equity and fairness, administrative efficiency, etc. This creates a
healthy tax system where tax payers donot feel the pinch of taxes and the
government gets adequate revenue.

35

mciT
REFERENCES:
1. Agrawal A. N. and others, 1992 : India Economic Information
Yearbook 1991-92, Delhi, National Publishing House.
2. Bagai S. S., 1991 : Black Money in India, Bombay, Bagai Tax Law
services P. Ltd.
3. Benjamin Higgins, 1990 : Economic Development - Problems,
Principles and Policies, Bombay, Universal Book Stall.
4. Harjeet Kaur, 1992 : Taxation and Development Finance in India,
New Delhi, Classical Publishing Company.
5. H. L. Bhatia, 1991 : History of Economic Thought, New Delhi, Vikas
Publishing House Pvt. Ltd.
6. H. L. Bhatia, 1990 : Public Finance, New Delhi, Vikas Publishing
House Pvt. Ltd.
7. Kangle R. P., 1963 : The Kautilya Arthshastra, Part -II, Bombay,
University of Bombay.
8. Majmudar A. K., 1980 : Concise History of Ancient India, Vol. II,
New Delhi, Munshiram Manoharlal Publishers Pvt. Ltd.
9. Pophale G. L., 1965 : A Quarter Century of Direct Taxation in India,
1939-1964, Bombay Economic Research and Training Foundation.
10. V. G. Mankar, 1992 : Public Finance - Theory and Practice, New
Delhi Himalaya Publishing House.
11. Vinaykumar, 1988 : Tax System in India and Role of Income-tax,
New Delhi, Deep & Deep Publications.

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