Law of Taxation - Teaching Plan With Reading Material

Teaching Plan
of
Law of Taxation
for
B.A. LL.B. (Hons.)
Semester VI
Session 2020-21
Prepared & Compiled By:
Ms. Ruchira Chaturvedi
1
Table of Contents
Sr. No. Contents Page No.
1. Preface 03
2. Objectives of the Course 04
3. Syllabus 05
4. Teaching Plan 07
5. Reference Material 08
6. List of Assignments/Projects 10
7. Important Instructions 10
2
1.0 Preface/Outline of the Subject: Law of Taxation
Benjamin Franklin once stated, “In this world nothing is certain but death and taxes.”
Taxation is an ancient and ubiquitous concept forming one of the central pillars around which
a civilization is built. With the advent of colonialism, colonial masters introduced several forms
of taxes to raise financial resources to run the colonial territories. Indian history’s controversial
India Salt Act of 1882 is a tell-tale of government monopoly and violations of sound principles
of good tax policy.
In contemporary society too, taxation plays a critical role and has the capacity to affect the lives
of everyone within it.
Taxation is an extremely important and useful area of law to study. But it is also extremely
challenging because of its voluminous nature, technical complexity, and constant reforms. The
effort applied in studying tax laws is worth owing to its wide social and economic impact and
its practical relevance to all sorts of commercial transactions.
The aim of this course is to introduce the learners to scheme, policy, principles and practices
that underpin the Indian Tax System. The principal objective is to explore not only the
legislations but also the principles that contribute well to the sound tax jurisprudence of the
nation. The legislations constitute the most voluminous part of the tax law, yet the regime of
tax law goes beyond the black and white statutory provisions.
The course is divided into four modules each divided into four heads. The discussion progresses
gradually from basic understanding of taxation law to the detailed, more advanced, and
specialised concepts as outlined below:
The First Module begins with the Indian Constitutional scheme of taxation as the foundation
of the Tax regime of India. It, then, lays emphasis on the principles of taxation. These basic
concepts and principles are widely and globally accepted guidelines that are discussed and are
suggested to be essentially considered while formulating tax policy and laws. A good tax
lawyer must equip its armour of legislations with these principles to have an upper hand in the
field of litigation.
The Second Module explores the Direct Tax regime of India. The most important and widely
imposed tax is income tax. The module while dealing with relevant legislations governing
Income tax, explains along with other concepts, the important concepts of ‘Income’ and
3
‘Residence’ that are crucial to the understanding of the system of Income tax. The module is
aimed at developing an understanding of the concept. Thus, thereby applying the same in
fulfilment of higher objective of professional skill enhancement.
The Third Module administration and remedies provided under the legislation in the direct
tax regime of the nation. The remedies are not restricted to the specific legislation rather there
are some genera remedies available to the aggrieved parties beyond the legislation. The module
further introduces the learners to the basics of tax assessment. It is expected that an
understanding of the idea will lay the foundation of prevalent sound tax policy. This study shall
also put them in a better place to appreciate and understand the emerging issues in the field.
The Fourth Module Every nation may develop its principles of governance, in the background
of international law, to suit its requirements, policies, priorities and ideals. International
taxation in simple language means the study of Taxation that goes beyond the national level.
By this point the learners are moderately aware of the Indian Taxation Laws. However, since
time has switched the economy from national to global, there is a need to study the taxation at
another level. Tax treaties and agreements hold relevance in this regard and at times may create
various tax disagreements, which domestic tax forums and courts must tackle intelligently. The
main trouble before such forums and courts would be that there are often no precedents to be
followed. This module is dedicated to developing the learner’s understanding of this global tax
regime thereby equipping them to contribute intellectually to its exploration and growth while
assessing and appreciating the emerging issues in the field.
On completion of this course two points would strike the students of Indian tax laws with
trepidation and amazement- as in the words of Nani Palkhivala ‘the precipitate and chronic
tinkering with the law by bureaucrats who are the unacknowledged legislators of India, and
the anaesthetised patience of Indian public.’ The students will also be in a better position to
undertake the subject area for attainment of professional expertise.
2.0 Objectives of the Course

This course is aimed at the following:
• Providing the learners with the conceptual clarity on taxation principles in general and
on the different forms of direct and indirect taxes.
4
• Developing in learners, the skill to analyse and appreciate the tax regime and policy of
India.
• Equipping the learners with sufficient practical knowledge so that they can adequately
utilise the services provided by the taxation system of India to their benefit and
wellbeing.
3.0 Syllabus
1. Introduction to Taxation
1.1. Indian Constitutional Scheme of Taxation
1.2. Kinds of Taxes
1.3. Tax policy of India: evolution and challenges
1.4. Canons of Taxation
2. Direct Tax Regime
2.1. Income Tax Act, 1961: Important Definitions
2.2. Income under different heads: Salary, House Property, Business & Profession.
2.3. Income from other sources, Capital Gains
2.4. Principles of Tax computation & filing
Professional Self-Development Activity
• Registration for PAN

• Filing of Income Tax Return
• Class discussion on ‘Does Tax cuts result in job creation’.
5
3. Administrative and Compliance Machinery Under Direct Tax Regime
3.1. Administrative machinery under Income Tax Act: Hierarchy and Powers
3.2. Appellate Mechanisms & Remedies under the Income Tax Act, 1961
3.3. Remedies beyond Income Tax Act, 1961: Constitutional Remedies.
3.4. Emerging Issues: Faceless Appeals and Assessment.
Professional Self-Development Activity
• Drafting of appeal application and reply to be filed before appellate authorities.
4. International Taxation
4.1. Fundamental Concepts in International Taxation.
4.2. Model Tax Conventions.
4.3. International Tax Agreements of India.
4.4. International Tax Issues: Permanent Establishment, Information Exchange.
Professional Self-development Activity:
Class discussion on
• ‘Can liberal tax regime play aa crucial role in expansion of economy?’
6
4.0 Tentative Lecture/Teaching Schedule
S. No. Topic Number of Lectures

Module I: Introduction to Taxation
1. Indian Constitutional Scheme of Taxation 03
2. Kinds of Taxes 01
3. Tax policy of India: evolution and challenges 02
4. Canons of Taxation 04
Total Lectures 10
Module II- Direct Tax Regime of India
5. Income Tax Act, 1961: Important Definitions 04
6. Income under different heads: Salary, House 04
Property, Business & Profession.
7. Income from other sources, Capital Gains 03
8. Principles of Tax computation & filing 02
Total Lectures 13
Module III- Administrative and Compliance Machinery Under Direct Tax
Regime
09. Administrative machinery under Income Tax Act: 04
Hierarchy and Powers
10. Appellate Mechanisms & Remedies under the 04
Income Tax Act, 1961
11. Remedies beyond Income Tax Act, 1961: 03
Constitutional Remedies
12. Emerging Issues: Faceless Appeals and 02
Assessment.
Total Lectures 13
Module IV- International Taxation
13. Fundamental Concepts in International Taxation 03
14. Model Tax Conventions. 03
15. International Tax Agreements of India 03
16. International Tax Issues: Permanent 03
Establishment, Information Exchange
7
Total Lectures 12
Total Lectures Proposed to be delivered 48.
5.0 Reference Material

As per the present scheme, Prescribed Readings are considered a part of the Syllabus. The list
of materials supplied herein may be considered as prescribed and thus a part of the syllabus.
This list of reference material may be supplemented with additional material and internet
sources that may be prescribed from time to time during the classroom lectures.
5.1 Module I
5.1.1 Legislations
Constitution of India.
5.1.2 Reports
Boothalingam Committee Report, 1968 on Rationalisation and simplification of
Tax structure.
5.1.3 Books
a. K.B. Sarkar, ‘Public Finance in Ancient India’ (1978) New Delhi: Abhinav
Publications.
b. Edwin Cannan (ed.) Adam Smith, An Inquiry in the Nature and Causes of the
Wealth of Nations, (Vol. I-V) (1994) New York: The Modern Library.
5.1.4 Articles
a. ‘The 12 tenets of Tax’, Association of Chartered Certified Accountants (2011)
b. J. A. Mirrlees, ‘An exploration into the theory of Optimum Income taxation’ The
Review of Economic Studies, Vol. 38, No. 2 (April 1971), pp. 175-208. Oxford
University Press
c. W. Neilson Hancock, ‘On the general Principles of Taxation as illustrating the

advantages of A Perfect Income Tax.’ (1850). Dublin: For the society of Hodges
and Smith.
d. Guiding Principles of Good Tax Policy: A framework for evaluating tax

proposals. Association of International Certified Professional Accountants.
e. Jon R. Neil- ‘The Benefit and Sacrifice Principle of Taxation: A synthesis’,

Social Choice Welfare (2000) Vol. 17 No.1 (2000) pp 117-124.
5.1.5 Judgments
Bharat Sanchar Nigam Limited vs. Union of India (2006) 3 SCC 1.
8
5.2 Module II
5.2.1 Statutes
• Income Tax Act, 1961, As amended by latest Finance Act.
• Income Tax Rules, 1962
• CBDT circulars.
5.2.2 Reports
• Direct Taxes Inquiry Committee (Wanchoo Committee) Report, 1971.
5.2.3 Books
• Arvind P. Datar, Kanga and Palkhivala ‘The Law and Practice of Income Tax’
Vol. I & II (Tenth Edition) (2014) Nagpur: LexisNexis.
5.2.4 Articles
a. Gauri Puri, ‘Discerning India’s evolving conception of Taxable Income- an
Interdisciplinary perspective’, National Law School of India Review, Vol. 23 No.
2 (2012) pp 44-75
b. R. Kavita Rao, ‘Income Tax Changes: What is the Objective and what are the
Implications’,
c. D.P. Sengupta & R. Kavita Rao, ‘Direct Tax Code and Taxation of Agricultural
Income: A missed opportunity’ Economic and Political Weekly Vol. 47 No. 15 pp-
51-60 (April 2012).
5.2.5 Judgments
a. Navin Jolly vs. ITO (2020) 424 ITR (karn) (HC)
b. Shiromani Gurudwara Prabandhak Committee vs. Somnath Das (2000) 160 CTR 61
(SC)
5.3 Module III
5.3.1 Statutes
• Income Tax Act, 1961, As amended by latest Finance Act
• Income Tax Rules, 1962
• CBDT circulars.
5.3.2. Reports
th
13 Finance Commission Report
5.3.3 Books
• Arvind P. Datar, Kanga and Palkhivala’s ‘The Law and Practice of Income Tax’ Vol. I
& II (Tenth Edition) (2014) Nagpur: LexisNexis.
Vinod K. Singhania & Kapil Singhania. ‘Direct Taxes Law & Practice’. 63rd ed. Taxmann
Publication.
9
5.3.4 Judgments
a. Commissioner of Service tax, Ahmedabad vs. Adani Gas ltd. 2020 SCC Online Sc 682.
b. Principal Commissioner Central tax & Central Excise Hyderabad GST Commissionerate
& Another vs. Prasad Media Corporation Pvt. Ltd. 2020 SCC Online NAA 34.
5.4 Module IV
5.4.1 Books
a. D.C. Agarwal. ‘Basic Concepts of International Taxation’. 2016. Taxmann Publications.
b. Nishith Desai. ‘Essays on International taxation’. 1st Ed. 2020. Bloomsbury India.
c. D.P. Mittal. ‘Indian Double Taxation Agreements and Tax Laws.’ Taxmann
Publications.
5.4.2 Articles
a. Matthias Bauer- ‘Unintended and Undesired consequences: The Impact of OECD Pillar
I & II proposals on Small Open economies.’, European Centre for International Political
Economy (2020)
6.0 List of Assignment/Project Topics
DHARMASHASTRA NATIONAL LAW UNIVERSITY, JABALPUR (M.P.)

BRBRAITT Campus, South Civil Lines, Ridge Road, Jabalpur (M.P.) 482001
B.A.LL.B. (Hons) BATCH 2018-19

S.
Enrolment No. First Name Last Name Email Address
No
1. BAL/001/18 Power of Board to make safe
Aaditya Kashyap harbour rules.
2. BAL/002/18 Abhinav Jena Advance Pricing Agreements
3. BAL/003/18 Arm’s Length Price under 92C &
Abhiroop Rathore 92A.
4. BAL/004/18 Abhishekh Verma Challenges of Income Taxation
5. BAL/005/18 Scope of tax avoidance under the
Abhyudaya Yadav Income Tax Act, 1961.
6. BAL/006/18 Adhiraj Lath History of taxation in India.
7. BAL/007/18 The story of free India’s first Income
Aditi Tiwary Tax.
10
8. BAL/008/18 Impact of multiple taxation on small
Aditya Puri scale businesses in India.
9. BAL/009/18 Taxation as a source of Government
Ajay Prajapati Funding.
10. BAL/010/18 Case Comment: UOI v. Delhi cloth
Aman Usmani Mills limited (AIR 1963 SC 791)
11. BAL/011/18 Income tax is one tax: case
comment: London County Council
Amita Thakur v. Attorney General (4 TC 265)
12. BAL/012/18 Case comment: Salisbury House
Ankur Shah estate limited v. Fry (15 TC 266)
13. BAL/013/18 Anmol Narang Legislative history of Section 88E
14. BAL/014/18 Impact of multiple taxation on
Annapurna Nahar medium scale businesses in India.
15. BAL/015/18 Set off and carry forward of
Anoop Bardiya Investment allowance.
16. BAL/016/18 Case comment: Deoki nandan
Anoop Rajput Agarwala v. UOI (237 ITR 872)
17. BAL/017/18 Deduction of legal and
accountability expenses: through
Anshita Dave case study.
18. BAL/018/18 Principles of retrospective
amendments to the Income Tax
Anushka Shrivastava laws.
19. BAL/019/18 Case Comment: CIT vs. Hirjee
Arpit Sanjar (1953)23 ITR 427.
20. BAL/020/18 Taxation as an instrument of fiscal
Arushi Agarwal policy.
21. BAL/021/18 Ashutosh Aarav Taxability of incomes of Judges.
22. BAL/022/18 Ashutosh Gautam Canons of Good Tax Policy.
23. BAL/023/18 Simplification of tax structure in
Ashutosh Khandelwal India.
24. BAL/024/18 Evolving concept of taxable income
Ayush Singhal in India.
25. BAL/025/18 Public finance system in Ancient
Balram Jat India.
26. BAL/026/18 Transparency in the current tax
Bhavya Gupta scheme of India.
27. BAL/027/18 Challenges before the current tax
Bhumika Chouksey policy of India.
28. BAL/028/18 Scheme of deductions in Income
Bulbul Kumari under IT ACT, 1961.
29. BAL/029/18 Charvi Yadav Challenges of tax revenue collection
30. BAL/033/18 Investigation into causes of Tax
Gaurav Dauneria Evasion
31. BAL/034/18 Residence based taxation system
Harshit Rathore under International Tax Regime.
32. BAL/035/18 Role of Tax authorities in detection
Himanshu Chhangani of Tax Frauds.
11
33. BAL/036/18 Analysis of amendments introduced
Hiya Prakash by Finance Act 2020.
34. BAL/037/18 Hrithik Jatwa Assesee under Income Tax Act.
35. BAL/038/18 Role of tax Authorities in prevention
Ipsita Ghanshala of tax Frauds.
36. BAL/039/18 Limitations of Income Tax
Ishaan Tripathi Appellate Tribunal
37. BAL/040/18 The Story of India’s first Income
Ishita M. tax: 1860
38. BAL/041/18 Judicial review of decisions of
Ishita Shrivastava ITAT.
39. BAL/042/18 International Taxation as an
Jayant Parmar emerging global regime
40. BAL/043/18 Case Comment: Savita Kapila v.
Jyoti Singh ACIT.
41. BAL/044/18 Failure of Assessment officer to
comply with sec. 144C of IT Act,
K. Devkaran 1961.
42. BAL/045/18 Income Tax rules on Online
Kanchan Verma Gambling win in India
43. BAL/046/18 Change in functioning of ITAT as
Kanishka Sihare per Finance Bill 2021.
44. BAL/047/18 Faceless Income Tax Appeal
Kaveesha Pandey Scheme 2020.
45. BAL/048/18 Khushi Bagga Decoding Finance Bill 2021.
46. BAL/049/18 Compensatory tax theory through
Kishan Parihar the eyes of Indian Judiciary.
47. BAL/051/18 Case Comment: K. Nirai Mathi
Azhagan vs. UOI. (2020)423 ITR
Kritika Choudhary 339 (Mad)(HC)
48. BAL/052/18 Dispute resolution Committee for
Lav Vyas small taxpayers: Analysis of Idea.
49. BAL/053/18 Case comment: Rajpal Singh v. CIT
Mansi Chhalotre Haryana.
50. BAL/054/18 Case Comment: PIU Ghosh v.
Deputy CIT & others. (2016) 386
Mihir Lunawat ITR 322.
51. BAL/055/18 Mukul Bhati Corelation between Arts. 265 & 13.
52. BAL/056/18 Tax reforms in the decade 2010-
Muskan Katthal 2020.
53. BAL/057/18 Administrative Simplicity as a
necessary element in a sound
Nayan Katariya taxation scheme.
54. BAL/058/18 Contribution of tax scheme in
Niharika Arya ensuring price stability.
55. BAL/059/18 Justifications for compulsive nature
Nilesh Kumar of Tax.
56. BAL/060/18 Contribution of Tax scheme to
Nishant Pandey employment generation
12
SECTION-B
57. BAL/061/18 Difference between Tax, fee, and
Nitin Soni cess.
58. BAL/062/18 Powers of Income Tax authorities to
Nitya Malviya collect information: conflicts
59. BAL/063/18 Linking of PAN and Aadhar: Utility
Pankaj Mehta vs. issues.
60. BAL/064/18 OECD model convention on
Paritosh Mishra International taxation.
61. BAL/065/18 Collection and recovery of taxes:
systemic improvements in past five
Payal Rajput years.
62. BAL/066/18 Poorva Vatsa Tax recovery officers.
63. BAL/067/18 Are Tax treatise a rational choice for
Prachi Sharma International tax administration.
64. BAL/068/18 Taxability of Income from other
Pragati Shakywar sources.
65. BAL/070/18 Utility of Double Taxation
Pranshu Chaudhary Avoidance Agreements
66. BAL/071/18 Common International Problems of
Prateek Yadav taxation
67. BAL/072/18 Federal balance between centre and
Priyanshi Budholia State through revenue distribution
68. BAL/073/18 Extent of residuary power of centre
Rachit Gupta in Taxation scheme of India
69. BAL/074/18 Evolution in the definition of
Residence under Income Tax Act,
Raghav Parashar 1961.
70. BAL/075/18 Rajeev Meena Lacuna in the Tax Scheme of India
71. BAL/076/18 Lacunae in the Direct Tax regime of
Ram Tiwari India
72. BAL/077/18 Reetesh Sahu Constitutional scheme of Taxation.
73. BAL/078/18 Richa Dixit Taxing power of Local Authorities.
74. BAL/079/18 Utility of DTAA: Bilateral vs.
Rishab Pillai Multilateral
75. BAL/080/18 Rishabh Gupta Taxing agricultural income.
76. BAL/081/18 Rishiraj Bhati Norms of Interpretation of Tax Laws
77. BAL/082/18 Limitations on Benefits clause in
Ritu Janjani DTAA.
78. BAL/083/18 Hurdles in revenue generation in
Rohit Parteti India.
79. BAL/084/18 e-assessment (PAN based
assessment) by CBDT: problem and
Rupal Yadav utility.
80. BAL/085/18 Rupesh Bansod Basic elements of tax.
81. BAL/086/18 Taxability of Digital Currency in
Sahaj Choudhary India
13
82. BAL/087/18 Preventive principles of
Saloni Singh Retrospective Taxation
83. BAL/088/18 Contribution of tax scheme in
Sangita Shah reducing income inequalities.
84. BAL/089/18 Promotion of social welfare through
Sanidhya Kshirsagar taxation.
85. BAL/090/18 Modern application of Adam
Smith’s theory on canons of
Sanket Solanki Taxation
86. BAL/091/18 Case comment: Shree Chaudhary
Transport Company v. Income tax
Santwana Sachan Officer.
87. BAL/092/18 Arguments against compulsive
Sanya Dhakad nature of Tax.
88. BAL/093/18 Shaileshwar Yadav Effect of Gender in Tax compliance.
89. BAL/094/18 Ability to pay theory of taxation
Shashank Tiwari through judicial pronouncements.
90. BAL/095/18 Residuary power of the Union and
Shobhana Uladi the power to levy taxes.
91. BAL/096/18 Income Tax Act and Rules: Section
Shreya Srivastava 14A read with Rule 8D: Analysis.
92. BAL/097/18 Taxability of Capital gains under
Shreyansh Vagrani Sec 45 of Income Tax Act, 1961.
93. BAL/098/18 Role of CBDT in general
Shruti Gogde administration of Income tax Act.
94. BAL/099/18 Restrictions on the powers of tax
authorities to utilise the disclosed
Shubham Pandey information of Taxpayers.
95. BAL/100/18 Section 271AAD, IT Act, 1961:
Shubham Saxena critical analysis.
96. BAL/101/18 Case comment: Maxopp investment
ltd. v. CIT (TS-5830-HC- 2011
Siddharth Chouhan (Delhi) O)
97. BAL/102/18 The Direct Tax Vivad se Vishwas
Somya Agrawal Act, 2020
98. BAL/103/18 Summoning Income Tax return vs.
Sparsh Rawatkar Right to Privacy.
99. BAL/104/18 Stuti Srivastava Safe harbour rules.
100. BAL/105/18 Ancient Indian Civilization on
Shubham Gandhi Taxation
101. BAL/106/18 Problems in Rural communities in
Personal Income Tax
Sudhanshu Bharadwaj Administration.
102. BAL/107/18 Case Comment: Shivraj Gupta
Sumit Parashar v.CIT, delhi ((2020) 425 ITR 420)
103. BAL/109/18 Court actions under the scheme of
Swapnil Pal IT Act, 1961
104. BAL/110/18 Rules to protect taxpayers under
Swapnil Pandey Income Tax Regime
14
105. BAL/111/18 Case Comment: UOI & others v.
Exide Industries ltd. and another.
Swati Dehariya ((2020) 425 ITR 1)
106. BAL/112/18 Criminal consequences of tax review
Vaishnavi Pathak under IT Act, 1961.
107. BAL/113/18 International Taxation: An answer to
Vaishnavi Singh globalized economy.
108. BAL/114/18 Alternate means of dispute
settlement under the scheme of IT
Vartika Agarwal Act, 1961.
109. BAL/115/18 Verification by the tax Authorities
of compliance with tax laws:
Vidhi Gupta challenges
110. BAL/116/18 Exemption in respect of charitable
Vikash Das trust and society.
111. BAL/117/18 Levy of Penalty u/s 271(1)(c) of IT
Vivek Athankar Act, 1961- debatable issues.
112. BAL/118/18 Taxability of deemed dividend u/s
Yash Garg 2(22)(e)
113. BAL/119/18 Taxation scheme of India during
Yashasvi Mujalde British Rule.
114. BAL/121/18 Impact of Taxation on Investment
Shivansh Parihar decisions.
115. BAL/122/18 Vibhor Mishra Adam Smith’s Canon’s of Taxation
116. BAL/123/18 Impact of Constitutional scheme of
Snehil Dadhich taxation on Indian Federalism
117. BAL/124/18 Retrospective Taxation: a mess or a
Reet Bose boon?
7.0 Instructions to Students

• All students shall carry bare act of the relevant statues as per the list supplied under the
head: Reference Material.
• Some Important judgments are listed hereinbefore, students are advised to download
these judgements and are further advised to prepare their short notes to enable
meaningful discussion in classroom.
• The above teaching schedule is tentative and is subject to change as per the need and
requirements of the session.
• The articles enlisted hereinbefore shall be supplied to the students as part of their
reading material. It is advised that the students join the class with short notes prepared
on relevant articles as to ensure a fruitful class discussion.
15
• Instructions regarding the projects will be supplied to the students during assignment
of Project topics. The students are advised to strictly adhere to the same during making
of their projects.
Ruchira Chaturvedi
Assistant Professor
(Course Teacher)
16
Public Finance in Ancient India
Author(s): Benoy Kumar Sarkar
Source: The Annals of the American Academy of Political and Social Science , Sep., 1921,
Vol. 97, The Revival of American Business (Sep., 1921), pp. 151-169
Published by: Sage Publications, Inc. in association with the American Academy of
Political and Social Science
Stable URL: https://www.jstor.org/stable/1015334
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65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
All use subject to https://about.jstor.org/terms
PUBLIC FINANCE IN ANCIENT INDIA 151
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case the American Government under- festly
festly our
our duty
dutyto toseek
seekthe
theservice
service ofof
took a similar engagement. The latter humanity
humanity by by reserving
reservingourourstrength
strength
agreement was not realized and there- and our resources for the difficult and
fore the Franco-British treaty lapsed. anxious days of reconstruction and
President Wilson, in neglecting torecovery when peace comes."
build his idealistic structures on sound The days of a peace which is uncer-
economic foundations, erected a pre- tain both at home and abroad are
carious work which was incapable of inconceivably anxious and difficult
practical realization. France, thanks It is the part of the United States to
to her extensive resources, both national shorten these days by contributing to
the economic restoration of the world.
and colonial, exploited by an industrious
Public Finance in Ancient India

By PROFESSOR BENOY KUMAR SARKAR
Member of the National Council of Education of Bengal and Director of the
Panini Academy of Allahabad, India
BUDGET making is an essentially In spite

spite of
of the
thecomparative
comparativeabun-
abun-
modern institution. It is only
dance
dance of
of reliable
reliabledata
datano
noingenuity
ingenuity
ofof
modern research has been able to recon-
since the time of Napoleon that regular
struct the sheet of liabilities and assets
estimates of receipts and expenditures
of the Roman Empire for any period,
have been yearly prepared in France.'
but the administrative history of
1 Palgrave's Dictionary of Political Economy
Hindu
(Art. on "Finances-France") Volume II, p. 68;
India is yet in its non-age. It
Leroy-Beaulieu's Traite de la science des is
finances, out of the question, therefore, to
Volume II, pp. 11-12 (8th Edition). attempt such wide guesses about the

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152 THE ANNALS OF THE AMERICAN ACADEMY
annual expenses even of the Maurya much too naive for an imperial organi-
Empire (B. C. 32-185), for which in- zation5 based as it was on the triumphs
formation is more plentiful than for of dig-vijaya (conquest of the four
others, as has been done in regard to quarters of the world) and military
the Athenian state by Bokh2; or about aggression6 no less than on the "vic-
the total revenues as has been done in tories of peace." The reporter was a
regard to the Roman Empire by Gib-layman and naturally failed to notice
bon and Guizot3; nor is it possible to the "sinews of war" that operated the
test the fiscal policy of Hindu states by administrative machinery of pax sdrva-
the modern canons of taxation, espe-bhaumica (peace of the world-em-
cially on the complicated questions ofpire).7 It is on such facile statements
justice, ability to pay, or equality of about "light taxes" and "religious
assessment. charities," however, that students of
comparative politics in the nineteenth
A LAY BALANCE-SHEET (C 640 A. D.) used to found their estimate of
century
A contemporary account of thethefi-Hindu political systems. Today
the
iiances of the Vardhana Empire (606-states of old Asia are treated by
scholars more or less in the same light
647) is furnished by Hiuen Thsang,
as the feudal kingdoms of medieval
the Chinese state guest of Harsha.
It is said that forced labor was notEurope; that is, as organizations mod-
exacted by the government. When on a private household, the domes-
eled
tic establishment of the ruler.8
the public works required it, labor was
exacted but paid for in strict propor-
tion to the work. Those who culti- SOUTH INDIAN REVENUES (C 900-1300
vated the royal estates paid a sixth A. D.)
part of the produce as the share ofLet
theus examine the imperialism of
state. The river passages and the the Hindu sarva-bhaumas (world-rulers)
road barriers were open on payment ofon the basis of their own char-
a small toll. In regard to public ex- ters, decrees and promulgations (shd
penditure there are said to have been sanas) that have been rendered acces
four charges on the private demesnes of sible by the archeological and epi-
the crown. The first charge was thegraphic investigations of recent year
management of the affairs of state andThe statesmen of the Chola Empir
the provision for sacrificial offerings. (900-1300) would appear to have been
The second was for providing subsidiesat their wits end in devising new form
for the ministers and chief officers of
of revenue. No complete list of al
state. Honorariums for men of dis-
the heads of government income
tinguished ability constituted the third
available for this South Indian (Ma-
charge, and the fourth was religious
dras and Mysore) state, but several
charity. Altogether, in the Chinese
scholar-pilgrim's opinion, the taxesSee
onthe extent of the Vardhana Empire oln
the map facing p. 340 of Smith's Early History of
the peoplewere light, and personal serv-
India (Edition 1914).
ice required of them was moderate.46 Bana's Harsha-charita (Cowell's translation),
Evidently we have here the material
p. 188.
7Vide the author's article on "The Hindu
for a very elementary balance-sheet,
Theory of International Relations" in the
American Political Science Review for August,
2 Schomann's Antiquities of Greece, p. 445.
3 Ramsay and Lancian's Roman Antiquities,
1919.
(16th Edition), p. 282. 8 Article on "Finance" in the Encyclopaedia
4 Beal's Si Yu-ki, Volume I, pp. 87-88. Britannica ( ltht Edition).

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Tamil inscriptions9 describe the im- erty, as contrasted with the real
inunities from dues to the state estate, was assessed in the form of
enjoyed by certain villages through
"fixed capital" like looms and oil
the grant of royal charters. From mills. Tanks, also, were included in
the schedule of these "privileges" we the list of property dues.
can automatically see a great part of A tax was realized on weights,
the other side of the shield; namely, whatever it might imply. Some light
the normal contributions to the im- may be thrown on this item from the
perial treasury for which each village legislation of the Mauryas. In the
was ordinarily liable. Artha shastra of Kautilya (c 300 B.C.)
The available list indicates only thewe read that no trader was allowed to
revenue from villages or village unions;have his own weights and mleasures.
but it is questionable whether we are Every (lay the business men had to
justified in treating it exclusively as have their scales and weights stamped
that which should technically be a afresh by the government.'4 The au-
branch of "local finance." The village thorities realized a revenue from the
through its panchayat (council of five;stamps. Now if this custom of the
that is, a body of competent men) wasfirst Hindu empire were followed by the
indeed responsible as a unit for the Tamil sarva-bhaumas, we may consider
realization of all public income within this business tax on weights to be
its area10; but the heads of income do another property tax.
not seem to have been classified and It is doubtful if the business or
specifically ear-marked as local and license tax paid by the Tamil gold-
national. 'I'hey can easily be brought smith should not be scheduled as a
(lown to the tripartite division into charge on property, but "unripe
taxes, fees and prices.11 fruit" in the Kartigai month, though a
In the first place, there was a "tax in
levy in kind, must be regarded as such.
mnoney."12 It may have been a direct tax
Stocks, bonds and mortgages that are
so prominent in modern economic
per capita like the poll tax of 1377-1380
in England during the Hundred Years' life and necessarily occupy an impor-
War, or the tributumn in Rome. tant place in the taxation of property,
Something like a "general property are naturally not to be looked for in
tax" is to be understood in several the Hindu finances of the tenth,
imposts. Like the horses and cattle eleventh, twelfth and thirteenth cen-
taxed by medieval German states13 turies. However, it is interesting to
"animals" were counted to contribute note that the "sonship" was assessed
to the Chola exchequer. The furni- among certain social classes; for
ture, clothing and ornaments are notexample, the "right hand" and "left
enulnerated in the schedule of taxes hand" orders. The public income for
on "personalty," but "movable" prop- the sonship dues was identical with
that accruing from inheritance tax, or
9 South Indian Inscriptions, Volume II, Pt.
i, No. 22. estate or "death duty"; that is, the
10 Aiyangar's Ancient India, pp. 161, 163-164. charge made by modern governments
1 Plehn's Introduction to Public Finance, pp. on the transfer of property from the
76-79, 92-100; Seligman's Essays in Taxation, dead to the living.
pp. 430-431.
None of these property dues were
12 The list can be seen conveniently in
Aiyangar, pp. 165-166, 180, 181-182. 14 Shamasastry's article on "Chanakya's
13Seligman's Essays, p. 39. cf. Aghnides' Land and Revenue Policy" in the Indian
Mohammedan Theories of Finance, pp. 526, 527. Antiquary 1905, pp. 50-51.

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prices charged by the government for Kulottunga's legislation (1070-1118) by

economic or other services rendered to
which the state charged a seigniorage
the people. They were all deduced upon coining.19
from the power of the state to obtain Income from the services of the
revenue by "compulsory dues and state is mentioned in threq connections.
charges upon its subjects"; that is, First, the villagers had to contribute
taxes in the strictest sense of the term. their mite to maintain the watchman
None of them, moreover, can be re- who was placed over the vettis (paths).
garded as income from "state prop- This was for obvious reasons a regular
erty" and "state monopolies,"-the rate or cess, though local, for one of the
minimum functions of government.
two sources that contribute about 25
per cent of French revenues.'5 Secondly, the state seems to have sup-
Taxes on consumption were not plied
ne- the karman to measure the paddy
glected by the Chola Empire. Thereof the cultivators. He had to be paid
for by the rural commune at a certain
was a tax on bazaars. The levy of tolls
was common. The tax on trade or rate. Lastly, a water rate or "tax
sales, like the Athenian and Roman on water courses" for irrigation was an
excise of 1 per cent,'6 was anotherinevitable charge upon every peasant.
regular feature of the financial system. Mines, though they must certainly
As taxes on the necessaries of life, have been important sources of Chola
these excise duties could not but touch revenues, are not mentioned in the
the community at every grade. They inscriptions, nor is there any reference
served, therefore, economically speak- to the customs duties. Neither of
ing, as real poll taxes though of an these could form part of the regular
"indirect" denomination. We do not dues of a village to the government.
know if salt was a state monopoly asWe have now to add the revenue
under the Roman republic,17 or asfrom in property par excellence, the "rea
Maurya India, but the French gabelle'1 estate" as it is called. Not only in
was not to be forgotten by the Tamils primitive communities, but in Rome
who were too mindful of their revenues also, even under the Empire, land
to overlook tapping this necessity of revenue was the mainstay of the
life that is bound to obey the law of government. This land revenue was
"inelastic demand." essentially a rent from "crownland,"
A rent or license tax was realized ager publicus; that is, public domain.
from the fishers. Taxes on the col- It took the Romans a long time to get
lection of rents also are mentioned. used to the idea of a non-land revenue.
Taxes like the tributum were considered
Tax-" farming" may thus have been
a fact in certain directions. Further- by the republic as "forced loans" to be
more, the "penal power" of the state repaid out of the loot of conquest, and
was effectively made use of to co6p- these were resorted to only when the
erate with its finance department.proceeds of the "domain" proved
It is known only that apothecaries wereinadequate to meet the extraordinary
fined for "rotten drugs." An income expenses.20
of minor character is obvious in
19 Aiyangar, pp. 149-150.
15 Palgrave's Dictionary, Volume II, p.2069.
Seligman's Essays, p. 35. The same Roman
16 SchSmann, p. 449. views are expressed in the sixteenth century by
17 Ramsay, p. 277. the French political philosopher, Jean Bodin, in
18 Brissaud's History of French Public
his Law, p. de la republique (Book VI, ch. ii,
Les six livres
505. Des Finances).

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PUBLIC FINANCE IN ANCIENT INDIA
Under the Tamils, South India's

to be inferred, communal property in
certain lands is also assured to village
financial backbone must have been
furnished by the realizations from
panchayats by the legislation of Raja-
land. The rate was not low. The raja the Great (985-1018).25 We may
early Roman Empire used to levy take it that so far as the Chola Empire
land
revenue at the rate of one-tenth of the is concerned, land was owned both in
produce,21 but in Chola India the gov-severalty as well as in common.
ernment demand was one-sixth. This This does not, however, settle the
high rate was the normal bhdga or question as to how far the crown was
share of the government in land prod- the legal proprietor of land; that is,
uce according to the stereotyped how far the "village community" or
"pious wish" of the dharma-shastras the individual cultivator were but
(law books) and nIti-shastras (political
"tenants" of the state landlord (paying
science).22 And yet in Realpolitik economic "rents" for the usufruct of a
this conventional norm was but a fiscal property) and how far their dues were
camouflage that may deceive the "direct taxes" paid on their own
academic student of financial history "immovable" possessions. It is the
but did not fail to press the taxpayers tendency of modern Indologists to
themselves. For in Chola legislation postulate all lands as state property
the additional imposts on land, besides and therefore the income from land as
the tolls and octrois, were clearly crown rent. It is hardly possible to
defined as being one-tenth of the maintain this position on the basis of
yield. The total revenue from landactual proprietary documents, shd-
was thus four-fifteenths or more than
sanas (laws or charters) and epi-
25 per cent of the gross outturn in
graphic records. For all practical
Rajadhiraja's time (1035-1053) .2 purposes the presumption should be
An interesting theoretical study in
that ancient India did not know of
connection with the Chola revenue state landlordism; that is, land nation-
from real property would be that bear-
alization,26 except in very limited areas.
ing on its precise character as to The land revenue of the Hindu states
whether it was rent or tax. Com- was, therefore, generally speaking, a
munism in land ownership is tax,
prac-
but, as Sir Robert Giffen27 explains
tically unknown in the Hindu law away the distinction between rent and
books.24 The trend of ancient legal tax, the fact of a government levying
thought on the subject of land tenureso general a charge may be held ipso
is to regard it as an individual concern, facto to convert the charge into a tax
but in Tamil inscriptions, while thehaving much the same economic effects
individualistic tenure (the ryotwari, toand consequences as a tax. In strict
use the British Indian term) is easily theory, "where the government makes
a charge, it levies a tax." The features
21 Ramsay, p. 276.
of monopoly and compulsion on the tax-
22 Vide the author's article on "Hindu Polit-
ical Philosophy" in the Political Science Quar- payer associated with all forms of land
terly for December, 1918 and on the "Hindurevenue "make the charges difficult to
Theory of the State" in the same journal for
March, 1921. 25 Aiyangar, pp. 161, 163-164.
23 Aiyangar, pp. 181-182. 26 Vide the discussion on public lands in Rau's
Finanzwissenschaft (1864), pp. 127-133. Cf.
24 Jolly's Recht und Sitte, pp. 93-96; Hopkins'
India Old and New (Land Tenure), pp. 221, 225,
Bodin, pp. 628-634 (Edition 1578).
229; Macdonell and Keith's Vedic Index, Vol. I,
27 Article on "Taxation" in the Encyclopedia
pp. 245-246. Britannica.

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156 THE ANNALS OF THE AMERICAN ACADEIMY
distinguish logically from other taxes." the fifteenth and sixteenth centuries
On the whole, the Chola revenues that the right of government to levy
were bulky in dimensions and the "taxes" on the people became estab-
people of southern India heavily lished or rather reestablished in the
taxed. Only one ruler is spoken of as western world. For purposes of com-
having slightly reduced the amount parative politics it is necessary to note
of the people's dues. Kulottunga's that the Chola finances do not exhibit
name became a household word in the features of the disintegrated feudal
Madras of the eleventh and twelfth polity of medieval Europe. The rev-
centuries, for in 1086, the year of the
enues of the Chola Empire possessed
Domesday Book, he abolished the the same variety in form as the Roman-
tolls28 after the completion of the Imperial and the modern French.
cadastral survey,-the second such They may be classified, if necessary,
survey of the Chola Empire, but the according to the Latin patrimonia,
general story of les nerfs de la re-
tributa and vectigalia, or the more
publique, the "nerves of the state," as
popular domaine, contributions directes,
Bodin puts it, under the Chola Empire and contributions indirectes of modern
was uniform. Like the governments of science. Of course the right of taxa-
Europe in the days of Adam Smith,29 tion was firmly planted in the political
the south Indian monarchs knew how consciousness of Chola India.
to exact as much as they could, "only
THE CONSUMPTION-SCHEDULE OF
desirous of finding the easiest means of
HINDU STATES
doing so." The one redeeming feature
seems to be that the empire was con- It is not difficult to explain why the
scious of the high price at which paximperial structures of the Hindus
sdrva-bhaumica was being enjoyed byshould have been heavily assessed
the people. Raja-raja the Great ac-organizations. The reasons are to be
cordingly instructed the finance officerssought in the great variety and
to be elastic in the collection of reve- quantity of the state's "consump-
ltiles.30 tion." They are essentially identical
Taxation as such was unknown in with what economists like Nitti and
France previous to 1300.31 As a Leroy-Beaulieu34 have traced in the
function of the state and as an insti- growth of public expenditures in
tution of "public law" it virtually modern times. The functions of
ceased to exist with the destruction of Hindu governments were manifold.
the Roman Empire by the Teutons. Consciously or unconsciously, whether
In its place was substituted the "pri- backed by a definite theory of niti
vate claim" of customary dues, fines (statecraft) like the late German
or tolls by landlords and barons.32 Empire or not, every state in India was
The transition from this "feudal" to a "culture-state." The invariable end
"modern" finance was a lengthyof every Hindu polity was the protec-
process in England.33 It was not be-tion and development of dharma.
fore the rise of the nation-states in Like Kultur and Arnoldian "culture,"
28 Aiyangar, 149-150. dharma is a very comprehensive cate-
2!) Encyclopedia Britannica (Taxation). gory. Exceedingly elastic in its sig-
30 Aiyangar, p. 182. nificance, like the English term "law,"
3' Brissaud, pp. 487-491; Leroy Beaulieu, Vol.
the concept is the basis of distinction,
11, pp. 6-7.
32 Encyclopedia Britannica (Finance). the fundamentulm division is, between
33 Ibid. (article on "English Finance"). 34 Leroy-Beaulieu, Vol. II, pp. 171-181.

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
man and the brute. Dharmena h*ndh The beautifying of cities and measures
(those who have not dharma) says the for street-cleaning, sanitation, etc. were
Gitd, pashubhih samandh (are like theimportant items of state business in
beasts). In dharma, the analogue ofChola territories.37 The promotion of
the "virtue" of Plato's Republic, is toaesthetic as well as "productive" arts
be found the differentium between the and crafts was a normal function of
human world and that of pashu oralmost every Hindu state. The en-
"beasts and birds" as Hobbes would couragement or "protection" of skilled
have it. An agency for the promotion workmen, the steady maintenance of
shipbuilders and naval architects,
of humanism, that is, for the advance-
ment of all that lets "the ape and and state employment of miners and
tiger
other industrial artisans, were among
die" and develops the people's material
and moral interests,-of anything, induties of the Maurya civil service.
the
short, that is conducive to national Shipbuilding38 and manufacture of
well-being was necessarily a multi- arms and ammunitions were in fact
functional corporate organism. The state monopolies. Wood cutting, car-
dharma-states of India had, therefore,pentry and smithery works came, there-
before them an almost unlimited fore, under the state control. All
range of what in scientific parlance governments
is undertook to lay out
known as "developmental" activity. parks and grounds for recreation and
Not of an Arcadian character could pastime. Pharmaceutical gardens
thus be the "appropriations" of were
the state necessities. Palaces and
Hindu empires. public halls were likewise some of the
We need not enumerate the duties of "useful magnificences" that no state
government stated in the nUti-shastras. could dispense with. The Pandya
Let us note only the functions of the
rulers (c 100-300 A.D.) were patrons of
historic state systems that may beparishads or academies of literature.39
gathered from the inscriptions andThe Guptas40 (330-600) and the
contemporary reports. The economicPalas41 (c 750-1150) considered univer-
development of the country was un-sities among important charges on the
dertaken by the Maurya, Gupta, imperial exchequer. Temples and vi-
Kashmirian, Tamil and Ceylonese gov- haras or monasteries were built at
ernments. Their care for irrigation35 state expense both by the Vardhana
in different parts of the empire is a and Chalukya emperors of the seventh
solid testimony to their recognition of century.42 Not the conventional re-
the secular interests of the state. The ligion and morality of the time alone
construction of magnificent roads was found an asylum in these institutions.
another function along the same line.36 The financial authorities must have re-
garded them as schools of higher learn-
35 Epigraphia Indica 1905-1906, pp. 46-49;
37Venkatarama Ayyar's Town Planning in
Gupta Inscriptions (Corpus Inscriptionum Indi-
carum), pp. 56-65; Kalhana's Raja-taranginee
Ancient Deccan, pp. 42, 44, 51.
(Stein's translation), Book V, verses 68-117;38 McCrindle's Ancient India, p. 86; Strabo,
Venkayya's "Irrigation in Southern IndiaXV, in 46; Mookerji's Indian Shipping, p. 102.
ancient times" in the Archaeological Survey of
39 Aiyangar, pp. 70, 337, 359, 360, 379-82.
India, Annual Report, 1903-4; Deakin's Irri- 40 Takakusu's Itsing: Record of the Buddhist
gated India and Ceylon, 239-242, 252; Aiyangar,
Religion, pp. 65, 154, 177.
185-188. 41 Indian Antiquary, 1888, pp. 308-311.
36 McCrindle's Ancient India (Megasthenes,42 Beal's Si Yu-ki, Vols. I and II (see Hiuen
XXXIV), p. 86, Arrian's Indika III; Aiyangar,
Thsang's account of any of the states visited by
him).
188-189; Law's Hindu Polity, Vol. I, pp. 68-75.

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
ing as well. From the cultural stand- endowments in the Andhra Deccan may
point these were at once the art serveas a standingexampleof the manner
galleries and museums of the people. in which the people cooperated with the
As resorts for the relief of the sick, thestate and supplemented its activity
distressed and the poor the ostensiblyalong developmental or cultural lines.
religious buildings discharged an im- One of the hill caves in Govardhana
portant economic function like the(Nasik District in the Bombay Presi-
Catholic institutions of medieval Eu- dency) was excavated at Ushavadata's
rope. Add to all this the minimum expense.4 Among his numerous bene-
functions of every state as state, factions we read of the gift of 300,000
namely, the protection of person and cows, the construction of flights of
property, or national defense by army steps on a river and the giving away
and navy, as well as internal policingof sixteen villages for religious pur-
by adequate executive and judicial poses. This philanthropist used to
staff. The extent of these minimum maintain 100,000 priests and scholars
functions can be realized from the fact with board. He bore the marriage
that in the Maurya Empire the appro-expenses of eight Brahmanas at Som-
priations on this head absorbed 25 pernath. His quadrangles, public halls
cent of the total revenues.43 and halting places, as well as gardens,
tanks and wells were spread over the
PRIVATE ENTERPRISE IN PUBLIC
country from Broach and Bassein,
WORKS
the ports on the Arabian Sea coast, to
It is not necessary to compare the Dashapura in Malwa, far inland in
functions of Hindu states item by itemUpper India. Ferry boats were placed
as regards quantity and variety with by him over six rivers in northern
the long list of modern state activities Bombay. Both sides of these rivers
that have been daily expanding under were also furnished with rest houses
the impact of socialism. The social- and equipped with arrangements for
istic trend of India's dharma-states is the distribution of water to travelers.
Moreover, he founded certain bene-
apparent enough. It must not be sur-
mised, however, that every publicfactions for the support of several
work among Hindus was the under- academies of Vedic learning in various
taking of the state, for the patriotism parts of the Maratha country.
of citizens was responsible in every Such private endowments for public
age for the founding and maintenance purposes were undoubtedly numerous
of useful institutions. In Gupta Indiain every epoch of Hindu polity. But
hospitals44 were built and endowed by none the less the financial burden of
the public spirited towns folk of Patali-public administration weighed heavy
putra (near modern Bankipore in upon the "pillars of the state." The
Bihar Province), the Rome of the Hin- government could not afford to depend
dus. Rudra-damana (cA.D. 150), a solely upon "local patriotism" and
satrap of Gujarat, repaired the voluntary contributions. The ex-
Sudarshana reservoir at his own expenses of national housekeeping had to
pense, the ministers having refused beto
met regularly from the resources of
supply funds from the government the empire. The financiers, therefore,
treasury.45 Ushavadata's (c 100 A.D.)
had to raise the necessary revenue by
43 Indian Antiquary, 1909, p. 963.
hook or by crook.
44 Beal's Travels of Fa Hien, p. 107. 46 Nasik Inscriptions, No. 17; R. G. Bhand-
4 Epigraphia Indica, 1905-1906, loc. cit. arkar's Early History of the Deccan, Sec. IV.

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
(B. C. 322-B. C. 185). One of the

VITAL STATISTICS
functions of the gopa, the officer at the
Census47 was an important institution lowest rung of the executive hierarchy,
of the Mauryas. It was used by the was to register the probable dues of
municipal corporation of Patali-putra the villagers in "working men"50 along
as well as by the imperial civil service. with taxes, tolls and fines. It is not
The gopa or village magistrate, the clear whether we are to understand
stlhanika or district magistrate, as well that the empire used to receive contri-
as the ndgaraka or mayor of the city butions in "services" like the Roman
were alive to the importance of vital republic in its earlier stages,-for
statistics. The numbering of persons, instance, such as is recommended by
houses, and cattle as well as the meas- Vishnu,51 Manu,52 and Shukra.53 In
urement of lands, pastures and gardensMegasthenes' account of India, we
furnished the samdhartd or collector- again read that one of the objects of
general with definite data for the valua- the vital statistics kept by' the census
tion and assessment of the people's officials of the municipal corporation of
wealth.48 The cadastral surveys or- Patali-putra was the levy of a tax.54
ganized by the Cholas49 in 986 and If some particular tax is to be singled
1086 were also calculated to ensure the out because of this statement it was
same end. Both these instruments evidently a poll tax on the citizens
tended to bring about centralization
per head.
and consolidation of the public reve-
The financial authorities themselves
nues and were indeed, together classified
with the revenues into seven prin-
the war office, the judiciary and the
cipal groups according to the kind of
executive service, the most effective
resource tapped by them. "Fortified
means of establishing pax sarva-bhau-
cities" constituted the first revenue
mica. The financial organization jurisdiction. The rashtra or "coun-
aimed at by the Hindu empires was thus try" districts constituted the second.
akin to the "integration" of national Mines were treated as a distinct
outlays and revenues that have been source of public income. Gardens and
the steady achievement of modern forests also formed two independent
Europe since the fifteenth and six- groups. Quadrupeds like cows, buf-
teenth centuries. It is the system of faloes, sheep, goats, asses, camels,
the Roman Empire in classical times horses and mules likewise contributed
with its official tax collectors who re- their quota. The seventh head was
placed the publicani or revenue- traffic both by land and water.
"farmers" of the republic that should Each of these sources is described
be kept before the mind's eye while in detail in the Artha-shastra.55 The
appraising the public expenditure, several items of income from the
national resources or heads of income, "country," for instance, the second in
and financial administration of Hindu the above grouping, comprised six
India from B. C. 332 to 1300.
51 Chapter III, 32 (The Sacred Books of the
KAUTILYAN FINANCES (C 300 B. C.) East Series).
We shall now proceed to analyze 52 VII, 138.
63 Chapter IV, Sec. ii, line 241 (Sarkar's
the revenues of the Maurya Empiretranslation in the Panini Office Series, Alla-
4 Law, Vol. I, pp. 106-114. habad).
48 Indian Antiquary, 1905, p. 5. 5 McCrindle's Ancient India, pp. 87-88.
49 Aiyangar, 144, 149-150, 175-177. 65 Indian Antiquary, 1905, p. 47.

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heads. Crown lands yielded the first As with the Roman Empire,56 the
revenue, known as sitd. The second chief source of Maurya income was the
head was bhaga (share) or revenue in receipt from land. In the west the
kind realized from private landlords. process of fiscal reorganization from
A special tax, bali, corresponding toHadrian to Diocletian led up to the
the dues realized by Athens for thesystem of assessment for fifteen years,
festivities was demanded for religious but in regard to the Mauryas no in-
purposes. Sundry collections known formation is available as to the period
as kara were made in money. Tdra for which the valuations were made.
was the toll realized on boats, ferries In Athens land belonged to the state.
and ships. The sixth item consisted In Maurya India certain passages of
of various dues, vartant (road-cess), the Artha-shastra may lend color to the
shulka (toll), etc. and was levied as ahypothesis as to the "public owner-
rate on all traffic. ship" of the chief "agent of produc-
tion." If Kautilya's statements may
The fortified cities contributed to the
imperial exchequer under twenty differ- be taken as "positive law" on the sub-
ent heads. These were toll, fines, ject, both land and water belonged to
weights and measures, jails, currency, the government. The people could
passports, excise, slaughter houses, exercise their proprietary right in re-
gard to all other species of property
oils, ghee (clarified butter), salt, gold-
smiths, commerce, courtesans, gam- excepting these two.57 On the other
bling, housebuilding, artisans, gate hand, this position would appear to be
inconsistent with the fact noted above
dues and religious institutions. There
that two distinct items were enumer-
were special taxes on a people called
ated as land revenue from the rashtra
Baharikas. They appear to have been
mercenary soldiers or some wealthyor country districts of the empire.
The stda was the income from the
community living at Nalanda, the
state lands. It was thus crown rent.
famous university town of later ages.
The other realization was specifically
Like Jews in Europe, this race was con-
sidered by the Hindu empire to be aknown as bhdga, the "share" of the
good victim for fleecing.
state in the "produce" of the people's
lands. The private proprietors were
Altogether, there were at least fifty
different names under which revenues known as sva-viryopajivinah. Besides,
the right of private property in real
flowed into the treasury. For our
estate was clearly recognized in the
present purpose we shall classify them
law of sales. According to the legis-
into eight modern categories: (1) land
lation in the Artha-shastra,5 village
revenue, including the income from
lands were to be sold in the presence of
forests and gardens, (2) customs duties,
forty neighbors who owned lands in the
(3) excise on sales, (4) "direct" prop-
vicinity. The state could demand
erty taxes of various denominations,only the legitimate excise on the sale.
(5) fines as penalties for all sorts of
The same proprietary right is to be in-
offense, (6) economic "earnings" orferred from, though also limited by,
profits from the commercial under-
takings of the naval department, (7) 66 Arnold's Roman System of Provincial Ad-
income from the state monopolies inministration, pp. 203-204; Ramsay, pp. 275-
281; Encyclopedia Britannica ("Finance").
extractive (mine, salt, etc.) and other
67 Artha-shastra, II, xxiv, cf. the Mohammedan
industries, (8) miscellaneous collec-theory of public domain, Aghnides, pp. 500-521.
tions like port dues, etc. 68 Indian Antiquary 1905, p. 10; Law, 161-162.

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the ruling that lands could be sold by Gardens were assessed at the same
cultivators only to cultivators, and rates as cultivated lands. An addi-
that persons enjoying revenue-free tional one-sixth or 16* per cent had
lands could sell them only to persons to be paid as excise on sales.62
who already had such lands. The dis- Important taxes of the Mauryas
tinction between crown lands and were twofold: customs and excise.
Along
private lands is also to be noted in the with land revenue these must
law of escheat. By the general law have
onconstituted the mainstay of
their finance. In Athens63 under Per-
the subject the rights of ownership
over houses, fields, gardens, tanks and
icles the policy of free trade appears to
temples were forfeited if proprietors have been adopted, as the city de-
took no cognizance for a continuous pended for its food supply on external
period of five years.59 sources. Its normal customs duty was,
In the budget of the Maurya Empire therefore, as low as 2 per cent. The
as in that of the Roman we have there-Roman portoria64 (customs dues) were
fore to look for two entries, theoreti-
higher, the earliest maximumbeing 5 per
cally considered, under land revenue. cent. The extreme maximum under
The first was rent paid by the ryot orConstantine was 192 per cent. But
tenant to the state-landlord, the sec-the Maurya tariff was high enough to
ond was a "direct tax" paid by theverge on, nay, actually establish, an
citizen to the government. The im-economic "protection." Thus, in re-
perial demand from land was verygard to imported salt the empire
high, higher even than what we have demanded, in the first place, one-sixth
seen under the Cholas. For the land or 161 per cent of the entire commod-
ity,
alone,60 where irrigation was carried onand in the second place, a 5 per
by hand, the due was one-fifth of cent
theas trade or sales tax on the re-
yield. Where irrigation was carried
maining five-sixths.65 Similarly foreign
on by conveying water on shoulders liquors,
or wines and intoxicants had to
through water raised from tanks, bear lakesheavy import duties which varied
and streams the due was one-fourth, from one-fifteenth or 61 per cent to
and where irrigation was carried on one-tenth or 10 per cent of their
by "pumping" water from rivers value.66 In both cases, in addition to
(sroto-yantra) the due was one-third. the tariff the government charged an
An additional udaka-bh&ga or water extra duty in order to compensate the
rate was charged by the government at loss in the sale of local produce. Prob-
ably the total maximum may have
one-fourth or one-fifth of the produce.
The total rates ranged, therefore, approached the British customs rate
from two-fifths or 40 per cent to which though down to 1700, not gen-
seven-twelfths or about 57 per cent of erally higher than 5 per cent, rose to
the gross outturn. Provisions for the 25 per cent by 1759.67
remission of taxes are recorded, but The normal Maurya duty on foreign
it was not done on any doctrinaire 62 Ibid., p. 114.
principle. Abatements were graduated 63, 64Encyclopedia Britannica ("Finance").
according to the difficulties and cost of For a detailed account of Athenian finances see
improvement effected by cultivators.61 Schomann, pp. 432-464.
59 Indian Antiquary, 1905, pp. 9, 105, 113. 66 See details, Ibid., pp. 50, 55.
60 Ibid., p. 110. Note the 50 per cent in Mos- 67 Dowell's History of Taxation and Taxes in
lem theory, Aghnides, 529. England, Vol. I, pp. 82-88, 145-146, 163-167,
61 See details, Ibid., p. 9. 211-223; Vol. II, p. 37.
12

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162 TIH ANNALS OF THE AMERICAN ACADEMY
goods was one-fifth of their value;profit was assured to the dealer in

that is, 20 per cent. One-sixth; thatimported goods. If necessary, special
is, 16a per cent was realized from fresh instructions were issued to the proper
fruits, vegetables, pepper, dried fish,officials to accord concessions in cer-
flesh and other perishable goods. The tain particulars to foreign merchants.
rates on conches, diamonds, pearls, etc.Under these conditions it is doubtful if
were to be fixed at the custom house by the Maurya tariff should be considered
experts. Silk garments, arsenic oxide,as "protective" in any significant
skins, carpets, etc. were charged adsense. In any case its character as a
valorem from 6 per cent to 10 permeasure for revenue purposes is un-
cent. The minimum rates on the questionable.
tariff schedule were 4 per cent to 5 The
per duty of one per cent on all
cent. In order to be consistent, the sales was a regular tax of the Roman
empire dealt severely with all cases of Empire. Such an impost, call it
smuggling. The highest fine of 3,000 market due, toll or octroi, was, as we
panas or $750 was the punishment have noted, prevalent in Athens also.
prescribed for this offense by the penal The rates in Maurya India were much
code.68 No figures are available as to higher. Commodities sold by cubical
the gross customs receipts, but it may measure were charged six and one-
be surmised that the 27 per cent offourth per cent, those by weighing five
the total German imperial revenues as per cent and those by computation
accruing from customs duties alone nine and one-eleventh per cent ad
would not have been envied by the valorem.7l This tax, known by the
Maurya finance minister.9 generic name of excise or inland trade
It might seem as if the empire in- revenue, was assessed by the Mauryas in
tended almost to place an embargo ontwo ways. In certain lines, as with salt
foreign import, but there were certainand precious metals, they retained the
tendencies in the fiscal policy of the monopoly of manufacture and sale for
Mauryas in regard to international the government, but the generalmethod
trade that indicate a different character of assessment was the grant of a license
of the tariff. The protective dutiesto the vendor or manufacturer.
were high, but they were not meant to The excise branch of the revenues
be "prohibitive." On the other hand, was thoroughly centralized. The
there was a deliberate attempt on the licensing procedure was most effi-
part of the authorities to encourageciently observed. Nobody was per-
foreign imports. They regulated the mitted to sell the goods at the places
prices70 in such a way that a reasonable of growth or manufacture; for example,
fields, gardens, forests and mines.72
68 Indian Antiquary, 1905, pp. 49-50. The
fine for smuggling according to United States All commodities had to be brought to
law is as high as $5,000 or imprisonment for two the customs house or toll office near
years, or both; cf. Higginson's Tariffs at Work, the city gate. These were then
p. 112.
69 Plehn, 184.
marked with the state stamp called
"0 Indian Antiquary, 1905, p. 57. Note the abhijndna-mudrd (mark of identifi-
seven distinct expenses of marketing: shulka cation) in sindura (vermillion or red
(toll), vartant (road cess), ativdhika (conveyance lead). The tax was levied, however,
cess), gulma-deya (duty payable at military sta- only after sale. The law was very
tions), tdra-deya (ferry charge), bhaktd (porter's
strict, as evasion of the tax was a
wage), and bhdga (share of the state) that were
calculated by the customs officials in fixing the 71 Ibid., loco citato.
price of the imported commodities. 72 See details, Ibid., pp. 50, 114.

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capital offense. False statements to have seen, weights and measures were
the officials made by merchants in re- taxed.76 Gamblers had to pay a
gard to amount or price were, besides, license.77 Dramatists, players, singers
punished as cases of theft; that is, by and musicians were charged five panas
fine, mutilation or even death.73 ($1.25).78 A tax was levied from
It is evident that customs and excise prostitutes as in Athens79 and in Rome
receipts of the Maurya Empire were under Caligula.80 As a rule, cattle
much more voluminous than those of were not taxed per capita. They
the Roman Empire. Analogues for figured in the samdharta's (collector-
general's) books only in connection
this aspect of Hindu finance have to be
with excise on sale. Under abnormal
sought in the modern states, like Eng-
land, Russia and France, where half of
conditions, when an emergency finance
the national revenues is made up of the was the problem, a special due was
returns of customs duties and excises,charged on domestic quadrupeds.81
The same circumstances brought
or in the United States where virtually
the whole of "federal" revenues is painters, sculptors and artists gen-
derived from these two elements.74 erally within the tax collector's grip.82
It seems, on the whole, however,
Recent authorities on the shifting of
taxation are, for practical considera-that the Mauryas considered the taxes
tions, inclined to do away withonthe property rather as a safety valve to
formal or verbal distinction that fall back on in dire necessity than as
economists have long recognized be-
a normal source of regular imperial
tween the taxes on consumption revenues.
(like When the necessity arose
customs and excise) and the taxes(throughon war conditions) the empire
property or income.75 Using thedid not hesitate to levy what were
con-
ventional nomenclature, we havevirtuallyto "super-taxes" on both im-
mention that in addition to customs movable and movable properties of the
and excise, the so-called "indirect" wealthier classes. In the first place,
taxes, the Maurya Empire levied the rates of land tax were enhanced,83
"direct" taxes also. It has already but regions barren or difficult to cul-
been pointed out that a great part of tivate were exempted from emergency
the land revenue was a direct tax on taxation. Persons engaged in "essen-
real estate insofar as land was the pri-
tial industries," for example, in agri-
vate property of citizens. The taxes culture, forestry or elephant training
on personalty or movable property were likewise granted a privilege. In
have now to be enumerated. the second place, contributions in"serv-
In Kautilya's list we do not have theices" were levied from "lacklanders,"
taxes on looms, oil mills, etc. that areespecially from culprits and bad char-
mentioned in the Chola inscriptions; acters.84
nor do the Tamil taxes on "sonship" In the third place, persons rearing
or inheritance and succession appear
in the Maurya statements, but, as we 76 See details, Indian Antiquay, 1905, pp. 50-
51.
77, 78 Ibid., 58.
73 See details, Ibid., pp. 48-49; Artha-shastra, 79 Sch3mann, p. 449.
II, xxxv, xxxvi. 80 Seligman's Essays, pp. 36, 37.
74 The Statesman's Year Book.
75 Giffen's article on "Taxation" in the En- 82 Ibid., p. 59.
cyclopedia Britannica (The Different Kinds of M, 4 See details, Ibid., p. 115; also Indian
Taxes); Seligman's Shifting and Incidence of Tax-Antiquary, 1909, pp. 260-261; Arthashastra,
ation (1902), pp. 310-311. V, ii.

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pigs and cocks had to contribute the government took special steps to
50 per cent of their stock. Those advertise and give publicity to the
who had sheep and goat farms were donations of the patriots in order to
taxed 161 per cent, and herdsmen create a spirit of rivalry among the
who reared cows and buffaloes ten rich in the acts of self-sacrifice.
per cent.85 In the fourth place, aIt was not with an alleged Machia-
special levy of 500 panas ($125)vellian
was wickedness, but in quite the
raised from merchants in diamonds, scientific way of "high finance," that
horses and elephants. Dealers in Kautilya approached the problem of
cotton goods had to pay 400 panas,financing a war. The financial heads
dealers in grains and liquids 300, of the Maurya Empire knew how to
traders in glass and glassware 200, cause the rich to "vomit" (vamana)
artisans and carpenters 100, and dealers their accumulated wealth or otherwise
in mudpots, inn-keepers and small deplete and drain (karshana) them of
retailers 50.86 In the fifth place, their property.92 Exploitation of the
dramatists (and theater managers) "gold lords" by the state was a process
as well as prostitutes had to surrender of expropriation that the Artha-
half their annual earnings.87 And shastra does not hesitate to pronounce
lastly, as in Athens,88 the government as the objective of the "Ways and
exacted extraordinary donations and Means" Committee. Like the "lit-
gifts from temples and religious estab- urgies" and eisphora of the Athenian
lishments.89 The process might al- city state93 high imposts of various de-
most be described as a legalized looting nominations were, therefore, borne by
of ecclesiastical property by the secular people of large incomes in Maurya
authorities. India. The impact of war finance
Some of the war taxes were de- must have tended to make the demands
scribed by Kautilya euphemistically
of the state even in normal times
as pranaya or "love" gifts.90 The
"progressive" in spirit, if not mathe-
empire used to pose as "beggar"matically
and so.
appeal to the "patriotism" of the
We shall now consider the "non-tax"
citizens for "voluntary" subscriptions.
revenues of the Maurya Empire.
In order that the "modernism" of
These were principally of two classes:
Maurya finance may be appreciated
one derived from the penal power of the
still further it has to be pointed out
state and the other from the economic
that titles of honor were conferred by
activities of the government. The
the government on the patriotic con-
empire as a danda-wielding or "sanc-
tributors. Subscribers to the "liberty
tion "-exercising organization must
fund" were honored, for instance, have realized an enormous amount
"with a rank in the court, an umbrella,
from fines, as these were the usual
or a turban or some ornaments in re-
penalties inflicted by the courts of jus-
turn for their gold."91 Furthermore, tice. The list of "crimes" was
85, 86, 87 See details Ibid., p. 116. See Gupta's lengthy. The arms of law could
"Courtesanship in Buddhist India" in the reach almost any individual. Dealers
Hindustan Review, Allahabad, August, 1919.
88 Schimann, p. 454.
in foreign goods had as many chances of
89 Indian Antiquary, 1905, p 117. transgressing the laws as the butchers
90 Ibid., pp. 115, 117; cf. "benevolences" in in municipal areas. The number of
British fiscal history, Dowell, Vol. I, pp. 155-157,
202-203, 243. 2 Arthashastra, IV, iii.
91 Ibid., 1909, p. 261; Arthashastra, V, ii. 93 Encyclopedia Britannica (Finance).

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offenses against sanitary laws94 was as under the supervision of the naval
large as that against the prescribed department. State boats were let out
hours and places of fording rivers.95 on hire by the ndvadhyaksha or port
Persons committing nuisance on roads commissioner for purposes of pearl
and other specified spots were fined fishery and the fishing of conch
one pana (twenty-five cents). Trav- shells.102 The ferry charges on rivers
elers without passports (bearing gov- must also be considered in connection
ernment stamps) had to pay a fine of with the government's commercial
12 panas.96 Bearers of false or forged ventures. These were regulated ac-
passes were fined 1,000 panas. No cording to the size of rivers and the
foreigners were admitted into the amount of freight carried.103 Any
country without permit. Delinquents load of commodities whether for sale
had to pay a fine of 3,000 panas, the or not was charged four mashads
highest fine97 sanctioned in Maurya (about six cents). One mashd was
legislation. This was the fine also paid by a traveler with a minor quad-
meted out to those who tried to smug- ruped carrying some load. Two vmd-
gle foreign goods in evasion of customs shas were demanded for a load car-
duties.98 Negligence in having the ried on the head or on the shoulders,
day's government stamp fixed on a cow or a horse. The rate was double
weights and measures was fined 274 for transporting a camel or a buffalo.
panas.99 A fine of 600 panas was in- The ferry charge for a small cart was
flicted on the merchant who having five mdshds, for one of medium size
imported foreign salt failed to compen-
drawn by bulls six mashds, and for a
sate the government for the loss it
big cart seven mdshds. The ferry dues
might incur in not finding customers
for its own salt.100 for large rivers were twice the respect-
ive rates.
The second head of non-tax revenue
By far more important than these
comprises the items of income that the
empire derived from its economic enter-
quasi-political commercial undertak-
prises. Shipping lines'0l with fleetsings as sources of "sinews of war"
were the industries owned and run or
of boats for passengers and goods were
controlled by the government. Al-
maintained by the state. The traffic
by sea was large enough to render thetogether three state monopolies are
undertaking a lucrative proposition. mentioned in the Kautilyan schedule.
The empire carried on another business The first monopoly was oil. The oil
94 See the list of fines in municipal areas inseeds were all brought to the govern-
the Indian Antiquary, 1905, pp. 51-52; also in re-ment granary and pressed and made
gard to the construction of buildings, pp. 58-59. into oil by the state mills.'04 The
Vide the fines realized from slaughter houses,
p. 55.
administration of tobacco monopoly in
France since the time of Colbert
95 See the ferry regulations, Ibid., p. 111.
96 Vide the passport regulations in regard to(1674) furnishes a modern analog
travelers, Ibid., p. 54, and in regard to traffic inThe next monopoly was salt as we h
goods, pp. 47-48.
97 Ibid., pp. 51, 52.
mentioned above. In order to "pr
98 Ibid., pp. 48-50. tect" this government industry th
99 Ibid., p. 51. empire legislated that purchasers
'00 Ibid., p. 54. foreign salts must pay compensation
101, 10 Mookerji, pp. 103, 106. Note en
passant the regulations to protect passengers on 103 Ibid., p. 107; Indian Antiquary, 1905, p
ships run by private companies, Indian Anti-
53, 111-112; 16 mashds =1 pana.
quary, 1905, p. 113. 104 [ndian Ant iquary, 1905, p. 55.

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cover the loss sustained by the state.106

and metals such as iron, copper, etc.'09
Evidently foreign salt was not excluded In ancient and medieval legislation
altogether from the territory. There or custom mines were "public" every-
was, besides, the system of granting where.10 The silver mines at Laurium
licenses by which private capitalists were owned by Athens. Mines were
could manufacture and sell the com-state property under the Roman
modity. In addition to the economicEmpire. Down to 1688 all English
mines belonged to the crown. In 1568
"profits" from the salt industry the
government thus came to realize thea Exchequer Chamber stated the
theory that the "King shall have the
large revenue from the customs, excise,
and licenses. The realization of salt whole of the base metal.""' Under
gabelle was threefold. First, the im- the Mauryas also both land and ocean
porting merchant had to pay the reg- mines as well as the essaying of ores,
ular 162% in kind as customs plus coining, and commerce in minerals
the 5% on the remainder as excise. were jura regalia or crown rights
Secondly, the indigenous manufac- sui generis; but they were not worked
turer purchased license from the gov- by the government except when the
ernment on the same terms. There operations needed small outlay. Mod-
was thus no economic discrimination ern advocates of modified laisser faire
against foreign salt. The effects of may quote the Maurya precedent as an
a countervailing excise duty were instance of the "individualistic mini-
mum" of state intervention in indus-
brought in operation indicating the
"fiscal" character of the tariff. And
try. As a rule, the empire let out the
thirdly, it appears that the govern-
mines on royalty basis to private enter-
prise. The royalty included nine dis-
inent charged 13}% as premium on the
tinct items.ll2 As usual, the rates
money that it received as price for the
salt collected from the importer and were high. The rental for the Laurium
the home manufacturer.'06 mines was only 4-1 per cent.1l3 The
The most important monopoly of the French mines yielded 10 per cent.l4
Maurya Empire was the mines and The English rate on copper was 124 per
minerals. Indeed the manufacture of cent to the state plus 111 per cent to
salt was scheduled in the Arthashastra the landlord,"5 but the Mauryas de-
under the category of mining. As de-manded 16] to 20 per cent as vibhdga;
fined by Kautilya, mining was a com-that is, the government's "share"
prehensive term including, as in medi-in the yield. In addition the capital-
eval British law, "wreck of the sea andists had to pay 138 per cent plus 5
royal fish."'07 There were, therefore,per cent as sundry charges."6
two branches of mining under the There may have been some other
Mauryas: (1) ocean mining, that is,industries similarly undertaken or let
pearl fishery, the fishing of conches,out on license with a view to augment-
shells, and corals, and manufacture of
salt, and (2) land mining.108 The 109 Indian Antiquary, 1905, p. 47.
10 For "state mines" vide Bastable's Public
revenues from land mining were de-Finance, pp. 174-176.
scribed as those accruing from gold1m Palgrave, loco citato.
mines, silver mines, mines of rubies 112 Indian Antiquary, 1905, p. 113.
113 Schomann, p. 448.
105 Indian Antiquary, 1905, p. 54. 114 Brissaud, p. 487.
'o6 Ibid., p. 53. 115 Palgrave, loco citato.
107 Palgrave's Dictionary, Vol. II, p. 765. 116 Indian Antiquary, 1905, p. 113. (Islamic
108 Law, pp. 5-10. law has 20 per cent, cf. Aghnides, p. 528.

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ing the public income. The ship- to the latest specialists in public
building and munition industries were, finance, for the methods and principles
of statesmen from Kautilya to Kulot-
of course, state monopolies, as has been
mentioned above. Obviously they are tunga were eminently realistic. With
to be regarded not so much from the the exception of stamp duties, national
standpoint of finance as of national debt, postal receipts and a few other
defense. characteristically modern duties, the
Several miscellaneous taxes remain assets schedule of the first class powers
to be discussed as minor sources of
of today can hardly exhibit any taxes
and non-tax revenues in addition to
revenue. The port duties117 realized
by the ndvadhyaksha were distinct the Hindu sumantra (finance
what
from both customs and excise. Vil-minister) and his board of experts hit
upon
lages on sea shores and on the banks ofpragmatically in the third and
rivers and lakes were assessed at cer- fourth centuries B. C. in order to
"cover" the appropriations on the
tain rates. The fishing license de-
manded by the state was one-sixthgovernmental
or machinery of the largest
162 per cent of the actual haul. Mer-
and most extensive of all empires in the
chants had to pay the customary tax world's
of history.122
port towns. Another group of minor
THE ABILITY TO PAY
collections came from currency. A
premium of 138 per cent was regularly
A study of the finances provokes
naturally the correlated investigation
charged on coins of private or foreign
mintage.l8 The same amount was also into the general economic condition of
realized by the government on every the empire. But as yet it is hardly
occasion that anybody had to pay a
allowable to attempt a wide solution as
to the "ability" of the people to meet
fine in cash.119 Lastly, we have to men-
the diverse demands of the govern-
tion the escheats. Houses, fields, gar-
dens, tanks and temples lapsed to thement. In the first place, an enormous
rise in prices may be postulated be-
state, as we have seen, if the proprietors
neglected to exercise their rights cause
of of the high rates of customs and
excise. This was sure to be felt by the
ownership for five years.'20 Similarly
the government was the heir of the entire community as consumers. In
property of prostitutes in the absence
the second place, the normal land tax
of daughters.'21 of 40 per cent to 57 per cent, though
it may not have shorn the land-
No conceivable resource of the peo-
owning or agricultural classes to the
ple appears to have been left untapped
by the Maurya Empire. The all- skin, was certainly not a moderate
reaching tentacles of Hindu finance lie
122 See the map of the Maurya Empire in the
on the surface. If, as Adam Smith re-third century B. C. facing p. 162 of Smith's
marks, there be nothing in which Early History. Compare the area with that of any
governments are so prone to learn ofof the European empires in Freeman's Historical
one another as in the matter of new Geography of Europe (with Atlas) or specifically
with that of the Roman Empire at its greatest
taxes, the first and the last empires extent
of (third century A. D.) in the Atlas of
pre-Moslem India can still give pointsAncient and Classical Geography (Everyman's
Library Series). Note, in comparison, that
117 Mookerji, p. 106. India is all Europe minus the Russia of the
118 Indian Antiquary, 1905, p. 53. Czars, and that Maurya India, though it ex-
119 Ibid., p. 54. cluded the southern fringe of the peninsula,
0 Ibid., p. 9; cf. Manu, VIII, 30. included the whole of Afghanistan and Baluch-
m Ibid., p. 57. istan.

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
levy. In the third place, the traders tected from the ravages of "profiteers."
and the intellectual middle classes
Reasonable prices and fair profits were
could not get scot free from thefixed
im- by official experts after calculating
perial demand, as the property thetax
legitimate expenses of production
(including the cost of marketing).124
was mercilessly applied to them espe-
cially in emergencies. And in the The government scheduled also the
fourth place, the moneyed aristocracy, rates of wages and fees for laundry
bankers, gilds and other wealthy men, painters, dramatists, singers and
groups had to "vomit" out their gold artists.12
at the call of the empire. Such an imperial intervention in
Economically speaking, there was economic life, or what is the same
no class discrimination. The empire thing, such "state socialism" under
maintained no privileged class on any- "enlightened despots," must have
thing like an appreciable scale; nor been appreciated at least by the com-
would the government demands, though mon laborer. The rate of wages in
heavy, appear to have been oppressive Maurya India was 5 panas a month or
or likely to sap the economic founda- 15 dollars a year.126 It is interesting
tions of the society. On the contrary, to observe that in Chola India in the
there were certain distinct services by eleventh and twelfth centuries a temple
which the state sought to develop the janitor earned Rs. 81 per month; that
"staying power" and taxable capacity is, 30 dollars a year.'27 These rates
of the people. We have spoken above were much above the Ricardian "iron
of the socialistic trend of Hindu states law of wages" when compared with
the current prices and the purchasing
as dharma-states, insofar as the sphere of
their activity was co-extensive with thepower of money during the two
range of human interests. It is necessaryperiods.28
now to note that the same tendency As for the salaries paid by the gov-
is noticeable in two other directions.
ernment, they were liberal enough to
In the first place, the Maurya satisfy the officers' appetite. They
Empire owned several industries and were, humanly speaking, calculated to
controlled the production of wealth inprevent the desire for "squeeze."'9
certain lines. Government supervi- The common soldier of the Maurya
sion of some sort or other brought the Empire received 500 panas or $125 per
economic activities of the people within year. The highest salary in the third
the compass of partial "public owner- and fourth centuries B. C., for example,
ship." The consequent abolition of that for the generalissimo was 48,000
entrepreneurs or middlemen in a few panas ($12,000) a year. The sama-
channels of business was a positive hartd (collector-general) was paid at
advantage to the community. In the lialf this rate. The earning of a
second place, the empire sought to
regulate by legislation the more im- 124 See details in the Indian Antiquary, 1905,
pp. 55, 56, 57.
portant branch of a nation's eco- 125 Ibid., p. 59.
nomic life; namely, distribution and 126 Ibid., p. 53.
exchange or value. The maximum 127 Aiyangar, p. 181.
rate of interest was determined by the 128 Indian Antiquary, 1905, p. 53; One Rupee in
government.123 The market was pro- Maurya India bought 491 sers (Madras) of rice.
In British India one Rupee buys not more than
123 The rate was 15% per year, cf. Law, pp. 6-7 sers. Aiyangar, p. 183.
171-177. The usual rate at Athens was 12% to 129 Vide the list of salaries in the Arthashastra,
18%. Vide Schomann, p. 435. V, iii, Indian Antiquary, 1909, pp. 263-264.

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
AMERICAN WAGES AND AMERICAN STANDARD OF LIVING 169
middle
middle class
classman
manininsouthern
southernIndia,
India, turies B. C. and the eleventh and
for
for instance,
instance,ananaccountant
accountantunder
underthethe twelfth centuries A. D. may be taken
Cholas
Cholas was
wasRs.
Rs.163
163per
per
month,
month,that
that
is, is, for what they are worth. Only it is
$60
$60 aa year.130
year.130Payments
Payments were
wereeither
either necessary to bear in mind that in
in
in kind
kind ororin
inmoney.
money.The The
Cholas
Cholasusedused British India the average per capita in-
to
to pay
pay even
evenhandicraftsmen
handicraftsmen often
often
in in come is Rs. 20 or $6 per annum. On
land
land for
for customary
customarywork.work.Under
Under thethe the whole, it may reasonably be con-
Mauryas
Mauryas payment
paymentiningold gold
might
might be becluded that the financial burden of
commuted for that in kind at fixed pax sdrva-bhaumica, howsoever heavy
rates.13 it might be, whether absolutely or
We are not concerned here with relatively, was easily borne by a con-
"index numbers" or with statistics of tented peasantry and working class, a
wages and prices or with the manner prosperous industrial and commercial
in which the tariff, if it was really pro- aristocracy, and last, but not least, a
tective, may have affected the course of well-paid civil service and army, espe-
industries and commerce. The straycially in view of the fact that under
figures for the third and fourth cen- Chandragupta and Asoka (third cen-
tury B. C.) the people of India had the
130 Aiyangar, p. 181.
131 Indian Antiquary, 1909, p. 264. For 5 conscious satisfaction of being citizens
panas one obtained 165 sers (Madras standard).of the first and greatest power of the
Indian Antiquary, 1905, p. 53. world.
Have American Wages Permitted an American

Standard of Living? *
A Review of the Important Inquiries and Their Findings, 1890-1920
By ABRAHAM EPSTEIN
Director, Pennsylvania Old Age Pension Commission, Harrisburg, Pennsylvania
AT no time before, probably, has ground that prices have come down
there ever been greater popular so much during the past year that
confusion and obscurity as to whatthere is no excuse for the "high war-
constitutes an American standard of time" wages. On the other hand, the
living and what is the relation of wages employes are, with rare exceptions,
earned and the standard of living vehemently and vigorously opposed to
necessary, as at this period. Indeed,
the present methods of arbitrary wage
the controversy between capital and cuts, contending that there has as yet
labor in regard to this question at this
been no substantial decrease in the cost
time is becoming very grave, and is of living which would justify cutting
fraught with the utmost danger. In- the rates of pay. They furthermore
dustrial concerns and railroad com- point out that as most of the reductions
panies are daily announcing reductions at this time are made in the rates of the
in wage rates, justifying these on unskilled
the workers it will reduce these
workers again to the prewar level of
*The material for this article is reprinted
wages which were found in many in-
from a chapter in Mr. Epstein's book, Facing
stances to have been below the Ameri-
Old Age, to be published by Alfred A. Knopf,
Inc.. New York.
can standard of living. They demand

65.0.33.20 on Fri, 12 Feb 2021 06:06:42 UTC
An Exploration in the Theory of Optimum Income Taxation
Author(s): J. A. Mirrlees
Source: The Review of Economic Studies , Apr., 1971, Vol. 38, No. 2 (Apr., 1971), pp.
175-208
Published by: Oxford University Press
Oxford University Press is collaborating with JSTOR to digitize, preserve and extend access to
The Review of Economic Studies

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An Exploration in the Theory of
Optimum Income 2axa on12
J. A. MIRRLEES
Nuffield College, Oxford
1. INTRODUCTION
One would suppose that in any economic system where equality is valued, progressive
income taxation would be an important instrument of policy. Even in a highly socialist
economy, where all who work are employed by the State, the shadow price of highly skilled
labour should surely be considerably greater than the disposable income actually available
to the labourer. In Western Europe and America, tax rates on both high and low incomes
are widely and lengthily discussed3: but there is virtually no relevant economic theory to
appeal to, despite the importance of the tax.
Redistributive progressive taxation is usually related to a man's income (or, rather, his
estimated income). One might obtain information about a man's income-earning potential
from his apparent I.Q., the number of his degrees, his address, age or colour: but the
natural, and one would suppose the most reliable, indicator of his income-earning potential
is his income. As a result of using men's economic performance as evidence of their
economic potentialities, complete equality of social marginal utilities of income ceases to
be desirable, for the tax system that would bring about that result would completely dis-
courage unpleasant work. The questions therefore arise what principles should govern an
optimum income tax; what such a tax schedule would look like; and what degree of
inequality would remain once it was established.
The problem seems to be a rather difficult one even in the simplest cases. In this paper,
I make the following simplifying assumptions:
(1) Intertemporal problems are ignored. It is usual to levy income tax upon each
year's income, with only limited possibilities of transferring one year's income to another
for tax purposes. In an optimum system, one would no doubt wish to relate tax payments
to the whole life pattern of income,4 and to initial wealth; and in scheduling payments one
would wish to pay attention to imperfect personal capital markets and imperfect foresight.
The economy discussed below is timeless. Thus the effects of taxation on saving are ignored.
One might perhaps regard the theory presented as a theory of " earned income " taxation
(i.e. non-property income).
(2) Differences in tastes, in family size and composition, and in voluntary transfers,
are ignored. These raise rather different kinds of problems, and it is natural to assume
them away.
I First version received Aug. 1970; final version received October 1970 (Eds.).
2 Work on this paper and its continuation was begun during a stimulating and pleasurable visit t
Department of Economics, M.I.T. The influence of Peter Diamond is particularly great, and his commen
have been very useful. Earlier versions were presented at the Cowles Foundation, to the Economic Study
Society, at the London School of Economics, and to CORE. I am grateful to the members of these seminars
and to A. B. Atkinson for valuable comments. I am also greatly indebted to P. G. Hare and J. R. Broome
for the computations.
3 Discussions on (usually) orthodox lines, including many important points neglected in the present
paper, can be found in [7], [1], [5, Chapters 5, 7, 8], and [6, Chapters 11 and 12]. [2] is close in spirit to
what is attempted here.
4 Cf. [7, Chapter 6].
175

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176 REVIEW OF ECONOMIC STUDIES
(3) Individuals are supposed to determine the quantity and kind of labour they provide
by rational calculation, corresponding to the maximization of a utility function, and social
welfare is supposed to be a function of individual utility levels. It is also supposed that the
quantity of labour a man offers may be varied within wide limits without affecting the
price paid for it. The first assumption may well be seriously unrealistic, especially at higher
income levels, where it does sometimes appear that there is consumption satiation and that
work is done for reasons barely connected with the income it provides to the " labourer".
(4) Migration is supposed to be impossible. Since the threat of migration is a major

influence on the degree of progression in actual tax systems, at any rate outside the United
States, this is another assumption one would rather not make.'
(5) The State is supposed to have perfect information about the individuals in the
economy, their utilities and, consequently, their actions. In practice, this is certainly not
the case for certain kinds of income from self-employment, in particular work done for the
worker himself and his family; and in some countries, the extent of uncertainty about
incomes is very great. Yet it seems doubtful whether the neglect of this uncertainty is a
simplification of much significance.
(6) Various formal simplifications are made to render the mathematics more manage-
able: there is supposed to be one kind of labour (in a special sense to be explained below);
there is one consumer good; welfare is separable in terms of the different individuals of
the economy, and symmetric-i.e. it can be expressed as the sum of the utilities of individuals
when the individual utility function (the same for all) is suitably chosen).
(7) The costs of administering the optimum tax schedule are assumed to be negligible.
In sections 2-5, the more general properties of the optimum income-tax schedule,
and the rules governing it, are discussed. The treatment is not rigorous. Nevertheless a
reader who wants to avoid mathematical details can omit the last page or two of section 3,
and will probably want to glance through section 4 rather rapidly. In section 6, I begin
the discussion of special cases. The mathematical arguments in sections 6-8 are frequently
complicated. If the reader goes straight to section 9, where numerical results are presented
and discussed, he should not find the omission of the previous sections any handicap.
He may, nevertheless, find it interesting to look at the results and conjectures presented at
the beginning of section 7, and at the diagrams for the two cases discussed in section 8.
Rigorous proofs of the main theorems will be given in a subsequent paper, [4].
2. MODEL AND PROBLEM
Individuals have identical preferences. We shall suppose that consumption and

working time enter the individual's utility function. When consumption is x and the time
worked y, utility is
u(x, y).
x and y both have to be non-negative, and there is an upper limit to y, which is taken to be 1.
In fact, it is assumed that: u is a strictly concave, continuously differentiable, function
(strictly) increasing in x, (strictly) decreasing in y, defined for x> 0 and 0 < y< 1. u tends
to - oo as x tends to 0 from above or y tends to 1 from below.
The usefulness of a man's time, from the point of view of production, is assumed to
vary- from person to person. To each individual corresponds a number n such that the
quantity of labour provided, per unit of his time, is n. If he works for time y, he provides
a quantity of labour ny. There is a known distribution of skills, measured by the parameter
n, in the population. The number of persons with labour parameter n or less is F(n). It
1 The relation of optimum tax schedules to propensities to migrate is discussed in another paper under
preparation.

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MIRRLEES OPTIMUM INCOME TAXATION 177
will be assumed that F is differentiable, so that there is a density function for ability,
f(n) = F'(n). Call an individual whose ability-parameter is n an n-man.
The consumption choice of an n-man is denoted by (xn, yn). Write zn = nyn for the
labour he provides. Then the total labour available for use in production in the economy
is
Z =
00 { z,,f(n)dn, . . .(1)
and the aggregate demand for consumer goods is
X = xnf(n)dn. ... (2)

0
In order to avoid the possibility of infinite labour supply, I assume that
S nf(n)dn < oo . .(3)
Each individual makes his choice of (x

an income tax, the government can a
z can consume no more than c(z) afte
arbitrarily. It makes sense to impose th
c be upper semi-continuous, for then
choices that maximize their utility, sub
(xn, yn) maximizes u(x,

Notice that (xn, yn) may not be unique
Un = u(Xn, Yn)) .. (5)
Proposition 1. There exists a number no > 0 su

Yn= O (n _ no),
yn>O (n>no). ...(6)
Proof. If m<n, and ym>0, u[c(

quently, ym = 0 if yn = 0, since then Ym
has the desired properties. | n =

Proposition 2. Any function3 of n,
continuous function c also satisfies (4) f
1 To say that c is upper semi-continuous me

lim sup c(zi) = c(z) when lim zi =
i-~o
If
un = sup {u(x, y) I x _ c(ny)}, and u(xi, yi)->un, xi _ c(nyj)
we can suppose that xi-x and yi->y (since {yi} and therefore {xi} is bounded). By the upper semi-continuity
of c,
x ? lim sup c(nyj) = c(ny);
and by the continuity of u, u(x, y) = lim u(xi, yi) = u,. Therefore the supremum is attained.
2 In other words, we have a correspondence, providing a set of utility maximizing choices for n-men.
It arises when the consumption function c coincides with the indifference curve for part of its length. It is
convenient nevertheless to use the notation of the text, despite its suggestion that we are dealing with a
function.
3 It is easy to see that the result is true for a correspondence also.

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-178 REVIEW OF ECONOMIC STUDIES
Proof. Define c'(z) = sup c(z'). If x' < c'(ny'), then, for any e >0, there exists
z' < z
y Y y'such that x - , ?c(ny'). Thus u(x - B,Yn) <un whi

ing function in y, that u(xn - 8, Yn) ? Un Letting Unn
(xn, yn) maximizes u subject to x < c'(ny).
c' is clearly a non-decreasing function of z. To prove that it is right-continuous, take
a decreasing sequence zi-z. c'(zi) is a non-increasing sequence, and therefore tends to a
limit, which is not less than c'(z). If it is equal to c'(z), there is no more to prove. Suppose
it is greater. Then for some i>0 each c'(z')>c'(z)+s. Therefore, there exists a sequence
(fi) such that 2' ? z' and c'(zi) > c(')> c'(z) +B. The second inequality implies that
zi>z. Thus z'-iz. Yet lim sup c() > c(z), which contradicts upper semi-continuity
Thus in fact, c is right-continuous. 11
This proposition says that the marginal tax rate may as well be not greater than 100
per cent. We shall consider later whether it should be positive.
The government chooses the function c so as to maximize a welfare function
00
w = G(un)f(n)dn. ... (7)
I use the function G here, rather than writing

special attention to the case uXy = 0 (when u c
ing only on x and a function depending only on y). In maximizing welfare, the government
is constrained by production possibilities: it must be possible to produce the consumption
demands, X, arising from its choice of c, with labour input no greater than Z. The produc-
tion constraint is written
X < H(Z). ... (8)
We have not yet fully specified the possibilities available to the government, since, if
(xn, yn) is not uniquely defined, it is not clear whether the government or the consumer is
allowed to choose the particular utility-maximizing point. Perhaps it is reasonable to
suppose that the government can choose, and that the necessity for market-clearing will
make its choices actual. But it will turn out that the issue is of no significance when we
make the following assumption, as we shall:
(A) Yn is uniquely defined for all n except for a set of measure 0.

Thus the class of functions c from which the government chooses is further restricted
by the requirement that the function lead to choices satisfying (A). It will appear in due
course that (A) is satisfied for all functions c in the particular cases we shall be most con-
cerned with.
3. NECESSARY CONDITIONS FOR THE OPTIMUM
On the assumption that an optimum for our problem exists, we shall now obtain
conditions that it must satisfy. The mathematical argument will not be rigorous. To do
the analysis properly, one must attend to a number of rather tricky points. Since these
technical details tend to obscure the main lines of the argument, rigorous proofs will be
presented separately, in the continuation of this paper. The nature of these neglected
difficulties will be discussed briefly in the next section.
The key to a reasonably neat solution of the problem is to find a convenient expression
of the condition that each man maximizes his utility subject to the imposed " consumption
function " c. If we suppose that c is differentiable, the derivative of u[c(ny), y] with respect
to y must be zero. Denoting the derivative of u with respect to its first and second arguments
by ul and u2, respectively, we have
ulnc'(ny)+u2 = 0.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
Recollect that un is the utility of n-man. Then a straightforward calculation, using the
first-order condition (9), yields
dun - u1yc' _ ...(10)

dn n
(The expressions on the right are, of course, alternative expressions for the partial derivative
of u with respect to n, evaluated at the maximum. The case where n enters u in a more
general manner can be analyzed by using this more general equation. We shall return to
this point later.)
Our problem is to maximize w subject to the constraint of the production function,
X < H(Z), the differential equation (10), and the definition un = u(xn, yn). Those who a
familiar with the Pontriyagin Maximum Principle will see that this is a form of problem
fairly suitable for treatment by it. Shadow prices p and w have to be introduced for X
and Z. Then we would like to maximize
W-pX+wZ = f[G(un)-pxn +wynn]f(n)dn . . . (11)
subject to (10). un is to be regarded as the state variable, yn (say) as the

while xn is determined as a function of un and Yn from the equation Un
Hamiltonian is
M = G[(un) - pxn + wynn]f(n) -4)n YnU2

n
where On is a function of n satisfying the differential equation
=~ __
dn Du
-f[G(n)- fl+ ... (12)
Yn should then be chosen so as to maximize M:
[wn+ pu 2] f(n) + O9n RIY = 0~ ... .(13)

where the function qi(u, y) is defined by
f(u, y) = -yu2(x, y), u = u(x, y), ... (14)
and y is its partial derivative with respect to y. (Notice, a
fu- = -YU12/ul.)
Equation (12) can now be integrated to obtain an expression for in; which, when
substituted in (13), provides us with an equation to be satisfied by the optimum we seek.
Before going on to use this equation, however, we shall derive it in a different way, by a
more explicit use of the methods of the calculus of variations. The use of the Maximum
Principle has a number of serious disadvantages. It does not show us how to obtain certain
important supplementary conditions on the optimum. The analysis provides no hint as
to how it could be made rigorous. It does not provide any insight into the kind of maximiz-
ation that is going on. When we have done a more explicit variational analysis, we shall
be better able to see where the logical holes are, and to understand why things come out
the way they do.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
For this purpose, I prefer to write (10) in integrated form:
n ~dm
Un - YmU2(Xm, Y.) + u(c(O), 0),
o m
= J Y(U., Y.) -+ U o s... 5

o m
using the notation ql introdu

no work by u0. Suppose first
U12= 0). If we consider a va
and Yn by " small " variation
be related by
Jn dm
bUn = fryYm m + L8oU .. .(16)
o m
This variation will bring about changes in W, X, and Z. As before, introduce shadow
prices (in terms of welfare) for X and Z. Then the variation must leave (11) stationary:
0 = XJ[G(un) -Pxn + wYnn]f(n)dn
= {[G'(Un)un-P (ubun -u 2 6n + WbYn jf(n)dn, ... (17)

where the variation in x is calculated as follows:
bUn = 3u(xn, Y) = UlbXn +u23yn ...(18)

It remains to substitute (16) in (17), yielding,
J p [ un) - d y Ym m + buo] + [wn+p 82] y n}f(n)dn
= I: {{: [G'(um) - -P]f(m)dm. Y + (wn+p p )ff(n)} yndn
+ f[G'(un)- ffP](n)dn. buo. ... (19)
The second equation is obtained by inverting the order of integration in the double integral.'
(19) is to be satisfied for all possible variations of the function yn, and the number u0.
Since u0 can be either increased or decreased at the optimum (if, as is to be expected in
general, some people will do no work at the optimum),
f G'([u - P-j f(n)dn = 0 ... (20)

at the optimum.
1 The double integral is
X G'(u)-P f(n) - mdn.

The region over which the integration takes place is defined by 0 ? m _ n. Thus, when the order of integ-
ration is inverted, n ranges between m and oo for given m. The integral can therefore be written
77 [G'-Pl-] f(n)dn. y8ym '

which is seen to justify (19) on permuting the symbols m and n.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
If all variations in yn were possible-and this is a question we shall take up shortly-

we could also claim that the expression within curly brackets ought to be zero:
(wn+p )f(n) = l{: [I - G'(um)]f(m)dm. ... (21)

ul n n U1
It should be noticed that this equ

n for which yn = 0 (except no) b
possible, since Yn cannot be negati
Finally we know that the marginal product of labour should be equal to the shadow
wage:
pH'(Z) = w. ...(22)
These equations, (20) and (21), have been worked out under the special assumption
that ql is independent of u. In the more general case, we have to replace (16) by
bun = f Tmnly6ym- + 5u0, ...(23)

o m
where
J m (4
Tmn =expf4(u ' . . . . (24)
To show this, we can go back to the differential equation (10). Applying the variation,
we obtain from it,
d bun = -1 /luUn + ly6Yn- ... (25)

dn n n
This is a first order linear equa
give the solution (23).
Having replaced (16) by (23), we can now go through the rest of the calculation as
before. We find that (20) is generalized into
co
T [G'(u.)-p/u1]T0nf(n)dn = 0; ... (26)

while (21) becomes
(wn+pu2fu1)f(n) = J[p/u1- G'(um)]Tnmf(m)dm. ... (27)

Notice that we have Tnm here, although it was Tmn that appeared in (23).
If these equations are correct, the two integral equations, (15) and (27) may be thought
of as determining the two functions un and yn, given the three parameters u0, w, and p. The
values of these parameters are fixed by the three equations (26), (22), and (8). We have
enough relations to determine the optimum tax schedule, since the function c can be deter-
mined once we know un and yn.
4. NECESSARY CONDITIONS: A COMPLETE STATEMENT
The argument used to derive these conditions for the optimum tax schedule had a
number of weak points. It is indeed unlikely that the relationships derived above hold in
general. Among the weak points of the argument, notice that
(i) the existence of the shadow prices p and w was assumed without proof;
(ii) the optimum tax schedule, and the resulting functions xn, Yn, and un were assumed
to be differentiable;
(iii) the application of the variation was quite heuristic; and
(iv) no justification was provided for assuming that the function Yn could be varied
arbitrarily (for n >no).
M

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
I shall not comment on (i) and (iii), which, though important, are technical matters: they
can be justified. (ii) is not satisfied in general: there was no reason to suppose that it
would be. When (ii) is not satisfied, the first-order condition, (9), for maximization of
utility ceases to be meaningful. Finally, (iv) is never justified. The function yn is derived
from the imposition of the consumption function c, and we have no a priori information
about it. We must expect that some conceivable functions yn can never arise from the
imposition of a consumption function. The class of possible y-functions is no doubt quite
complicated in certain cases. Fortunately it is possible to specify that class quite simply in
the realistic cases, and it is then possible to use the variational argument rigorously.
Problem (ii) is dealt with in the rigorous analysis by depending on equation (15)
instead of the differential first-order condition (9). It is a remarkable fact that this conditio
holds if and only if the various functions arise from utility-maximization under an imposed
consumption function, even when that function is not differentiable. For proof, the reader
is referred to [4].
To deal with problem (iv), we have to restrict the class of utility functions considered.
We assume that
(B) V(x, y) = -yu2/u, is an increasing function of y for each x>0 (and bounded in
0 < x < x, 0 < y < y for any < oo and y< 1).
It will be noticed that this is an assumption about preferences, not just about the form of
the utility function used to represent preferences. The second part of the assumption is
readily acceptable. The first, and main part of the assumption holds if and only if, for a
given level of consumption x, a one per cent increase in the amount of work done requires
a larger increase in consumption to maintain the same utility level, the greater is the amount
of work being done. It is equivalent to assuming that (in the absence of taxation) the con-
sumer's demand for goods is an increasing function of the real wage rate (at any given
non-wage income.' Few individuals appear to have preferences violating (B), and intuitively
it is rather plausible. We shall later use the fact that (B) holds if preferences can be repre-
sented by an additive utility function. (It will be noticed that, as y-> 1, V-> + 00, so that
the assumption must hold for some ranges of y.) If the assumption does not hold, the
theory of optimum taxation is more complicated.
The point of the assumption is indicated in
Theorem 1. Under Assumption (B), zn = nyn maximizes utility for every n under some
consumption function c if and only if
(i) zn is a non-decreasing function definedfor n >0;

(ii) 0 < zn<nfor all n>O.
1 This equivalence is fairly obvious from an indifference curve diagram. For a formal proof tha
implies that consumption is an increasing function of the wage rate, let w be the wage rate, and m non-l
income (both measured in terms of goods). (B) states that wy, regarded as a function of x and y, is an
increasing function of y. Write x and y as functions of w and m, putting x = x(w, m), y = y(w, m) and
x' = x(w', m), y' = y(w', m) where w'> w. I shall show that x'> x. To do this, choose w" and m" such
that x" = x(w", m") = x, and
w
y = y(w", m") = W y
Since x"-w'y" = m, (x', y') is preferred to (x", y"); and therefore
x'-x > w"(y'-y")
e L (wtytwty) = !! (w'y'-wy)
W W
= w' (X'-X),
since x'- wy' = m = x - wy. This implies, with our assumption w'< w', that x'> x.
The converse proposition can be proved by reversing the steps.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
For a rigorous proof of this theorem, the reader is referred to [4]. For a heuristic justi-
fication, suppose that zn is differentiable, and that c is twice differentiable. The first order
condition, (9), can be written
- u(c(z), z/n) = I [zc'(z)-V(c(z), z/n)] = 0. ...(28)

Oz z
Furthermore, we have the second-order condition, that the derivative is non-increasing

at zn. Since it is zero there, this is also true when we drop the positive factor ul/z. In
other words,
[ZC'(z) - V(c(z), z/n)] _ 0, at z = Zn. ... (29)

Oz
Now differentiate the equation znc'(zn) - V(c(zn)zn/n) = 0 with respect to n:
azc8-v]lz = Z V(c(zn), zn/n)z/n2. . . .(30)

Oz n ~dn
It follows from (29) and assumption (B) that
dzn >0 ... (31)

dn
unless zn = 0. In fact zn is strictly increasing when n > nO and c is differentiable; a corner

in c causes zn to be constant for a range of values of n. (An indifference curve diagram
makes this clear.) Condition (ii) of the theorem clearly has to be satisfied by the utility
maximizing choice.
To prove that a suitable consumption function exists for a given z-function satisfying
the two conditions, one defines c by the first-order condition (28). (30) then shows (nearly)
that the second-order condition for a maximum is satisfied. This does not yet prove global
maximization of utility, but that also is true.
It should be noticed that, as a corollary of Theorem 1, condition (A) holds when con-
dition (B) holds, for zn is shown to be non-decreasing even if it is a correspondence. It
therefore takes a single value for all but a countable set of values of n. A fortiori, condition
(A) is satisfied in this case.
Theorem 1 at once implies that zn and therefore also xn are non-decreasing functions
when the optimum tax schedule is imposed. Furthermore, it shows us quite straight-
forwardly what changes in the function yn we are allowed to contemplate when applying
the variational argument that allowable small changes should make only a second-order
difference to the maximand. The rigorous argument is still complicated, in part because
one has to allow for the possibility that zn is constant over some intervals, and discontinuous
at some values of n. The full statement of the result, which is proved in [4], is as follows:
Theorem 2. If preferences satisfy assumption (B) and (un, x", yn) arise from optimum
income taxation, then
(i) zn = nyn is a non-decreasing function of n;

n
(ii) Un = Uo-3 [YmU2(Xm, ym)/m]dm (n > 0); ... (32)
(iii) at all points of increase of zn (i.e., where zn >zn, for all n'<n, or
n'>n)
An = [w+u82I/nul]f(n)- K [ G-A (u) Tnmf(m)dm =0, ... (33)

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
where superscripts " (n) ", etc. indicate that the function is evaluated at n-man
(etc.)'s utility-maximizing choice, and
= -u(-n) (n) + ynU(n)U(n)/U(n) ...(34)

~ m-
= exp - Ymyu12(xm', Ym')/U(Xm, ). dm' ];*(35)

(iv) If n e [nl, n2], where z is constant on [nl, n2], and [nl, n2] is a maximal interval
of constancy for z,
rn rn2
{Amdm 2, Of,JAmdm < 0; ...(36)
ni n
(v) If z is discontin
m *n-
(9n, Y7n) = Un = U(Xn, Yn),

and ui1, etc., denote u1 evaluated at n,, 5n, while u1, etc., denote evaluation at x", y
(Wyn-xnln) - (w57n - ,nln) w + U2/nul - w + ii2/ni1 (37

YnU2 ,YnU2 y jy
If qly is a non-decreasing function of y for co
(vi) {G [-)iG'(um)] T0mf(m)dm = 0, ...(38)

o _ui
(vii) X= H(Z), ...(39)

w H'(Z). ...(40)
It will be noticed
earlier notation),
utility of commodities (national income). The second part of (v) should be particularly
noted, since we are quite likely to be willing to assume that y is a non-decreasing function
of y, and it is a great advantage not to have to worry about possible discontinuities in Zn.
It does not seem possible, unfortunately, to delimit a class of cases in which one can be sure
that [0, no] will be the only interval of constancy for z. It should be mentioned that, when
4fy is not non-decreasing, and the equations (37) may possibly apply, the conditions of
Theorem 1 may define more than one candidate for optimality, and then only direct com-
parison of the welfare generated by the alternative paths so defined will solve the problem.
5. INTERPRETATION
If n is not in an interval of constancy for z, and c(.) is therefore a differen

at zn, the first-order condition (9) applies. It can be written
-u2/nu1 = c'(z). .. .(41)
d
If we denote the marginal tax rate, d[wz - c(z)], by 0, we have
d(wz)
wO = d [wz-c(z)] = w+u2/nul
dz
= A- a Tnmf(m)dm, ...(42)

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
by (33). (42) suggests the considerations that should influenc

tax rate. First, it can tell us something about the sign of 0:
be greater than 1, but we were not previously able to say an
we expect that it will not usually be negative. Using (42) and
we can establish this rigorously.
Note first that 1- AG'u1 is a non-decreasing function of n, since xn is a non-decreasing
function of n, and a G = G'u1 a decreasing function of x. If 1 -AG'u1 were always positive

Ox
or always negative, Equation (38) could not be satisfied. Therefore
00 l
f (1-AG'u 1)Tn,f(m)dm
Jn ul
is increasing in n for n less than some n, and decreasing for n > n; but in any case positive
for n >n. (Here we use the properties u1 >0, Tmn>O.) Since the integral is zero when
n = 0, it is non-negative for all n. Consequently the marginal tax rate is non-negative at
all points of increase of z. If n is not a point of increase of z, c is not differentiable at Zn.
It is easily seen that, if [n1, n2] is a maximal interval of constancy of z, - u2/nu1 is equal
to the left derivative of c at n1, and the right derivative at n2. Thus both the " right " and
"left" marginal tax rates are non-negative in this case. Summarizing:
Proposition 3V1 If assumption (B) is satisfied, wz- c(z) (the " tax function ") is a non-
decreasing function for all z that actually occur (and may therefore be taken to be a non-
decreasing function for all z).
Having established that the integral in Equation (42) is non-negative for all n, we can
see that the marginal tax rate will be greater if there are relatively few n-men than otherwise;
or if the utility-value of work, -yuy, is more sensitive to work done (utility being held
constant); or if n is closer to ni, the value of n at which 1 = AG'u1 (and the integral is
therefore a maximum). Iff is a single-peaked distribution, the first consideration suggests
that marginal tax rates should be greatest for the richest and the poorest; but the last
consideration tells the other way.
In any case, it is important to note than no, the largest n for which yn = 0, may be
quite large: if the number who do not work in the optimum regime is large, the marginal
tax rate may not be high at zero income. Explicitly, we can rewrite Equation (38) in the
form
[U1(X~, 0) -i'G'(uo)] F(no)+ A[--lG'] Tnomf(m)dm = 0 ... (43)

which, when combined with Equation (33) (for n = no) gives
w+ u2(Xo, ?) = t;e (uo, 0) F('no) [AG'(uo) - 1I] ... (44)

nOlxO ) 0O(O ul(xo, ?)-
Unfortunately, one cannot get much information from these " local" conditions, at least
for small n. For any detail, and in particular for numerical results, one must examine the
whole system of equations. It is easier to do that for particular examples of the general
problem, and that is what we shall do in succeeding sections. It may be noted, however,
that Equation (44) does provide us with some information about no and x0. For example,
it is clear that no can be zero only if F/nf tends to 0 as n tends to 0; indeed, since the left
hand side of Equation (44) is bounded, no = 0 only if x0 = 0, and therefore 1/u1 = 0.
It follows that no = 0 only if F/(n2f ) is bounded as n-*0, which means that F tends to zero
faster than exp (- 1/n). This excludes the cases usually considered by economists. We
1 The analysis and result can be generalized to the utility function u(x, z, n) where the parameter n
can indicate- variations in tastes as well as skill. The extension is fairly routine and will not be discussed
here.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
may conclude at this stage that it will be optimal, i

some of the population to be idle.
A number of conclusions have been obtained, but they are fairly weak: the marginal
tax rate lies between zero and one; in a large class of cases, consumption and labour supply
vary continuously with the skill of the individual; there will usually be a group of people
who ought to work only if they enjoy it. The main feature of the results is that the optimum
tax schedule depends upon the distribution of skills within the population, and the labour-
consumption preferences of the population, in such a complicated way that it is not possible
to say in general whether marginal tax rates should be higher for high-income, low-income,
or intermediate-income groups. The two integral equations that characterise the optimum
tax schedule are, however, of a reasonably manageable form. One expects to be able to
calculate the schedule in particular cases without great difficulty. In the next sections of
the paper, we shall show how this can be done in certain special cases, and obtain further
properties of the optimum tax in these cases.
6. ADDITIVE UTILITY
An interesting case arises when, for all x and y,
Ul2 = 0. ... (45)

Thus ul depends only on x, and u2
Proposition 4. If assumption (45) is satisfied, V(x, y) is an increasing function of y,

bounded for small x and y.
Proof. V = -yu2(y)/u1(x), and V2 = (-u2-yu22)/u1>0. Boundedness is obvious. 11

Corollary. Under assumption (45), Theorem 1 applies.
In particular we know, from statement (v) of that Theorem that yn is continuous pro-
vided that fry is non-decreasing. In the present case, this condition is equivalent to the
requirement that
-yu2(y) is convex. ...(46)
There is no reason why this assumption should hold in general, but it is easily checked for
any particular case. We shall now restrict attention to cases for which (46) holds.'
If we restrict attention also to cases where z is strictly increasing when n >no, the opti-
mum situation will be a solution of the equations
W+ 8 ) n2fi(n) = VI, ( -AG') f(m)dm, ... (47)

nu, n Ul
Un = Uo-J YmU2 d. ...(48)

o m
We shall further assume that f is continuo
in this case, it follows that un and + _!

nu,.
w+ U2
v=- nu, ...(49)
4iy
1 In [4] a theorem is proved which states that the conditions of Theorem 2 are in fact sufficient (as well
as necessary) for an optimum in the special case now being considered.

65.0.33.20 on Fri,ff:ffff on Thu, 01 Jan 1976 12:34:56 UTC
u and v are continuously differentiable functions o

Ox ay
as can easily be seen, eV <0 eV <0, the Jacobian a(u, v) is al

Ox ay o(x, y)
x and y can be expressed as continuously differentiable functions of u and v, and are there-
fore themselves differentiable functions of n.
We can now write Equations (47) and (48) as differential equations:
dv Vm_ vI
f (2+_
n 1 2G'... (50)
dn n f n 2ul n 2
du Y2 ...(51)
dn n
which, as we have just shown, can be thought of as equations in u and v. The particular
solution we seek, and the particular value of A,, are defined by the boundary conditions,
Equations (39), (40),
Vno = 2f(n) UAG'(un))] ...(52)
which is the form (38) takes here, and
vnn f(n)-0 (n- oo),, ... .(53)
which is apparent from Equation (47). Provid

solution that satisfies all those conditions will, by Theorem 2 of [4], provide the optimum.
Equations (39) and (40), the production function and the marginal productivity
equation, may be ignored in the calculations. Corresponding to the particular values of
w and 2 used in the calculation, one obtains values for Xand Z. Thus we know the optimum
tax schedule when the marginal product is w and the average product is X/Z. In this way
one could obtain a range of tax schedules corresponding to different average products and
marginal products-which is what one wants. Of course, it is desirable to choose 2 so
that the average product will be related to the marginal product, w, in a reasonable way.
This should not present any great difficulty.
To determine the sign of = Yn + ndy we calculate, from Equation (49),

dn dn
dv _ (22 _ y dy u2 u
dn nu, dn n2ul nu2 dn
_ (u22 _ \) dy - u2 + u2211 dy _ U2U11 du

nu, I dn n2ul nu3 dn nu3 dn
1( _Vly y+ U2UI1) dz _Y v( y - 22 *(54)

n nu, nu 3 dn n nu, n2ul
=-yl(2~+n +YL// )+ V+G$ . . (55)

substituting from (51). Therefore, using (50)
Lu22 _vr* +u2u11 dz = YU22 _yy + U2 - + ) +

-nu, nu, _ dn nu, nu + f n2t( n

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
We may therefore check the assumption dz > 0 by

dn
(2+ - + YYY 2 - -G'> 0. ... (56)
Equation (56) is equivalent to dz >0 because the expression in

dn
(55) is negative, term by term.
In computation, one can proceed as follows:-
[1] A value of A is chosen. To get the right order of magnitude, one can calculate
|u 'fdn/ { G'fdn (cf. (38)) for some particular feasible, and a priori plausible,
allocation of consumption and labour.
[2] A trial value of no> 0 is chosen. (It should be borne in mind that the inequality
vno > 0 may, with (52), restrict the range of possible no.)
[3] Bearing in mind that yno = 0, the values of vno and uno are obtained from (49
and (52).
[4] The solution of equations (50) and (51) is calculated for increasing n until either
(56) fails to be satisfied, or it becomes apparent that (53) will not be satisfied (see
[6] below).
[5] If (56) fails to be satisfied, zn is kept constant, un (and v") being calculated from
(49) until (56) is satisfied again, when zn is allowed to increase and the solution
pursued as in [4].
[6] The attempted solution should be stopped if un or xn begins to decrease, or vn o

Yn fall to zero, or xn, yn cannot be calculated (e.g. because un exceeds the upper
bound of u, if there is one). Other stopping rules can be given for particular
examples, depending on the structure of the solutions of the equations.
[7] A range of trial values of no must be used to find the one that most nearly provides
a solution satisfying (53). Efficient rules for iteration might be obtained in
particular cases.
7. FEATURES OF SOLUTIONS
Solutions may, for all I know, be very diverse in their characteristics; but examination
of the equations suggests a number of comments. First we note that v" will always lie
between 0 and 1 , since
qy(O),
1+ U2 l+ U2
0 < nu nu, < ...(57)

We are therefore led to expect that v tends to
forms off, of a kind one would perhaps be unlikely to use.) y is also bounded, by 0 and
1, and is therefore likely to tend to a limit. One is then led to certain conjectures about the
limits, which ought to hold for sufficiently regularf and u.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
Let
- +y+2<oo. ...(58)
b00
(Since nfdn < oo, y > 0: otherwise n2f is increasing for large n, therefore bounded
0
below.) Further, suppose
u, aex ..> )* (59)
as x-+ oo. Then there appear to b
results to hold.
(i) u<1. Asn -+oo,
Yn-+ 1 .. .(60)
and v 0. .-.+.(61)
The marginal tax r
0-+ 1. ...(62)
(ii) u = 1. As n-+oo,
Yn Y~ * * .(63)
where y is defined (uniq
YU2(Y) = -a, . . .(64)

and Vn -[-(1 + )u2(j))-YU22(0)]1. ...(65)
Furthermore,
0-> 1j+ ...(66)
where
v YU22(Y) ...(67)
(iii) 1u > 1. As n -+oo, UY)
. * *(68)
and v-[-(1 +y)u2(0)]1. ...(69)
1 ...(70)
1+y
(It may be noted that, in a natural sense, (66) holds for all cases.)
Before indicating the reasons for these conjectures, a few words of interpretation may
be in place. On the whole, the distribution of income from employment appears to be
Paretian form at the upper tail1: Equation (58) holds with y between 1 and 2, rough
speaking. It is not improbable, however, that marginal productivity per working year
distributed differently from actual incomes: the lognormal distribution is the most plausib
simple distribution. For this, y = oo, and
nf _ logn ...(71)
f a2
for large n; (a2 is the variance of the distribution of
1 See the general assessment by Lydall [3].

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
The realism of alternative assumptions about utility may be assessed by calculating

the response of the consumer to a linear budget constraint, x = wy +a. It is easy to see
that utility-maximization requires (since ul2 0)
u1(x) 1
=-, x=wy+a. ... (72)
U2(y) W
If u1 = cxx, we have to solve
caw = -(a+wWY)4U2(Y). ...(73)

(If aw < &-au2(0), y = O.) Clearly the solution has the following properties:
y-+ I as w- oo if < 1,.
y-+O as w-*oo if j> 1.J
(Cf. (61) and (68).) Also
x-a+w (y<1),
aw )t ( 13(5
These asymptotic properties suggest that the case yu 1 is particularly interesting.
When p = 1, since, by (73)
aa =ax
- --y
w U2
-Yu2-+c as w-*oo;
i.e.
Y- , . . . (76)
where y is defined by (64). (Cf.
u2(y) = -(-y)A (3>0), .. .(77)
we have
90(1 y) = a,
y(1-9) = v.
The choice of a may be influenced by considering that y = 0 when wla < 1/a. It
ing to note that, if
ac=2, 3 = 1, y =2,
y=2/3, v=2,
and, if our conjectures are correct,
0-+60 per cent.
This case is perhaps not completely unrealistic; but it should be remembered that the homo-
geneous form for u means that the decision not to work depends only on the ratio of earned
to unearned income, which is not a very realistic assumption.
It will be noticed that, in this case, the asymptotic marginal tax rate is very sensitive
to the value of ,u (in the neighbourhood of 1).
The reasons for the conjectures Equations (60)-(70) (in fact, I can provide a proof of
(iii) and will do so below) are as follows. One expects that, as n-* oo, the relevant solution
of the differential equations will tend towards a singularity of the equations: not only will
y and v tend to limits, but n dy and n dv will tend to zero. Denote the postulated limit of
dn dn
y,, by y. Consider first the case ul = oax-(4u<

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
In this case utility is unbounded. I shall show that

finite limits, and, from (51), we have
nu dx _u(y+n dy\ - U2(- ...(78)
Therefore, since u1 dx= o [ 1 x -Ja

dn dn I1- y
x X1 - =-9u2(y log n[1 + o(1)]. ...(79)

This implies that I
nu1 = 0[n(log n)f 1i] ...(80)
o00. ..(81)
Therefore
1 ('x IF 1+ 1
n2f(n) J [i --A jf(m)dm= [1 + 2] - >0, ...(82)
which is readily seen to be inconsistent with (80) if the distribution is either Paretian or
lognormal.
We must therefore expect that y = 1. Suppose now that 1 + 2, the marginal tax
flu
rate, tends to a limit t < 1. Then
dx _ U2 (y dy\
+nI->1+1,1 ... (83)
dn nu, dn
and consequently
X ...(84)
n
This implies that
-= - (1- )0n'1 + o(1)], ...(85)

U1 OC
from which we can deduce the behaviour of
I { U(I - )f(m)dm ...(86)

as n-> oo. In the Paretian case, f- n-2-y, it is easily seen that
I--(2+y-u)-1>O. ...(87)
Since 1-I = limn-v . u2 J-, and y 1 _ d log f

u2 nu, u2 dy
to a limit at all), we must have U2 -+O, which
nu,
the lognormal case, one obtains
1-l = lim Y u2 constant ...(88)

u2 nu1 log n
If 'y 1 tended to a finite limit, since

u2 log n
log I u2 # log (1-l) +log (nu,) #(1-ji) log n,

65.0.33.20 on Fri, 12 Feb 2021 u, 01 Jan 1976 12:34:56 UTC
1 _ d log u U2 I would tend to a finite limit a

log I U21 dy
Thus in the lognormal case too, we expect that t = 1. This explains the conjectures in
the case u < 1.
If,u= 1,
oc d(log x) = nu, dx = yn( dy *dy(89)

d(log n) dn dn
which therefore cannot tend to oo, since in that case uj1 = n >nM eventually for any
finite M, so that 21 f 1 f(m)dm becomes unbounded as n- oo.

We can expect, therefore, that y- < 1 and
logx Y-yU2(y). ...(90)

log n
It is easily seen that the only plausible value of y is that for which log x/log n- 1, i.e.
YU2(Y) = -a. ... (91)
Then if 1+ U2 -4, we shall have

nu1
-1 -U2(Y)
nocx - -+ U-,
1-t
and
VIy f( m)Pfdm-+ (I)'r Y)

n2f(n) Ju -U2(Y) Y'
which suggests that
t=frt) G') -
-U2(Y) Y
= (1 - t)(1 + v)/y, ... (92)

in the notation (57). This is equivalent to (56). In particular, we expect that I = 0 in the
lognormal case.
When u> 1, the utility function is bounded above, and a more general and rigorous
treatment is easy. un is an increasing function, and being now bounded tends to a finite ii.
We shall write
u(x,y) = x(x)+p(y). ...(93)

Since x is an increasing function, X(x) also tends t
limit, and so does y. The limit of y must be zero, since otherwise (32) implies u-+co,
which is now impossible.
Now
nu, q y ip nul
-+ ... (94)
-U2(0)

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
in this case (since -, being < , is bounded . Therefore Equation (50) becomes
nu, U2
dv1
n (Y+1+o(1))v+ +o(l) ...(95)
dn ~~~~U2(0)
in the Paretian case. From (95) one deduces, by the usual method of solving a first-order
linear differential equation, that
- 1 ...(96)
_ U2(0)(Y + 1)
from which it follows
checked that in the lognormal case the marginal tax rate tends to zero.
In the next section, a particular case is examined in detail, and provides confirmation
for some of our conjectures.
8. AN EXAMPLE
Case I. Let us, by way of illustration, analyze the following case:

u = oc log x+]og(1-y)
G(u) = - (lPog 1.
f(n) = 1exp [ (log n + 1)2
L 2 J
(The last assumes a lognormal distribution of
We put w = 1. With these assumptions, Equat

dv logn x A
dn n n2 n 2
du y
dn n(l-y)'
where
1- x
V = 01+ /V/
nu, ],*= n( --y)2
1/cc(l y) = e(1 Y)( 1y x
and
eu = x (1-y).
For simplicity, we consider the case ,B = 0 first, and put
s= 1-y,
t = log n.
The equations become, since u = a log (an) + a log s- + log s,
dv = v t+ 1 -s+2e-t, ...(98)
ds = [1-a _ (1 + a)s](s2-v)+ocs(vt+2e-t) (99)

dt -(1 +a)s2-(1-a)v
1 In the case of 9 = 0, we define G = u.

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Solutions of these equations are depicted in Fig. 1. W

We remember that, in the optimum solution, 0< v <s2
between 0 and 1). Using this fact, we can deduce from
v-+O (to so).

Suppose that, for some t, vt > 1. Then
d v-s2
- v >vt+V >vt-1_O,0
dt s
'I
v~~~~~~~~~~~~~~~~
2-t~~ 1 5
FIGuVR 1
since v>0, and s < 1. Therefore v is increasing at an increasing rate, contradicting

v<s2 < 1. This shows that, in fact,
0<v< l/t. ...(100)
The two equations together imply that
d '-a I 1-(1 +oc)s I-a2

- [S 'a(S2 _ V)] - s a (S -V), ...(101)
dt s
as one may see if

subtracts. Write
r =sa(s2_v). ... (102)

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so that
dr _ 1-(1 +ex)s r ...(103)

dt s
When s < , r increases; when

limit other than l/( +oc): we shall show more, that s-?1/(1 +oc). (Cf. Fig. 1.)
Since v-+0, given s>0, there exists to such that 0<v,<e for all t _ to. Then
1+a 1-a 1+a
s a - cs a <r<s rS (t_ to). ... (104)
If rt>(l+o)- a , the right hand inequality implies that

1
St >-~~. ... (105)
l+oc
Therefore r is decreasing. If
1++a 1-a
rt<(l +oa)- a -e max[l, (1 + oc) cc J. . ..(106)
we obtain from the left hand inequality (104),
St a <(1+x)- a -e{max[1, (l+ O)~ ]-St a } <(1O)- a ... (107)
if, either oc ? 1 (in which case {...} ? 0 since s _ 1), or a> I and st> . Thus, in
fact
St <- .. .(108)
1+cx
and, by (98), rt is increas

l+cc
-+<(l+o() a
which in turn implies, since v>0, that
St- 1+ . ... (109)

1+c
Our demonstration that v and s tend to limits 0 and , respectively, confirms the
conjectures for the special case. It is readily checked that exactly the same arguments apply
to the case /3>0. As we have noted previously, the marginal tax rate is v/s2. Thus, as
t ->oo
o0-. ... (1 10)
It is a striking result; but we should note at once that 0 is a poor approximation to V/S2
even for large t. This becomes apparent when we demonstrate that vt-* 1
I1+o
Suppose the contrary, that vt- >s > 0 for an unbounded set of values of t.
If Vt> + s, and t is large enough to imply that st < 1

1+e 1+
dv > ... (Ili)

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Thus vt continues greater than 1 +6, and - > is f

1+0e dt
v-* c, which we have already shown to be false. If on the other hand vt< -?, and
l+cx
t is greater than 2 and is large enough to imply
vt< A 2tet < + Stx 1 -

4 4 ~~~~1+0e
then
d-(vt) = v + t(Vt-S) + Vt + Ate-t

dt s
I__ -8
1+ +
< 1+ +
2 1
This implies that vt becomes ne

all large enough t:
Vt-* I . (113)
I+o
Thus
o = v/s 2_ =... =..(1 14)

t
Only 1 per cent of our population have t > 1P7 (one in a thousand have t > 2*4).
Since one might want to have ac as low as 1, the above approximation is clearly rather bad
even at t = 2., 2 How bad will become apparent in the next section.
Case II. It is also of interest to examine the case of a skill-distribution with Paretian
tail:
nf' y+2, y>? ... (115)

f
The equations for the optimum become (with,B = 0),
dv_ v
dt - vy(t)+ v -s++ et, ...(116)
dtt
ds =[I1-oec-(I + O)S](S2 -v) +
dt (I + Oe)S2 Oe-)V
1 In this example, r2 = 1: that is, the standard deviatio
venience in manipulations. A precisely similar theory holds
It can be shown, by continuing the methods of t
The fact that the optimum path is tangential to the vertical at (s, v) = (1 1 , O) implies that s<
for large t, since otherwise r would be decreasing, and that, as can be seen from the diagram, is inconsistent
with dv ?? Thus we have the situation portrayed in Fig. 1.
2 The case /> 0 can be treated in a precisely similar way, to obtain the same qualitative results.

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and, exactly as before, one has the equation
dr _1-(1+ao)s (118)
dt s
where r = s ( (S2-v). The situation is portrayed in Fig. 2. The broken curves have
equations
s a (s _v) ri i 2 v= s ,2 3) ... (119)

V~~~~~~~
v 1/
/ //
S2~~~~~~~~~~~~S
vs +1 ~ ~ ~~~~~
v2= + p (p constant) . . (121)

FIGuRE 2
with 0 < r1 < r2 < r3. It will be noted that such a curve, with equation
v= s2-rs ac(r constant), ... (120)

always cuts from below the curve
dVI = sv - r s3 _ r cntant),> ... (120)

that passes through the same point. This follows from
ds ds ds \ys+
dN1 _ dv2 _ d vs3 ~rs >0. ...(122)
N

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This remark will prove very useful; but first we
the sign of dt is nearly the same as the sign of v_ -YS

dt vs +1
Let e' be a posit
1 1
t ? t1. Since s = 1 at to = log no, s< at t only if s = for some previous t1;
1+o 1+o
if (for the given t) t1 is the g
rt> t =(1 -a)- a (nf + t St 2-Vtl
{(1 +a)2 | 1+oc dt 5

=A/\>0, ... (123)
since as t- oo, 0> d- imp

dt
s2
Vt < -t + o(1)
VSt + 1
< S2_ yS t3+ o(1). ... (124)

Therefore st is positively bounded below, say
st > A'>0. ... (125)

Hence, when_t _ t1,
= vy(t)+ v -s+Ae-t
dt s
>, ... (126)

if
s2 2s'
S+ + 1 ... (127)
ys+ y 1
Similarly, we can show that
dv<, ... (128)

dt
if
v< s 2 ... (129)

YS+1 Y+ 1
Now write ?= 8'/( + 1). It is clear that, if, for some t t,
v s-I +s and s >

YSl =1+aoc

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then dv >0 and also dr <0. Therefore, by the proper

dt dt
s 2 ~~~~~~~~dv
Fig. 3), v _ is increasing. Thus for all sub
Ys +1 dt
cannot be optimum
1 S2
either s< or v? +C. ...(130)
l+oc ys+1
Similarly, for t > tl,
either s> 1 or v> s -?. ... (131)

1+oc -ys+1
X~~~~~~ + pi
/~~
FIGuRE 3
Suppose that at t1, s> 1 (An exactly similar argument applies if s< 1*)
Then r is decreasing, and continues to do so until
r =r' =(1+Soc)~
( 1+oe)2 (1+oe+y) N
a ( E 2 ( 1 ) +6,
Only then can s become less than 1 (Cf. Fig. 4.)

1+x ~ ~ ~~+
Therefore at no time is
r<r" = (1+Oc) G a +a)2(1 +a
Nor can we have r>r' at any later time. Thus we have found t2 such that, w
(st, v) lies in the curvilinear parallelogram LMPQ in Fig. 4, which contains X
made as small as we please by suitable choice of 6'. Therefore as t-+oo,
1 +o (t oc)(l+oc+y)32)

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The optimum path is indicated by XZ in Fig. 2. On it, the marginal tax rate,
v2 1+ocys2 l + a +Y ' ~~~~~.. .(133)
which confirms our conjecture in this special case.' 2

It should be noted that we have not shown, in either o
(nor even that z = ny = et(1 - s) increases) all along the path: the possibility that z is
constant for some range of n, in the optimum regime, remains in both the examples we have
discussed. Calculation of specific cases is required to settle this issue. Such calculation is
not difficult with the information about the solution that we now have.
/ sZ
/ ~~/
/ /
w~~~~~~~~~~~~~~ -M+T
// X~~
Ls
FIGu1 4
9. A NUMERICAL ILLUSTRATION
The computations whose results are presented in the tables below were carried out
for the first case examined above, with oc= 1, but with a more realistic value for c2.
Computations have also been carried out for the case U2 = 1, and these provide an interest-
ing contrast to the main set of calculations. In all cases, we take w = 1; and for computa-
tional convenience, the average of log n is -1. This means that the average marginal product
of a full day's work is ef27 2, but it amounts only to a choice of units for the consumption
good. The results show, for particular values of the average product of labour, X/Z,
what is the optimum tax schedule, and what is the distribution of consumption and labour
in the population.
1 The case 3> 0 can be treated in a precisely similar way, to obtain the same qualitative results.
2 It is possible to calculate optimum tax schedules explicitly for a uniform (rectangular) distribution
of skills; but since that distribution is of no great interest in the present context, the analysis is omitted.

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For purposes of comparison, one naturally wants to know what would have been the
optimum position if it had been possible to use lump-sum taxation (or, equivalently,
direction of labour). Let us consider this first for the case ,B = 0. We shall assume a
linear production function
X=Z+a ...(134)
(which one thinks of as ap

that are to be considered
T [log x + log (1- y)] f(n)dn
subject to .. .(135)
fxf(n)dn = fny
It is clear that x will be the same for everyone:

x = x?, ...(136)
and that yn must maximize
log (1-y)+Jny/x0, ... (137)
for otherwise we could improve matters by
of course) and changing the constant x co
y= [1-x?/n]+, .. .(138)
where the notation [...]+ means max (0, ...).
It is worth noticing that in the full optimum, only men for whom n > xo actually work,
and an interesting curiosity that, with the particular welfare function specified in (135),
utility will be less for more highly skilled individuals. This is, as we have seen, impossible
under the income-tax. The value of xo is determined by the production constraint:
x? (n-xo)f(n)dn+a, ...(139)
xo
where, for convenience, we have taken f(n)dn = 1. In the case of the special lognormal
distribution used here, it can be shown that this equation reduces to
2x0 - x?F(x) - e-ff2 [-F(e 2X0)]= a. ...(140)

Solution of this equation gives the consumption level in the full
skill-level below which no work is required of a man, namely tha
labour would provide a wage equal to the consumption level.
When f,>0, a similar theory holds. In that case, x>xo for men with n>xo, but it is
still the case that such men are made to have a lower utility level than their less skilled
neighbours. The equation corresponding to (140) is a little more complicated and will not
be reproduced. For n > xo, consumption and labour are
Xn = (x0)(1+P)/(1+2P)n/(l+2P) ..2.(141)
Yn = -(X01n)(1
In the tables, certain features of the optimal regime under income taxation are
along with xo for the full optimum for the same linear production function. In T
the lognormal distribution has parameters a = 0 39. This figure is derived fro
figures for the distribution of income from employment for various countries ([3
It is intended to represent a realistic distribution of skills within the populat

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TABLE I
(Case 1)
ot = 1, =0, c 0-39, mean n = 0 40, XIZ = 0 93.
Full optimum for X Z-0-013: xO = 0419, F(xO) = 0-045.
Partial optimum (income-tax): xo = 0-03, no = 0-04, F(no) = 0-000.
full
F(n) x y x(l -y) z optimum
x
0 0-03 0 0 03 0 0419
010 010 0-42 005 009 019
050 0-16 045 0-08 0 17 0 19
0 90 025 048 0-13 0-29 0419
0.99 0-38 0-49 0419 0 45 0419
Population average 0417 0418 0419
TABLE II
Same case as Table L
Average Marginal
z x tax rate tax rate
per cent per cent
0 0 03 23
005 0*07 -34 26
0.10 0*10 -5 24
0-20 0418 9 21
0 30 0-26 13 19
040 0*34 14 18
050 043 15 16
TABLE HI
(Case 2)
o=1, =, cr = 039, mean n = 0 40, X/Z= 140.
Full optimum for X = Z+0-017: xO = 0-21, F(xO) = 0-075.
Partial optimum (income-tax): xo = 005, no = 0-06, F(no) = 0-000.
Full
x
0 0*05 0 0.05 0 0-21

0410 0411 0-36 0 07 0-08 0-21
0 50 0-17 0*42 0.10 0415 0-21
0 90 0-27 0-45 0-15 0-28 0-21
0 99 0 40 0-47 0-21 043 021
Population average 0418 0417 0-21
TABLE IV
Same case as Table III.
Average Marginal
per cent per cent
0 005
005 0'09 -80 21
040 1013 -30 20
0-20 0*21 -5 19
0 30 0-29 3 17
040 0*37 6 16
0 50 0-46 8 15

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TABLE V
(Case 3)
= 1, P - 1, o = 0 39, mean n = 0 40, X/Z = 1V20.
Full optimum for X = Z+0-030: xO = 0 16, F(xO) = 0 016.
Partial optimum (income-tax): xo- 007, no = 009, F(no) = 0000.
Full
x
0 0*07 0 0-07 0 0416

0 10 0*12 0-28 0*08 0-07 0-18
0 50 0-17 037 0*11 0-14 0-21
0 90 0-26 043 015 0-26 0 25
0.99 0*39 0*46 0-21 0-42 0 29
Population average 0 18 0 15 0 21
TABLE VI
Same case as Table V.
Average Marginal
per cent per cent
0 0-07 23
0 05 0 11 -113 28
0'10 0414 -42 27
0-20 022 -8 25
0*30 0-29 2 23
0 40 0 37 7 21
0 50 0A45 10 19
TABLE VII
(Case 4)
= 1, ,3 = 1, o = 0 39, mean n = 0 40, X/Z= 0-98.
Full optimum for X = Z-0 003: xO = 0414, F(xO) = 0 007.
Partial optimum (income-tax): xO = 0 05, no = 0-07, F(no) = 0 000.
Full
x
0 0-05 0 005 0 0-14

0410 0410 0 33 0 07 0-08 0417
0 50 0415 0-41 0 09 0415 0-20
0 90 0*24 0*46 0*13 0-28 0-23
0.99 0*37 0*48 0.19 0 44 0 26
Population average 0416 0417 0419
TABLE VIII
Same case as Table VII.
Average Marginal
per cent per cent
0 005 30
0 05 0 08 -66 34
010 012 -34 32
020 019 7 28
0 30 0-26 13 25
0 40 0 34 16 22
0 50 0-41 17 20

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TABLE IX
(Case 5)
o= , ,B = 1, o = 039, mean n = 0 40, X/Z = 0-88.
Full optimum for X = Z-0-021; xO = 0-13, F(xO) = 0 004.
Partial optimum (income-tax): xo = 004, no = 0 06, F(no) = 0 000.
Full
F(n) x y x(1 -y) z optimum
x
0 004 0 004 0 0-13

0 10 0 09 0O36 0-06 0-08 0-15
0 50 0O14 043 0-08 0-16 0-18
0 90 0O23 0-48 0O12 0-29 0-22
0.99 0O36 0 50 0418 0 45 0-25
Population average 0415 0417 0.19
TABLE X
Same case as Table IX.
Average Marginal
per cent per cent
0 004 35
005 007 -43 39
010 0.10 -3 36
0-20 0-17 15 31
0 30 0-24 20 27
0 40 0-31 22 24
0 50 0 39 21 21
oc= 1, = 1,o = 1, mean n = 0-61, XIZ 0 93.

TABLE Xl
(Case 6)
Full optimum for X = Z-0-013: xO = 0-25, F(xO) = 0 35.

Partial optimum (income-tax): xO = 0410, no = 0-20, F(no) = 0-27.
Full
x
0 0*10 0 0*10 0 0-25

0*10 0*10 0 0*10 0 0-25
0 50 0-14 0*15 0.11 0-06 0-28
0 90 0-32 0-41 0.19 0 54 0 44
0.99 0*90 0*49 0*46 1-84 0-62
Population average 0418 0-20 0-32
TABLE XII
Same case as Table XI.
Average Marginal
per cent per cent
0 0.10 50
0 10 0415 -50 58
0-25 0-20 20 60
050 030 40 59
1P00 0-52 48 57
1P50 0 73 51 54
2-00 0*97 51 52
3 00 1P47 51 49

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.4
.3
*cXs s 1-4-
I0 1 *2 3 .4 5 z
FIGURE 5
Optimum Consumnptio
Function
.3 i Distribution of
4 Consumption
after Tax
.2 CaSe 5:
;nea X 1c=,
X
I=
Distribution of Income
/7<SX/B/ k/;///,;;;t -efore Tax
10 - / //777rr-.
12 .3 .4 .5 z
FIGuRE 6

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case, x0, no, and the values of x, y and x(I -y)

50 per cent, 90 per cent and 99 per cent points of the skill-distribution are given. In separate
tables, the average and marginal tax rates are given for a representative range of values of
z. Graphs of the optimal consumption schedule (x = c(z)) are given in Figs. 1 and 2.
In Fig. 2, the distributions of xn and zn are displayed in case 5.
It will be noticed at once that, under the optimum regime, practically the whole
population chooses to work in each of these cases: this contrasts, in some cases, with the
full optimum, where sometimes a substantial proportion of the population is allowed to be
idle. In most cases, a significant number work for less than a third of the time. It is also
somewhat surprising that tax rates are so low. This means, in effect, that the income tax
1*5
.5
Case 6: c=I
? .5 1 *5 2 z
FIGURE 7
is not as effective a weapon for redistributing income, under the assumptions we have made,
as one might have expected. It is not surprising that tax rates are higher when,B = 1.
When objectives are more egalitarian, more output is sacrificed for the sake of the poorer
groups. Nevertheless, the difference between the optimum when only an income tax is
available, and the full optimum, is rather large.
The examples have been chosen for X/Z fairly large: this corresponds to economies
in which the requirements of government expenditure are largely met from the profits of
public production, or taxation of private profits and commodity transactions. Tax rates
are, as one might expect, fairly sensitive to changes in X/Z (i.e. to the production possibilities
in the economy, and the extent to which income taxation is used to finance government
expenditure as well as for " redistribution "). Tax rates are mildly sensitive to the choice
of,f. (When c = 4i, the main features are unchanged).
Perhaps the most striking feature of the results is the closeness to linearity of the tax
schedules. Since a linear tax schedule, which may be regarded as a proportional income
tax in association with a poll subsidy, is particularly easy to administer, it cannot be said
that the neglect of administrative costs in the analysis is of any importance, except that

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considerations of administration might well lead an optimizing government to choose a

perfectly linear tax schedule. The optimum tax schedule is certainly not exactly linear,
however, and we have not explored the welfare loss that would arise from restriction to
linear schedules: nevertheless, one may conjecture that the loss would be quite small.
It is interesting, though, that in the cases for which we have calculated optimum schedules
the maximum marginal tax rate occurs at a rather low income level, and falls steadily
thereafter.
This conclusion would not necessarily hold if the distribution of skills in the population
had a substantially greater variance. The sixth case presented has a = 1. So great a
dispersion of known labouring ability does not seem to be at all realistic at present, but it
is just conceivable if a great deal more were known to employers about the abilities of
individual members of the population. The optimum is in almost all respects very different.
Tax rates are high: a large proportion of the population is allowed to abstain from produc-
tive labour. The results seem to say that, in an economy where there is more intrinsic
inequality in economic skill, the income tax is a more important weapon of public control
than it is in an economy where the dispersion of innate skills is less. The reason is, presum-
ably, that the labour-discouraging effects of the tax are more important, relative to the
redistributive benefits, in the latter case.
10. CONCLUSIONS
The examples discussed confirm, as one would expect, that the shape of the optimum
earned-income tax schedule is rather sensitive to the distribution of skills within the popula-
tion, and to the income-leisure preferences postulated. Neither is easy to estimate for real
economies. The simple consumption-leisure utility function is a heroic abstraction from
a much more complicated situation, so that it is quite hard to guess what a satisfactory
method of estimating it would be. Many objections to using observed income distributions
as a means of estimating the distribution of skills will spring to mind. Yet the assumptions
used in the numerical illustrations seem to fit observation fairly well, and are not in them-
selves implausible. It is not probable that work decisions are entirely, or even, in the long
run, mainly, determined by social convention, psychological need, or the imperatives of
cooperative behaviour: an analysis of the kind presented is therefore likely to be relevant
to the construction and reform of actual income taxes.
Being aware that many of the arguments used to argue in favour of low marginal tax
rates for the rich are, at best, premissed on the odd assumption that any means of raising
the national income is good, even if it diverts part of that income from poor to rich, I must
confess that I had expected the rigorous analysis of income-taxation in the utilitarian
manner to provide an argument for high tax rates. It has not done so. I had also expected
to be able to show that there was no great need to strive for low marginal tax rates on low
incomes when constructing negative-income-tax proposals. This feeling has been to some
extent confirmed. But my expectation that the minimum consumption level would be
rather high has not been confirmed. Instead, virtually everyone is brought into the work-
force. Since this conclusion is based on the analysis of an economy in which a man who
chooses to work can work, I should not wish to see it applied in real economies. So long
as there are periods when employment offered is less than the labour force available, one
would perhaps wish to see the minimum income-level, assured to those who are not working,
set at such a level that the number who choose not to work is as great as the excess of the
labour force over the employment available. A rigorous analysis of this situation has still
to be attempted. The results above do at least suggest that we should allow the least skilled
to work for a substantially shorter period than the highly skilled.
I would also hesitate to apply the conclusions regarding individuals of high skill: for
many of them, their work is, up to a point, quite attractive, and the supply of their labour

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
may be rather inelastic (apart from the possibilities of

theoretical work on this problem too. I conclude, for the present, that:
(1) An approximately linear income-tax schedule, with all the administrative advan-
tages it would bring, is desirable (unless the supply of highly skilled labour is much more
inelastic than our utility function assumed); and in particular (optimal!) negative income-
tax proposals are strongly supported.'
(2) The income-tax is a much less effective tool for reducing inequalities than has
often been thought; and therefore
(3) It would be good to devise taxes complementary to the income-tax, designed to

avoid the difficulties that tax is faced with. In the model we have been studying, this could
be achieved by introducing a tax schedule that depends upon time worked (y) as well as
upon labour-income (z): with such a schedule, one can obtain the full optimum, since one
can, in effect, construct a different z-schedule for each n.A Such a tax would not be fully
practicable, but we have other means of estimating a man's skill-level-such as the notorious
I.Q. test: high values of skill-indexes may be sought after so much for prestige that they
would not often be misrepresented. With any such method of taxation, the risks of evasion
are, of course, quite great: but if it is true, as our results suggest, that the income tax is not
a very satisfactory alternative, this objection must be weighed against the great desirability
of finding some effective method of offsetting the unmerited favours that some of us receive
from our genes and family advantages.
REFERENCES
[1] Blum, W. J. and Kalven, H. Jr. The Uneasy Case for Progressive Taxa
of Chicago Press, 1953).
[2] Diamond, P. A. " Negative Income Taxes and the Poverty Problem-a Review
Article ", National Tax Journal (September 1968).
[3] Lydall, H. F. The Structure of Earnings (Oxford, 1968).
[4] Mirrlees, J. A. " Characterization of the Optimum Income Tax " (unpublished).
[5] Musgrave, R. A. The Theory of Public Finance (McGraw-Hill, 1959).
[6] Shoup, C. S. Public Finance (Weidenfeld and Nicolson, 1969).
[7] Vickrey, W. Agenda for Progressive Taxation (Ronald Press, N.Y., 1947).
1 The essential point of these proposals is that the marginal tax rate (as represented by rules for deduc-
tions from social security benefits) should be significantly less than 100 per cent. Proposals of this kind
have sometimes been put forward in terms that suggest-quite wrongly of course-that any plausible-
sounding negative income-tax proposal is better than a system in which all earnings are deducted from social
security benefits. It was a major intention of the present study to provide methods for estimating desirable
tax rates at the lowest income levels, and a surprise that these tax rates are the most difficult to determine,
in a sense. They cannot be determined without at the same time determining the whole optimum income-
tax schedule. To put things another way, no such proposal can be valid out of the context of the rest of the
income-tax schedule.
2 J am indebted to Frank Hahn for pointing this out. It would seem to be true that lump-sum taxation
is possible in any formal model where uncertainty is not introduced explicitly.

65.0.33.20 on Fri, 12 Feb 2021 06:09:38 UTC
CHAPTER 3
EVOLUTION OF INCOME TAX SYSTEM IN INDIA
3.1 Income Tax System in India from 1860 to 1939
Income Taxation from 1860 to 1886
In its modem form, the income-tax was introduced in India for the first time in 1860 as
a temporary measure to overcome the financial difficulties created by the events of 1857. Thus
the credit for introducing income-tax in its modem form in India goes to the British. It may be
asserted that, like the introduction of the study of English language in Indian Education, the
introduction of Income-tax in the Indian financial system is one of the few happy heritages of
British rule in this country '. The period from 1860 to 1886 was a period of experiment in
which 23 Acts were passed in the field of direct taxation. In the year 1860, tax was levied at
2 percent on income between Rs. 200 and Rs.500 and at 4 percent on incomes above Rs.500.
It is significant to note that even at that time the authorities were very careful about exemptions.
Persons earning income less than Rs.200 a year from all sources (Including agriculture income)
were exempt from tax. All government property was also exempted.
Exemption were also granted to cultivators of land, the rent value of which was less than
Rs. 600 per annum and to religious and charitable institutions. Thereafter rates were changed
from time to time. This Act of 1860 lapsed in 1865. Although the income-tax of 1860 was not
operated successfully, the procedure concerning levy and collection of tax was continued under
different nomenclature thereafter viz. ‘licence tax’ (introduced in 1867 and abondoned the next
year), ‘Certificate tax’ (introduced in 1868 and abondoned the next year), ‘General Income-
Tax’ (introduced in 1869 and abolished in the year 1873) and a licence tax on trades and
professions (introduced in 1878). Agriculture Income was excluded from the ‘licence tax
'(1867) and the Act VI of 1880, applicable to whole of India together with the local Acts,
raised the exemption limit to Rs. 500 per annum, but the rate continued to be 2 percent, This
Act together with the local Acts remained in force till 1886. Ultimately the Act took the
final form in favour of income tax since the experience, convinced the Government that
income taxation had cometo form a necessary compliment of its revenues and was the only
means of compelling the official and professional classes to pay taxes who prospersed most
at that time. Therefore, afresh legislation was undertaken in 1886 which was the first
systematic legisation on income-tax.
1. Rao, V.K.R.V. : Taxation of Income in India. Longmans Green & C.n I -td , Rnmh.iv 1Q11
35
The 1886 Act
Act II of 1886 was the first important landmark in the history of income-tax in our
country. This act was not only a great improvement on its predecessors but its basic scheme
contained the germs of the subsequent Income tax Acts also. This Act excluded agricultural
income from the ambit of the income-tax which has continued to be a feature of income tax
since and introduced a definition of‘agricultural income’ in almost the form in which it stands
today. Income was divided in to four heads Viz., income from salaries and pensions, profits
of companies, interest on securities and other sources of income including income from house
property. The tax was levied on individual’s different sources of income separately and not on
his total income. A flat rate of 5 pies in the rupee of 192 pies (about 2.6 percent) was applied
on income over Rs. 2,000/- with a rate of 4 pies on ‘salaries’ between Rs.500 and Rs. 2,000.
‘Interest on securities’ was also taxed at the same rate. In the year 1903 the taxable minimum
was raised to Rs. 1,000.Enhanced rates of taxation by gradation or graduation were introduced
in 1916 when eight different rates of tax were prescribed for the different brackets of income.
The first world war also caused increase in tax rates. An additional income tax was also
introduced for the first time in 1917 in the name of‘super-tax’. This super-tax was introduced
mainly with a view to raise more revenue for the government. While income-tax was being
levied at ‘step basis’ for ‘super-tax’ the ‘slab system’ was used. Till 1916, there was no penally
for failure to furnish a retum(except in the case of companies) but in 1917, it was made
obligatory for an assessee, with an income of Rs. 2,000, to make a return. The Act of 1886 stood
in force for 32 years till 1918 with a number of amendments.
IM-m&Afi!
In 1918, a new act was enacted - the Act VII of 1918, which was introduced to re-cast
the entire tax law. The scheme of ‘all income if it accrues or arises or is received in British
India’ from whatever source it is derived [Sec.3 (l)],i.e. total income, was introduced for the
first time to determine the rate. The tax levy was imposed in respect of the taxable income of
the year of assessment, unlike on the income of the previous year, as obtained under the earlier
Acts. Section 2 of the Act contained many definitions. The terms ‘company’ and ‘previous
year’ were defined. The term ‘assessee’ included a firm and Hindu undivided family. Section
3(2) contained a list of ten items of exemptions including agricultural income. Taxable income
was divided in to six heads viz., income from salaries, interest on securities, income derived
from house property, income derived from business, income from professional earnings and
income derived from other sources. The rates varied from four pies in the rupee to twelve pies
in the rupee. This Act remained in force up to 1922 when, on the recommendations of All-India
36
Income-tax Committee-appointed in 1921, The Indian Income-tax Act XI of 1922 came in to
being.
The 1922 Act
This Act of 1922 marked an important change from the Act of 1918 by shifting the
administration of the income tax from the hands of Provincial Government to the Central
government. Another remarkable feature of this Act was that the rales were to be enunciated
by the annual finance Acts instead of in the basic enactment. This Act, like the Act of 1918
applied to all incomes except capital gains, casual income and incomes in kind not convertible
in to money (except rent free accommodation). Charge in the year of assessment was estab
lished on the basis of the income of the ‘previous year’, instead of using the income of the
'previous year to make adjustment when the actual income of the assessment year was
ascertained (1918 Act). The levy of Super-tax
was being incorporated in the provisions of this Act now which was being assessed as
a separate-tax till then and the super-tax was defined as an additional duty of income tax. The
assessable entities were “individual, Hindu Undivided family, company, firm and other asso
ciation of individual”.
This Act permitted an assessee to set off loss of profits or gains under one head of income
against profit under any other head, both relating to the same assessment year. Further, this Act
granted relief in respect of discontinuance of a business which had been assessed under the Act
of 1918. The Act of 1922 was amended as many as twenty times between 1922 and 1939 as
it was realised that there were loopholes in the administration of the Act which might lead to
tax-avoidance and tax evasion, and the rates of tax were also being increased since from 1921
onwards, the increasing need for government’s growing expenditure compelled the taxing
authority to pay more emphasis on ‘taxes on income’ Thus, by 1939, these taxes occupied the
second important position among Central taxes, and they made a contribution of about 20
percent of the total tax revenue to the Govt, of India. With increased taxation, more deductions,
allowances and reliefs were also allowed from time to time. The Indian Taxation Hnquiry
Committee was also constituted in 1924-25 to consider different aspects of taxation.
Act VII of 1939 was an Amendment Act which was based upon the Income-tax
Committee also called Aiyer’s Committee’s Report(1936). This Committee was appointed to
make an investigation of the Indian Income-tax system in all aspects and to report on both the
37
incidence and efficiency of administration of the tax. The recommendations made by this
committee changed the basic structure of the 1922 Act and ushered in a new era, both in the
matter of incidence of tax on income and its administration. This Act of 1939, marked a
departure from the past, by bringing to charge the foreign income of‘residents’ in British India.
An intermediate class of assessees between ‘residents’ and ‘non-residents’ called ‘resident’but
ont ordinarily resident’created2. This Amendment Act, 1939 gave a new definition of income
which was an inclusive definition. A number of different types of receipts were included in
‘income’ which were not otherwise taxable/Salary’ which was taxable on ‘receipt’ basis was
to be taxed on ‘due’ basis according to this Act. It granted to a business, for the first time, relief
by way of carry forward of loss for a period of six years. ‘Slab system’ was introduced in 1939
for income-tax also and since then it is an integral part of the Indian income-tax system. ‘Slab
system’ is no doubt, better than ‘step system’. Under the step system’, a single average rate
is charged on each taxpayer’s entire (total) income, increasing with the size of that income,
where as under the ‘slab system’, the total income is split into slabs and progressive higher rates
are charged on successive slabs of income. Roughly, to effect, progression, whereas the step
system prescribes average rates, (tax liability as a percentage of income), the slab system
prescribes marginal rates (the rate on the last increment of income). Under step system, when
the total income just exceeds one of the levels at which the rate increases, the whole income,
not merely that excess, will be taxed at a higher rate. For example, the income is Rs.l 0,000
and it is being taxed at 5 percent. If the incbme exceeds by Rs.50, the whole income of
Rs.l 0,050 will be taxed at the next higher rate, e.g., 10 percent. This increase of Rs.50 in the
income will increase the tax payable from Rs.500 to Rs.1005. On the other hand, under slab
system an increased rate is applied only to the increase in income above a slab, the tax as
percentage of the total income rises gradually as the income rises. This Act also introduced
many provisions to check tax avoidance.
3.2 Income Taxation from 1939 to 1961
The drastic changes of 1939 did not prove very effective as far as the income-tax reform
was concerned. Therefore, the 1922 Act was amended nine times between 1940 and 1947 and
not less than twenty nine times between 1939 and 1956. Each Amendment Act passed had been
of immense importance. The scheme of payment of tax in advance was introduced in 1944 and
the diffrentiation between earned and unearned income in 1945 was also introduced. The
scheme of provisional assessment, was introduced in 1948.
2. Meaningsof residents’,‘non-residents’ and ‘resident but not ordinarily resident’ are given
in Ch.4 ‘Present structure of Income Taxation’ in India.
38
A tax on capital gains was imposed for the first time in 1946, although the concept of
‘capital gains’ has been amended many times by later amendments. In 1947, the Taxation of
Income (Investigation Commission) Act, 1947, was passed. The India Income Tax (Amend
ment) Act, 1953 (XXV of 1953), effective from 1 April, 1952, gave effect to the recommen
dations of this Commission. In April 1953, the Government appointed another Commission,
known as the Taxation Enquiry Commission under the chairmanship of Dr. John Mathai. Its
terms of reference were very much wider than those of the 1935 Committee and 1947
Investigation Commission, The main task entrusted to this commission was to examine the tax
system in relation to the incidence of the tax system regarding the distribution of the burden
of taxation and inequalities of income and wealth, the suitability of the tax system with
reference to the developmenmt programme of the country, the effects of income taxation on
capital formation and development of productive enterprise, and the use of taxation in dealing
with inflationary and deflationary situations. The Finance Act of 1955 incorporated many
changes recommended by this Commission and this was the beginning when the recommen
dations of the commission were given the effect from time to time.
In January 1956, the Indian Statistical Institute invited Mr. NicholasKaldorto inves
tigate the Indian Tax System in the light of the revenue requirement of the second five-year
plan. His report was concentrated on the question of personal and business taxation. He
submitted an exhaustive report for a coordinated tax system and therefore,the result was the
enactment of several Taxation Acts, viz., the wealth-tax Act 1957, the Expenditure-tax Act,
1957 and the Gift-tax Act, 1958. Income-tax was also revived on ‘Capital Gains’. In 1956, The
Government also referred the Act to the Law Commission in order to recast the Act on
logicallines and to make its provisions more intelligible and simple without affecting the basic
tax structure. The report of the Law Commission was received by the1 Government on 26
Sept. 1958. Meantime, the Direct Taxes Administration Enquiry Committee, under the
Chairmanship of Shri Mahavir Tyagi was appointed by the government to consider measures
designed to minimise the inconvenience to assessees and to prevent evasion of income-tax.
This Committee submitted its Report on 30th Nov. 1959. The recommendations made in the
two reports took shape in the Income Tax Act. 1961.
3.3 The Incomcrlax Act, 1961
The Income-tax Bill, 1961 which was submitted to the Lok Sabhaon the 24th April, 1961
was the outcome of above recommendations. On 1st may, 1961, it was referred to a Select
Committee and its report was presented to the Lok Sabha on 10th August, 1961. After passing
through both the House of Parliament, the Bill received the assent of the President on 13th Sep.,
39
1961 and the Act came in to force with effect from 1st April, 1962 by replacing the Indian
Income Tax Act, 1922 which had remained in operation for 40 years. The present law of
income tax is governed by the Income Tax Act, 1961, which has 298 sections and 4 schedules
and is applicable to whole of India including the state of Jammu and Kashmir.
The search for an effective tax system answering the developing needs of the nation has
led to the appointment of various committees and commissions which have led to many
changes in the Act, 1961. Changes have been brought in by almost every Finance Act,
AmendingActs and Ordinances. About 70 laws have been passed between 1962 to 1989 to
amend the Income-tax Act, 1961. Some of these amendments were made in pursuance of the
recommendations made by (i) Bhootalingham’s Report on Rationalisation and Simplification
of Tax Structure submitted in two parts, one dated 5th April, 1967 and the other dated 26 Dec.,
1967,(ii) the Report of the Working Group of Administrative Reforms Commission on Central
Direct Taxes Administration, headed by Shri Mahavir Tyagi (1969), (iii) the Report of the
Direct Taxes Enquiry Committee (1971), under the chairmanship of Justice K.N.Wanchoo,
regarding unearthing black money, preventing evasion and avoidance of taxes, and reducing
arears, (iv) the Committee on Taxation of Agricultural Wealth and Income (1972), (v) the
Interim Report (1977) and final Report (1978) of the Direct Tax Laws Committee headed by
Shri C.C Chokshi, (vi) the Report of the Enquiry Committee under the Chairmanship of Shri
Bhoothaligam regarding changes in the concepts of the financial year and the previors year,
(vii) Economic Administration Reforms Commission, called L.K.Jha Commission (1981),
which submitted its report in 1983, (viii) a long term fiscal policy, announced by the govern
ment and laid before the Parliament on 19th Dec, 1985,(ix) a White paper enunciating
government’s policy published in 1986, and (xx) Direct Tax Laws (Amendment) Act, 1987 and
1989. A study on black money was published in March 1985 by the National Institute of Public
Finance and Policy in India, with contributions by Dr. RJ.Chelliah. An expert Committee was
also constituted in 1989 on revision of tax reforms, which submitted the interim report in 1990.
The Tax Reforms Committee was also appointed in 1991 under the Chairmanship of Sh. Raja
J.Chelliah which submitted its Final Report Part-I in Aug, 1992, and final Report Part- II in
January 1993. Some of the recommendations of the Tax Reforms committee have already been
implemented in subsequent budgets. This Committee is basically concerned with the question
of administrative reforms with respect to both direct and indirect taxes. The Committee also
presents detailed and specific recommendations for important changes in India’s tax structure.
The essence of these changes is to lower nominal rates and to broaden tax-base. This Commit
tee is also in favour of progressive income taxes. Therefore, even the Income-tax Act of 1961,
which was then considered to be very comprehensive, had to be amended from time to time.
40
The 1961, Act has enlarged the number of categories of assessable entities to seven as
against six of the 1922 Act, including ‘every .artificial juridical person’, who has not been
included in the six categories, i.e. residuary class3. A scheme of self-assessment was intro
duced which, in course of time, displaced the scheme of provisional assessment. Provisions
regarding advance tax, interest and penalty were made more rigorous. Regarding reopening
of back assessment for escaped income, the Act retained the limit of eight years where the
assessee has failed to make a return or failed to disclose all meterial facts. The procedures for
assessment were completely recast in April 1989, i.e., assessment year 1989-90.
Income-tax revenue originates mainly from two taxpaying entities Viz., ‘Companies’and
‘Individuals - Hindu Undividedfamily, Registered firms and others contribute very little. Since
this study is concerned with ‘Individuals’ - which account for more than 99 % of the 'Salaried-
Class’ - 'Companies’ are not taken in to account.
3.4. Some Salient Feature of the Rate Structure of Income -Tax on Individual in India :
The rates of income-tax as well as the slabs have undergone frequent changes from time
to time. In pre-independence time, the tax system was designed with the single main objective
of raising sufficient amount of revenue for expenditure of Government for administration and
allied services. The position, however, has completely changed in post-independence period.
In designing the tax system, Government took into consideration the objective of ‘growth with
social justice’, which led to the frequent changes in the income-tax structure from time to time.
Besides, the tax on income was levied in a variety of ways viz. income-tax; surcharge on
income-tax; super-tax; surcharge on super-tax; surcharge on earned incomes; surcharge on
unearned incomes; additional surcharge; special surcharge etc. The Finance Act,1963, im
posed ‘additional surcharge’ for the assessment year 1963-64. This levy of ‘additional
surcharge’ was closely connected with the Compulsory Deposit Scheme (1963), which gave
place to Annual Deposit for the assessment year 1964-65 and onwards. Although the main
objectives of the above mentioned ways adopted, were to withdraw the purchasing power on
account of prevailing inflationary pressures on the economy and to make large funds available
to the public sector, the system became complicated year by year.
3. Details are given in 4th Chapter,’Present structure of Income Taxation’.

41
To simplify the system, super-tax was subsequently integrated with income-tax by the
Finance Act, 1965 that is, effective from the assessment year 1965-66. The distinction between
earned and unearned incomes, introduced in 1945, was completely abolished from April
1,1968. Now there was only one type of surcharge and one kind of tax, that is, income-tax was
levied at varying rates on different slabs of incomes and a surcharge was added at a prescribed
rate upon the tax so computed to arrive at the total tax liability.
An attempt has always been made by the Government to keep the incidence of tax at a
relatively lower level for persons in the lower income groups. Therefore, a minimum exemp
tion limit—all individuals having prescribed income are not subject to tax has always been
provided by the different Income-Tax Acts. Since 1947, exemption limit has been gradually
raised. At the time of introduction of the Income-Tax Act, 1961, exemption limit was Rs.3,000
for individual and Rs. 6,000 for Hindu Undivided Family. From the assessment year 1957-58,
these exemption limits were subject to the provision of ‘family allowance’ computed in
accordance with the personal circumstances of an individual. More concession was given to
married individual with two or more children compared to unmarried one or married having
one child.
Under the Finance Act 1965, every individual got relief on account of personal allow
ance in terms of amount of tax otherwise payable depending upon the marital status. This was
in addition to a minimum exemption limit. This scheme of personal allowance was discontin
ued by the Finance Act, 1970 and ‘first tax free slab’ was prescribed for the first time for the
assessment year 1971-72 for individuals whose income up to Rs.5,000 was fully exempt from
tax — whatever their marital status may be. This step further simplified the system.
Since, the Direct Taxes Enquiry Committee (1971), popularly known as Wanehoo
Committee, recommended reduction in the rates of direct taxes which were mainly responsible
for tax evasion because they made tax evasion more attractive, the maximum marginal rate of
income-tax on individual was reduced from 97.7 per cent in the assessment year 1973-74 to
66.0 per cent in 1980-81 on income exceeding Rs.l Lac [ Government of India, Finance Acts
(various years)].
The number of slabs was reduced to 7 from 8 in the budget of 1975-76. In 1985-86
the number of slabs became 4 and now it is 3, i.e., in the budget of 1996-97. This is also an
important step towards the simplification of tax system.
42
The exemption limit for individuals has been continuously enhanced from Rs. 5,000 for
the assessment year 1971-72 to Rs.6,000 for the assessment year 1975-76 and to further
Rs. 12,000 for the assessment year 1980-81. The following table 4 depicts the exemption limit
provided under the law and the range of marginal tax rates applicable to individual tax payers
in different assessment years from 1980-81 to 1997-98.
43
Table 4
Range of Marginal Tax Rates Applicable to Individual Taxpayers in the Assessment
years 1980-81 to 1997-98.
Assessment Exclusive of Surcharge Inclusive Exemption

Years Surcharge On Income of Surcharge Limit
(Percent) Tax(Percent) (Percent) (In Rs’000)
1 2 3 4 5
1980-81 15.00-60.00 20.0 18.00-72.00 8'

1981-82 30.00-60.00 10.0 33.00-66.00 82
1982-83
and 1983-84 30.00-60.00 10.0 33.00-66.00 15
1984-85 25.00-60.00 12.5 28.125-67.500 15
1985-86 20.00-55.00 12.5 22.500-61.87 15
*
1986-87
and 1987-88 25.00-50.00 Nil 25.00-50.00 • 18
1988-89
and 1989-90 25.00-50.00 5.03 25.00-52.50 18
1990-91 20.00-50.00 8.04 20.00-54.00 18
1991-92
and 1992-93 20.00-50.00 12.05 20.00-56.00 22
1993-94 20.00-40.00 12.06 20.00-44.8 28
1994-95 20.00-40.00 12.06 20.00-44.8 30
1995-96* 20.00-40.00 - 20.00-40.00 35
1996-97 20.00-40.00 - 20.00-40.00 40
1997-98 15.00-40.00 - 15.00-40.00 40
Notes :
1. If income does not exceed Rs. 10,000, it is treatedas exempt.
2. If Income does not exceed Rs.12,000, it is treatedas exempt.
3. Applicable only if the taxable income exceeds Rs.50,000 and otherwise ‘Nil’.
4. Applicableonly if the taxable incomeexceedsRs. 75,000 and otherwise ‘Nil’.
5. Applicableonly if the taxableincomeexceedsRs. 75,000 and otherwise ‘Nil’.
6. Applicableonly ifthetaxableincomeexceeds Rs. 1,00,000 and otherwise ‘Nil’.
*. No surcharge is leviable from A.Y. 1995-96 and maximum marginal rate is applicable
to income over Rs. 1,20,000 (which is over Rs. 1,00,000 for all the previous assessment
years mentioned above).
Source : Budget of Union Government of India, for different years.
44
The maximum marginal tax rate (exclusive of surcharge) was 60 percent from the
assessment year 1980-81 to 1984-85 and the rate inclusive of surcharge varied from 72 percent
to 67,50 percent because of variation in the rate of surcharge. Subsequently, maximum
marginal tax rate has been brought down to 40 percent. Marginal tax rates at low income levels
continued to rise in early eighties and reached at 33 percent in the year 1981-82 and remained
same till 1983-84, Subsequently, marginal tax rates at low income levels also continued to
decline like maximum marginal tax rates resulting in 20 per cent in the assessment year 1996-
97 and further, 15 percent in the assessment year 1997-98. This decline in the rate of income
tax on individuals in the first income slab, i.e., between Rs.40001 to Rs.60Q00 in the assess
ment year 1997-98, as compared to the assessment year 1996-97, has reduced the tax liability
on different income levels. The table 5 reveals the impact of reduction of tax rate in the first
income slab in the case of individuals.
Table. 5
Tax Liability in the case of individuals at Different Income Levels in the Assessment
Year 1996-97 and 1997-98, and the Resultant Relief.
in Rs.
Total Tax Tax Relief

Income Liability in Liability in Amount %
the assessment the assessment
year 1996-97. year 1997-98.
1. 2. 3. 4. 5.
41000 200 150 50 25

45000 1000 750 250 25
50000 2000 1500 500 25
55000 3000 2250 750 25
60000 4000 3000 1000 25
75000 8500 7500 1000 11.8
100000 16000 15000 1000 06.3
120000 22000 21000 1000 04.5
150000 34000 33000 1000 02.9
200000 54000 53000 1000 01.9
45
Five percent decline in the rate of income tax on individuals, as compared to previous
year, in the first income slab caused 25 percent relief from income tax up to the income level
of Rs.60000 (first income slab) in the assessment year 1997-98. With the increase in the level
of income from Rs.75000 to Rs.200000, tax relief declined from 11.8 percent to 1.9 percent
respectively.
The exemption limit for individual income tax payers has been substantially raised
during the period 1980-81 to 1997-98 from Rs. 8,000 to Rs.40,000.
While the range of marginal tax rates exclusive as well as inclusive of surcharge in the
assessment years 1980-81 to 1997-98 is shown in table 4, the marginal tax rates by income
brackets are presented for the same period in table 6 .
46
Iabk-6
Marginal Tax Rates Applicable to Individual Taxpayers in the Assessment Years
1980-81 to 1997-98.
(Percent)
Taxable Assessment Years

Income
1980-81& 1982-83 1983-84 1984-85 1985-86 1986-87 to
1981-82 1989-90
1. 2. 3. 4. 5. 6. 7.
On the first Rs. 10,000 Nil Nil Nil Nil Nil Nil
On the next Rs. 2,500 15 Nil ' Nil Nil Nil Nil
On the next Rs. 2,500 15 Nil Nil .Nil ' Nil Nil
On the next Rs. 2,500 18 30 30 25 20 Nil
On the next Rs. 500 18 30 30 25 20 Nil
On the next Rs. 2,000 18 30 30 25 20 25
On the next Rs. 5,000 25 30 30 30 25 25
On the next Rs. 5,000 30 34 34 35 30 30
On the next Rs. 5,000 40 40 40 40 35 30
On the next Rs. 5,000 40 40 40 40 35 30
On the next Rs. 10,000 40 40 40 40 40 30
On the next Rs. 10,000 50 50 50 50 45 40
On the next Rs. 10,000 50 50 52.5 52.5 45 40
On the next Rs. 10,000 55 55 55 55 50 40
On the next Rs.5,000 55 55 55 55 50 40
On the next Rs. 15,000 55 55 57.5 57.5 50 40
On the next Rs.20,000 60 60 ’ 60 60 55 50
Over Rs. 1,20,000 60 60 60 60 ' 55 50
Contd....
47 :-
Tablfc.6
Taxable Assessment Years.

Income --------------------------------------------------------- ------------------------
1990-91 1991-92& 1993-94 1994-95 1995-96 1996-97 1997-98
1992-93
8 9 10 11 12 13 14
On the first Rs. 10,000 Nil Nil Nil Nil Nil Nil Nil
On the next Rs.2,500 Nil Nil Nil Nil Nil Nil Nil
On the next Rs.2,500 Nil Nil Nil NiL Nil NiL Nil
On the next Rs.2,500 Nil Nil Nil Nil Nil Nil Nil
On the next Rs.500 Nil Nil Nil Nil .Nil Nil Nil
On the next Rs.2,000 20 Nil Nil Nil . Nil Nil Nil
On the next Rs.5,000 20 20 Nil Nil Nil Nil Nil
On the next Rs.3,000 30 20 Nil Nil Nil Nil Nil
On the next Rs.2,000 30 20 20 Nil Nil Nil Nil
On the next Rs.5,000 30 30 20 20 Nil ' Nil Nil
On the next Rs.5,000 30 30 20 20 20 Nil Nil
On the next Rs. 10,000 30 30 20 20 20 20 15
On the next Rs. 10,000 40 40 30 30 20 20 15
On the next Rs. 10,000 40 40 30 30 30 30 30
On the next Rs. 10,000 40 40 30 30 30 30 30
On the next Rs.5,000 40 40 30 30 30 30 30
On the next Rs. 15,000 40 40 30 30 30 30 30
On the next Rs.20,000 50 50 40 40 30 30 30
Over Rs. 1,20,000 50 50 40 40 40 40 40
Note: The marginal tax rates presented here do not include surcharge or special surcharge:
if any.
Source : Budget of Union Government of India, for different years.
Both the tables (5 & 6) given above reveal the declining marginal rates of income-tax on
individuals in India. But the general impression that India is a highly taxed nation is still true
in regard to rate of income-tax on individuals. The following table 7 reveals the different
income-tax rates on individual in OECD member countries.
48
Table?
Rate Schedules of Central Government Income Tax
on individual in different countries
Country Lowest Rate of Highest Rate of

Income tax on Income Tax on
Individuals , Individuals
Australia 20.0 47.0

Austria 10.0 50.0
Belgium 25.0 55.0
Canada 17.0 29.0
Denmark 22.0 40.0
Finland 7.0 ^ 39.0
France 5.0 .
Germany 19.0
5.0
t*Ifc wana.#0.0
®p3.0
Greece
Iceland 32.8 32.8
India 20.0 44.8
Ireland 27.0 48.0
Itlay 10.0 51.0
Japan 10.0 50.0
Luxemburg 10.0 50.0
Mexico 3.0 35.0
Netherlands 13.0 60.0
Newzealand 24.0 33.0
Norway 9.5 13.0
Portugal 15.0 40.0
Spain 20.0 56.0
Sweeden 20.0 20.0
Switzerland 1.0 13.2
Turkey 25.0 50.0
United Kingdom 20.0 40.0
United States 15.0 31.0
OECD Average * 15.4 41.3
Notes :
1. * Unweighted
2. For comparison with India, member countries of OECD have been chosen for conven
ience as the data for these countries are readily available.
3. OECD stands for Organisation for Economic Co. operation and Development.
Source: Revenue Statistics of OECD Member Countries, OECD, Paris, 1994.
49
A comparison of personal income tax rate in India with OECD member countries reveals
that still India comes in the list of Highly Taxed Nations. Although rates of personal income
tax (lowest as well as highest) in India are lower compared to some OECD member countries,
because these rates have been declined in India compared to previous years, still the lowest as
well as the highest rates are higher than the OECD average rates(lowest as well as highest).
Which proves the comparatively heavy burden of income-tax on individual tax-payers in India.
To reduce the burden of income - tax on individuals, besides raising the exemption limit,
scope of deductions has also been widened and the ceilings have been raised from time to time.
For Example, the ceiling on the amount of investment in specified assets that qualifies for a
graded deduction up to assessment year 1990-91 (Sec.^Gp^WSs^sed from Rs. 10,000 in
1961-62 to Rs.40,000 with effect from 1983-84.4
The ceiling on allowable deduction of intereslSdiUMBend received from some

specified assets has been raised from Rs.5,000 in 1961-62 to Rs. 9,000 in 1983-84 to 13,000
with effect from the year 1989-90 and subsequently it has been enhanced to Rs. 15,000 with
effect from the assessment year 1997-98. The list of specified assets have also been enlarged.
With effect from the assessment year 1975-76the system of itemised expense deduction
with respect to expenditureincidental to earning salary income has been replaced by a standard
deduction based on the salary income. The ceiling on the amount of standard deduction has
been raised from Rs.3,500 in 1975-76 to Rs.5,000 in 1983-84, Rs. 12,000 in 1989-90 and
subsequently to Rs. 15,000 (or @ 33 1/3 % of gross salary, whichever is less,in case of salaried
women Rs. 18,000 or 331/3 % of gross salary, whichever is less, having income upto Rs.75,000)
with effect from theassessment year 1994-95. Standard deduction has been raised to Rs. 18,000
for persons drawing salary up to Rs.60,000 in the current budget for the assessment year 1997-
98, which will provide relief to the low -paid salaried employees. “Thus, a salaried employee
with an income of Rs.60000 per year, making the minimum contribution to his provident fund,
will now pay no tax at all. If he has no savings, he will still pay only Rs.300.5
After reviewing the evolution of income tax system and analysing the changes occurred
from time to time in the structure of income tax, now we will discuss the present structure of
income tax in India and its justification.
4. This section (80 C) was applicable up to the assessment yearl990-91. The same
investments and contributions (specified under sec. 80 C) are now eligible for rebate from
tax under section 88 from the assessment year 1991-92.
5. Finance Minister’s Budget Speech, Union Budget, 1996-97.
The Ability-to-Pay Theory of Taxation
Author(s): M. Slade Kendrick
Source: The American Economic Review , Mar., 1939, Vol. 29, No. 1 (Mar., 1939), pp. 92-
101
Published by: American Economic Association
is collaborating with JSTOR to digitize, preserve and extend access to The American Economic
Review

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THE ABILITY-TO-PAY THEORY OF TAXATION
Ability to pay, the dominant theory of taxation, is usually interpreted in term
sacrifice. It is held to justify progressive taxation under any one of three possible int
pretations of sacrifice: the equal, equal-proportional, and least-sacrifice theories. T
theories rest in turn on three assumptions: the declining marginal utility of money w
an increase in its supply, the existence of sacrifice arising from the payment of t
and the quantitative expression of that sacrifice. Analysis discloses each of these supp
to be defective and thereby breaks down the theory of ability to pay. Progressive
tion may, however, be justified on other grounds. These grounds should be founde
the broad realities of the economic system. Taxes have economic effects, and these ef
entail social consequences. The choice of the taxes to be laid and rates at which th
are to be applied expresses a preference for one set of economic effects, and hen
social consequences, to another. The theory of taxation, progressive or other, should c
respond to these facts. The thin nebula of hedonism in reverse is no longer adequate.
Advocated alike by the scholar in taxation and the common man, t

theory of ability to pay has achieved the primacy among theories of taxati
The rival theories, cost-of-service and benefit-of-service, though recog
as of some usefulness, are now mentioned chiefly for their defects as
clusive principles. Only ability-to-pay reaches the height of a general p
ciple to which taxes and tax systems should in the main conform.
The phrase "ability to pay" has a good and honest sound. It says th
money for public expenditures should come from "him that hath" ins
of from "him that hath not." Who could oppose such a principle?
sentiment reasonable in itself and so appealing in its context of ethic
associations was bound to win increasing support.
But-we may ask-what does it mean to lay taxes according to ability
to pay? At the outset of this inquiry, it may be observed that, in practice,
this principle means much more than the levy of taxes on sources from
which they can be paid. If it were so easily satisfied, most taxes would
be levied according to ability to pay. Even a sales tax paid by consumers
on necessaries of life would correspond to ability to pay interpreted in
the revenue sense. About the only exception would be a poll tax. Clearly
then a narrow and literal conception of ability to pay will not do. Graduated
income and inheritance taxes are commonly given as examples of the ap-
plication of the principle of ability to pay. We shall, therefore, pursue
our quest of the meaning of ability to pay by examining the basis of
graduated taxation.
The usual and indeed the only serious justification of ability to pay
is on grounds of sacrifice. The payment of a tax is viewed as a deprivation
to the taxpayer. He might have spent the money for his own purposes
but instead must turn it over to the public treasury from which it will be
expended for social ends. In surrendering his money to the government,
he is said to make a sacrifice. It is held, therefore, that sacrifice is the basic
principle to which the levy of taxes should conform, for that is their
meaning to taxpayers.

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Ability-to-Pay Theory of Taxation 93
The sacrifice attached to the payment of taxes is, however, in Professor

Seligman's view, to be modified by the relative ease with which the dollars
surrendered were obtained. "A man's ability to pay taxes is to be measured
not only by the relative burden imposed upon him in parting with his
wealth, but also by the relative ease with which he has acquired his wealth."'
Both the basic premise of sacrifice and the Seligman variant will now be
examined.
The idea of sacrifice when linked to the concept of the declining marginal
utility of money has given rise to three theories of progressive taxation:
the equal, equal-proportional, and least-sacrifice theories. According to
the equal-sacrifice theory, taxes should be laid in such a manner that the
sacrifices of all taxpayers are equal. The theory of equal-proportional
sacrifice holds that the sacrifice of taxpayers should bear an equal propor-
tion to their incomes. Thus in this view equality of sacrifice is not sufficient.
The rich man's tax payment should represent a greater sacrifice than the
contribution of a man of moderate means. It should, however, not be
greater in relation to his income. The equality is, therefore, to be found
in the proportion, not in the quantity of sacrifice.
The theories of equal and of equal-proportional sacrifice both involve
the taxation of poor as well as rich persons. In neither theory is there
an attempt to make any income group bear all the taxes. The problem for
both theories is the distribution of the tax burden among individuals
possessed of varying incomes. These theories of taxation may, accordingly,
be classified as individual theories. The least-sacrifice theory, on the other
hand, is a group theory of taxation. Least sacrifice is interpreted in the
group sense. The objective of taxation is least sacrifice to the group. Ac-
cording to this theory, taxes should be laid first on the incomes of the
very rich. When these incomes are reduced to the level of the rich, then
the rich would be taxed. Persons of moderate means would be taxed only
after the incomes of the very rich and the rich have been reduced by
taxation to their level. The theory calls for the progressive elimination
of the high incomes by taxation. In order to obtain the levelling effect
sought, the rates of graduation imposed would be extremely steep in
the upper ranges.
All three theories, however much they may vary from one another, have
a common rootage in the principle that the marginal utility of money
declines with an increase in its supply. But, as Professor Pigou has shown,
the utility of money must fall more sharply than the theory of declining
utility requires if the objective of equal sacrifice leads to progressive taxa-
tion. On the contrary, any degree of decline in the utility of money with
an increase in the supply would give a basis for progressive taxation under
'E. R. A. Seligman, Studies in Public Finance, Macmillan, 1925, p. 188.

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94 M. Slade Kendrick [March
either the theory of equal-proportional sacrifice or that of least sacrifice.2

The concept of marginal utility was developed in economic theory for
the purpose of explaining the demand for goods (including services). It
is of material assistance in accounting for the fact that an increase in the
supply of goods offered results in their sale at lower prices. The curve
of the money demand for goods slopes downward to the right. Increasing
supplies can be sold only at lower prices. The uncovering of lower strata
of purchasing power is not sufficient in itself to account for this economic
fact. Recourse must be had also to the decline in utility that comes as
additional units are supplied. With a fall in price the poor buy, but the
well-to-do who would purchase some units at a higher price buy more
at the lower price. When automobiles sell at $1,500, few have two cars.
But as the price of an automobile falls to $1,000, the number of families
with two cars increases.
The marginal-utility concept when applied to taxation must be extended
from the specific commodities for which it is used in economic theory
to the generalized commodity, money. For the purposes of graduated
taxation, it will not do to say merely that the utility of food, clothing,
and other goods declines as their supply increases. The tax is laid not
on these things but on money income or inheritance. The utility of money
itself, that which has command over all things of purchase and sale whether
for near or distant uses, for consumption or investment, and which, in
consequence, has come to be the substance of power, the symbol of success,
must be held to decline with an increase in supply. The application of the
marginal utility concept to a sacrifice theory of taxation requires also that
the payment of money by the individual to the government shall be cleemed
a sacrifice on his part. And, if any of these sacrifice theories is to mean
anything in practice, the sacrifices involved in the payment of taxes must
be capable of quantitative expression. All these requirements are basic to
2 A. C. Pigou, A Study in Public Finance, Macmillan, London, 1928.

Professor Pigou's analysis of the general opinion respecting the relationship between
the theory of marginal utility and progressive taxation is so effectively presented that it
is quoted here:
"This opinion is to the effect that, in all circumstances, in order to secure equal
sacrifice, the tax formula must be in some measure progressive, in the sense that the rate
of taxation per ? of income grows as incomes grow. This proposition is supposed to be
logically deductible from the law of diminishing utility. That supposition is incorrect.
All that the law of diminishing utility asserts is that the last ? of a ?1,000 income carries
less satisfaction than the last ? of a ?100 income does. From this doctrine it can be
inferred that in order to secure equal proportionate sacrifice,(a) taxation must
gressive, but not that it must be progressive in order to secure equal sacrifice. In order
to prove that the principle of equal sacrifice necessarily involves progression we should need
to know that the last ?10 of a ?1,000 income carry less satisfaction than the last ?1 of a
?100 income; and this the law of diminishing utility does not assert" (p. 106).
(a) "It is casy to see that proportionate taxation could only yield equal proportionate
sacrifice if the curve whose ordinates represent the quantities of utility derived by the
representative man from successive units of income were a horizontal straight line-a
condition incompatible with the law of diminishing utility."

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1939] Ability-to-Pay Theory of Taxation 95
the doctrines of sacrifice. Thereby they ultimately support the theory of

ability to pay as a justification of graduated taxation. Let us examine them.
The relation of the utility of money to the supply possessed by an
individual is most difficult to write about. It is easy to believe that the desire
for food, even for costly dainties, slackens rapidly as the supply grows from
the stage of plenty into that of abundance. Nor is it difficult to think of
an individual as having so much clothing, so many automobiles, servants,
houses, yachts that the addition of a suit, a car, a maid, a town house, or
a cruiser would make little difference to him. Each direction of outlay
returns less satisfaction per dollar for the amount expended. There can
be too much of any one thing. But can there be too much of all things?
That is the problem. If the total of things that money buys were composed
of goods and services only-clothing, furniture, paintings, houses, servants,
operas, theatrical performances-the problem would be difficult but perhaps
not impossible of solution. Somewhere physiological considerations would
limit the satisfaction received from these things. But, as incomes grow
larger, goods and services bought for consumption become relatively less
important in the total. This is true even of the things of show-the costume
balls, racing stables, trips to Newport and Deauville with their rotogravure
outcomes, the yachts long of keel and broad of beam-that certify so
tangibly the possession of great wealth. Stocks, bonds, mortgages, invest-
ments of all kinds, on the other hand, grow relatively greater in significance,
and as income is received from them, not all this return is spent for goods
and services, so still more money is available for investment. With increased
holdings and growing wealth, there come directorships and chairmanships
in important corporations, and the valuable perquisite of "inside informa-
tion" for further gains; honorary degrees from aspiring colleges and
universities; memberships in exclusive clubs; the respect of the successful,
the envy and admiration of the striving; the notice of everyone, headlines
and pictures in the press; power to better or to worsen the lives of thousands
of working men, endow colleges, fill party campaign chests, provide art
galleries, stimulate research; and perhaps ultimately the enjoyment of
political preferment.
Does income of this kind decline in satisfaction as more is received?
Are power and prestige subject to the same principle as food and furniture?
They may, for aught that we know, respond to the opposite principle.
Suppose, for example, that an ambassadorship is wanted but that a fortune
of 5 million dollars must be had before the required political prominence
can be reached, and the necessary expenses of maintaining an ambassadorial
establishment can be met. In that instance, once the goal appears in striking
distance, the growth of the fortune needed for its attainment is clearly at-
tended by increasing utility. Men being as they are, who can deny that
power and prestige may whet but never satiate the appetite?
The second requirement for a sacrifice theory of taxation is that the

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payment of taxes shall be a sacrifice to the payer. At first thought, it might

seem that this requirement could be passed over without discussion. The
payment of taxes is ordinarily not a cause for rejoicing. The taxpayer feels
the loss, and may strive by one means or other to avoid it. If, however,
we ask whether the payment of taxes is, in reality, a sacrifice, we are on
different ground. The collection from the taxpayer finances many govern-
mental services that he would be unwilling to do without, and for which
he would be glad to pay if they could not be had on other terms.3 We
do not consider payment for groceries, gasoline, or other commodities to
be a sacrifice. Such payments are mere exchanges. Dollars are surrendered,
satisfactions are received. Sacrifice does not enter into the matter at all. Why
then, should the payment of taxes that finance needed services of govern-
ment be called a sacrifice? The fact that there is no direct quid pro quo,
as in trade, may account for the feeling of deprivation that the taxpayer
experiences. This feeling is, however, not conclusive in respect to the
question of sacrifice. The services of government would, it is true, be
accepted preferably without the payment of taxes. But groceries, automo-
biles, and other good things of life would also be received gladly on the
same terms. It would indeed be a glorious world if things could be had
without cost.4
Still another aspect of the difficulty with the concept of sacrifice, effective
throughout progressive income and inheritance taxation, appears at its
clearest with respect to the upper ranges of the graduation. We have already
observed the nature of large incomes, the fact that they are spent only
in small part for the material necessaries and even luxuries of life, and
are significant mostly for the power and prestige that go with the possession
of great wealth and its accumulation. Suppose now a progressive tax to
be laid, which imposes a heavy obligation on large incomes. Is the payment
of such a tax to be accounted a sacrifice to these rich possessors? Their
current expenditures for consumption are disturbed little if at all. They
still eat choice foods, drink rare wines, ride in expensive automobiles, and
maintain cruisers or yachts. True, the automobile may have less custom
work, and the yacht may be shorter of keel, narrower of beam, and contain
cabins less gorgeous with gilt and murals. The chief deprivation that these
rich folk suffer must, therefore, be in relation to their investments. Not
so much money is available for investment. Thus, whether the avenue
of expenditure be consumption or investment, less money is available for
'This is not an intermixture of benefit theory. One may be glad that a given govern-
mental service is provided and be willing to pay for it without being able to evaluate
the worth of this service to him personally.
'The point-brought out later-that individuals differ in their attitudes, feelings, re-
sponses is also not properly to be urged in support of the position that the payment of
taxes is a sacrifice. On balance, these differences might be held, by the same logic, to indicate
that the payment of taxes is a benefit.

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the things of power and prestige. But power and prestige are relative
concepts. They are to be had only on the condition that others do not
possess them. The peaks stand out only because they are above the mass
of the range. Attainment of power and prestige, those human peaks, is
the objective of an intense competition in which the rich win as against
the poor, the very rich as against the rich, and the richest as against all
others. In such a struggle, each contestant would feel the loss of his place
seriously. But the tax is not selective in its application. It is laid on all
alike within each income group. No one, therefore, is handicapped in
the competition. Each is as well off as before in comparison with others
in the same group. As among the groups, the richest decline somewhat
in relation to the very rich, and the very rich in relation to the rich. But
this tendency toward the telescoping of income groups, brought about
by the levy of progressive taxation, has small significance in relation to
sacrifice. The very rich are still richer than the rich, and the rich continue
to have more than the well-to-do.
All this is not put forth as a denial of the existence of sacrifice in
taxation. A person who is over-taxed in relation to others of the same
status bears a sacrifice. The very poor who pay a general sales tax on the
necessaries of their existence clearly sacrifice to make this payment. A
whole community may bear a sacrifice in that the people pay taxes and yet
do not receive in return governmental services of equivalent worth. The
argument here is not directed to these instances of sacrifice but rather
to the sacrifice concept in its various interpretations as a justification for
the levy of personal income and inheritance taxes at graduated rates.
In order to examine the third requirement for the sacrifice theory of
progressive taxation, we shall have to accept the first two for purposes of
this inquiry. This last requirement is that the sacrifices arising from the
payment of taxes shall be capable of quantitative expression.5 Perhaps
this requirement should be explained with reference to the various sacrifice
theories. The theory that the sacrifices of all taxpayers should be equal
conveys within itself the idea of quantitative expression. The sacrifices
cannot be equal, save as quantities. My sacrifice cannot be equal to yours,
in any other than a quantity sense.
'Ample support for this requirement is to be found in the literature of taxation:

Gerhard Colm, "The Ideal Tax System," Social Research, August, 1934, New School for
Social Research, New York City.
"The principle of taxation corresponding to the social-liberal ideology is that of ability,
of equal, proportionate, or minimum sacrifice. The idea is that taxes should be so assessed
as not to disturb the stratification of incomes measured, however, not in money but in
some utility unit" (p. 326).
H. G. Brown in The Economics of Taxation, Holt, points out (p. 199) that the con-
cept of equal sacrifice means "to impose an 'equal' amount of 'sacrifice' on all taxpayers."
Essentially the same idea made with respect to the theory of least sacrifice is to be
found in Pigou, A Study in Public Finance, p. 75.

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The theory of least sacrifice realizes its end by progressive reduction

of the larger incomes. The quantity of sacrifice by this method of sub-
traction is found to be less than that following from the taxation of all
incomes. In order to obtain such a result, the sacrifices of the relatively
few at the upper end of the scale must be totalled for comparison with the
sum of sacrifices that would be suffered by the taxation of all incomes.
In no other way is it possible to know which method will yield the least
sacrifice. An individual may know that one pain is greater than another,
though, as Sir Josiah Stamp remarks, "it is very difficult for a man to say
quantitatively that one boot pinches three times as much as the other."6
But where different persons are concerned, as in the instance of equal sacri-
fice, it cannot be said that one group bears less sacrifice than the other except
by a comparison of the quantities of sacrifice borne by each.
The theory of equal proportional sacrifice seems, on its face, not to
involve a quantitative expression of sacrifice. In this view, the test for
distribution of the tax burden is the proportion. It would appear then that
the sacrifices of taxpayers might be proportionately equal without being
quantitatively equal. And so they might, if there were as many tax rates
as individuals. In that event-given the necessary degree of insight-the
tax payments might be adjusted so that the sacrifice borne by each individual
would be in a given proportion to his income, and the quantity of sacrifice
would nowhere come into consideration, only the proportion.
But, even if the needed information on sacrifice were available, taxes
could not be laid on an individual basis. There could not be the thousands
or perhaps millions of rate combinations that would be required if each
individual's payment were made to represent proportionately the same
sacrifice that every other individual's payment would represent. At most,
even with full use of the device of graduation, relatively few rates can be
levied, and these must be imposed in relation to size of income, source, or
other large general considerations.
What does it mean then, in practice, to lay a tax according to the
principle of equal proportionate sacrifice? Simply this-if the principle
is to be followed-all persons within each income classification must bear
the same quantity of sacrifice. Otherwise, the equality of the proportion
would fail of realization. Thus if A and B each have a taxable income of
$100,000, to which the same schedule of graduated rates is applied, their
sacrifices must be quantitatively equal in order that they may be propor-
tionately equal. Furthermore, as among income groups, the quantity of
sacrifice borne by each must be computed in order that the graduation shall
impose a proportionately equal burden on all the groups. Taxation, ac-
cording to the principle of equal proportionate sacrifice, cannot, in practice,
escape the quantitative determination and comparison of sacrifices. In that
'Josiah Stamp, The Principles of Taxation, Macmillan, London, 1921, pp. 53-54.

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respect, it is linked to the other theories. All three theories of taxation

according to sacrifice rest, therefore, on the same basis-the quantitative
expression of sacrifices.
We have been at some pains to examine the foundation for the sacrifice
theory of progressive taxation. It is only by so doing that one can get behind
the screen of impressions that the sacrifice concept interposes and examine
the reality. The verdict on the sacrifice theory, however interpreted, is clear.
Reasons for doubting two of the three essentials on which this theory
is founded have already been given. The third fares no better. The reason
for this finding is simple. Individuals differ in their complement of feelings,
attitudes, responses. No two of us are alike-identical twins excepted.
Sacrifices are relative to the individuals that experience them. They are,
therefore, not possible of expression in quantitative units of the im-
personal sort needed if the sacrifices of persons or groups of persons are to
be compared.
If we examine Professor Seligman's variant that ability to pay is an
amalgam composed of the sacrifice of paying taxes and the ease with which
the money was obtained, the same results are obtained. The points made
respecting application of the principle of declining marginal utility to
money, and the existence of sacrifice in progressive taxation hold for this
view also. And the ease of obtaining money is clearly as much an individual
matter as the sacrifice of parting with it. My ease and your ease cannot, there-
fore, be reduced to comparable units more than our respective sacrifices
can. Sacrifice whether pure or an amalgam is not possible of reduction to
quantitative expression.
Perhaps it will be helpful at this point to compare the theory of sacrifice
in taxation with that of marginal utility in economics. This comparison
is more than apt; it is exact. Indeed, as has been observed, the sacrifice
theory of progressive taxation is but the reflection of the economic principle
of marginal utility. The sacrifice of parting with the generalized com-
modity, money, is held to be less as the amount increases, but this state-
ment of the matter for purposes of taxation, is but a derivation from the
economic principle that the utility of a commodity per unit declines with
an increase in its supply. It is, therefore, relevant to ask whether utility is
capable of quantitative expression. As has been noted, the concept of
utility, including its refined statement in the theory of marginal utility,
was developed to explain the purchases of individuals in the market for
consumable goods and services. Why do they buy, and more particularly,
why do they buy more as prices fall and less as prices rise? The theory states,
in substance, that each individual buys according to his wants and purchas-
ing power, and that, in general, his desires for any one good are satiable.
Consequently, his purchases of additional units depend on the payment of
a lower price. Since the desires of each in relation to his means for satisfying

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them are individual, there can be no quantitative or social expression of

marginal utility. My desire being in relation to me cannot be added to your
desire which exists only in relation to you. There is then in the concept
of marginal utility from which the doctrine of sacrifice was derived no
warrant for quantitative expression or comparison.7
It is time now to summarize the conclusions that have been reached
respecting the sacrifice theory of progressive taxation, the foundation of
the ability-to-pay theory. The sacrifice theory has been shown to rest on
(1) the declining utility of money accompanying an increase in its supply,
(2) the sacrifice involved in the payment of taxes, and (3) the quantitative
expression of that sacrifice. All these supports are required if the theory
is to be sustained. No one can be missing. All have been found defective.
With the support of its underlying theoretical structure removed, the
ability-to-pay theory of taxation breaks down.
The collapse of a theory raises, of course, the question of what happens
to the things that have been done in its name. Graduated taxes both on
income and inheritance have been imposed widely not only in this country
but throughout the world in the belief that these levies were justified by
the doctrine of ability to pay. The chief question, therefore, which arises
in this connection is whether the defection of the ability-to-pay theory
undermines the basis for graduated taxation.
The answer is clearly in the negative. The passing of the theory of ability
to pay means that graduated taxation can find its support in the solid
substance of reality. By way of deducing a principle on which it might
rest, let us see what graduated taxation does.8 Clearly, as incomes and
inheritances grow greater, the possessors thereof must pay more to the
government. They have, therefore, progressively less of the increase for
their own uses. Money, whether received in the form of income or in the
lump amount of an inherited share, may be spent for the various purposes
of consumption, or may be saved and invested. Since a greater proportion
of large incomes and inheritances is saved than of small, the effect of
graduated income and inheritance taxation of the kind we know in this
country is chiefly on savings and investment. Why not say then that these
7This statement is not made in forgetfulness of the work that has been done by
Professor Irving Fisher on the problem of measuring marginal uitility. That work, for
various reasons, is believed not to bear upon the issue examined here. In this omission,
no criticism is intended. See Irving Fisher, "A Statistical Method for Measuring 'Marginal
Utility' and Testing the Justice of a Progressive Income Tax," in Economic Essays con-
tributed in honor of John Bates Clark, Macmillan, New York, 1927.
An economic analysis in line with that given here may be found in H. J. Davenport,
The Economics of Enterprise, Macmillan, New York, 1922, ch. 8. See also the essay in a
footnote beginning on p. 387.
8 In strict logic, one does not accept a principle and then look for its supports. This
injunction is particularly to the point when the basis on which that principle rests has
been removed. The exposition at this point simply follows a short cut.

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taxes are on the ability to save, for that is their economic effect?9 On this
basis, a proposal to increase or to decrease the rates of income and inherit-
ance taxation would be examined in relation to what it does, not in relation
to the hypothetical consideration of sacrifice, which, in practice, has never
really been used anyway save as a vague and general justification for what-
ever graduation was advocated.
There may be other bases on which progressive taxation could rest. The
thought here is not to explore all possible foundations, but simply to show
by example that progressive taxation need not be based on the ability-to-pay
theory. But whatever support may be indicated and related to the rate
structure, it is important that graduated taxation shall be founded on the
broad realities of the economic system, and not on the thin nebula of
hedonism in reverse. Then decisions as to the use of such taxes can be
governed by economic considerations. Taxes are imposed by collective
action. They have economic effects; and these effects, in turn, entail conse-
quences for the society levying the taxes. The choice of the taxes to be laid,
and the rates at which they are to be applied expresses, therefore, a prefer-
ence for one set of economic effects and hence of social consequences to
another. Such are the facts. The theory should correspond.
M. SLADE KENDRICK
Cornell University
9 Professor Pigou (pages 77-80 of A Study in Public Finance) broadens the concept of
sacrifice to take into account the effect of progressive taxation on saving, and the con-
sequences following from that effect. Thus he holds that a check to capital accumulation,
brought on by progressive taxation, may result in lower real wages. He concludes that
"the principle of least sacrifice points to a system somewhat more merciful to the rich
than the canon of equi-marginal contemporary sacrifice would command."
But how far can the meaning of sacrifice be extended? That is the question for purposes
of this analysis. If the indirect and remote effects of a taxation policy are to be described
in terms of sacrifice, then all ill effects of any public policy, taxation or other, are "sacrifices."
It would seem that such extension of the meaning of sacrifice robs it of the sense in
which it is understood in ordinary usage. The meaning of a word cannot point to some-
thing in particular, and at the same time include general considerations of an extraneous
nature.

65.0.33.20 on Fri, 12 Feb 2021 06:11:24 UTC
The benefit and sacrifice principles of taxation: A synthesis
Author(s): Jon R. Neill
Source: Social Choice and Welfare , 2000, Vol. 17, No. 1 (2000), pp. 117-124
Published by: Springer
Springer is collaborating with JSTOR to digitize, preserve and extend access to Social Choice
and Welfare

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Soc Choice Welfare (2000) 1 7: 1 1 7- 1 24 ~
Social . Choice
and Welfare
© Springer-Verlag 2000
The benefit and sacrifice principles of taxation:

A synthesis
Jon R. Neill
Department of Economics, Western Michigan University, Kalamazoo, MI 49008,

USA (e-mail: |)
Received: 10 April 199 7/ Accepted: 16 November 1998
Abstract. The implications of equal sacrifice taxation have only been pursued
in a very narrow context. This note applies this principle to the problem of
levying taxes to provide public goods. Its purpose is to determine how taxes
used to finance public goods must be structured in order to benefit each agent
equally. This tax structure may be viewed as a benchmark against which to
compare tax regimes with redistributive intent.
Equality of taxation, therefore, as a maxim of politics, means equality of

sacrifice . . . This standard, like other standards of perfection, cannot be com-
pletely realized; but the first object in every practical discussion should be to
know what perfection is.
J. S. Mill
1 Introduction
One well-known ethical principle for levying taxes is the principle of equal
sacrifice. Despite its shortcomings and advanced age, it is still viewed by some
as "one of the fundamental concepts of distributive justice."1 Thus, though
equal sacrifice is no longer the dominant view of fairness, it continues to be a
common theme in the public finance and social welfare literature.2
I would like to thank William Baumöl, Allan Feldman, and the anonymous referees
for their comments and criticisms. This paper has benefited greatly from their interest.
1 Ok (1995), p. 454. As Young (1990) observes, "Fairness is the dominant theme in
almost every political debate about income tax policy." Equal sacrifice is of course
simply one formal characterization of fairness.
2 Recent and notable articles in which equal sacrifice is a theme are Ok (1995), Berlaint
and Gouveia (1993), Young (1990, 1988, 1987), Buchholz et al. (1988), Richter (1983).

65.0.33.20 on Fri, 12 Feb 2021 06:12:16 UTC
118 J. R.Neill
Another princ
taxation. This
the benefit th
state. Like equ
arena, most re
However, the
grant that an
public goods a
this relations
Thus, the bene
the other han
such goods an
whether or n
cient, as well a
by a tax. After
ture of tax re
that benefit in
Mill justified
argument that
essentialy inde
course, moder
bility. The pu
agents for pub
private and pu
today.
The fact that each of these paradigms offers something that the other does
not invites some sort of synthesis of the two. One such synthesis would be an
equal benefits paradigm; that is, taxes and expenditures could be structured so
that the benefit to each agent is the same. The purpose of this note is to con-
trast the tax regime resulting from adherence to equal sacrifice with that pro-
duced by following an equal benefits paradigm when the purpose of taxation
3 Smith (1991), pp. 424-25. According to Blum and Kalven, "sacrifice analysis has
been the most prominent form of argument for progression both at a popular and at a
sophisticated level. Although the doctrine is not as fashionable as it was a generation
ago, the doctrine as a whole makes up a curious and fascinating chapter of intellectual
history." For example, Edgeworth (1910) notes that "the scheme of graduated death
duties, introduced by Sir William Harcourt's Budget of 1894, was rested by Mr.
Courtney on the first principles of taxation . . . Mr. Courtney, in answers which he
submitted to the Royal Commission on Local Taxation, maintained 'that taxation for
common purposes should be levied from each member of a community according to
the law of equal sacrifice."
4 The most well-known benefit principle of taxation is due to Lindahl. See Musgrave,
Chapters 4 and 5 for a synopsis of classical and neo-classical taxation theory. For more
recent research on the benefit principle see Burgat and Jeanrenaud (1996), Maital
(1975), and Aaron and McGuire (1970).
5 Mill, p. 807.

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Benefit and sacrifice principles of taxation 119
is to provide agents with a pure public good. We offer t

benchmark against which any tax intended to be redistributiv
After all, if the benefit from the provision of public goods ris
it could be difficult to argue that there has been redistributio
of lower income agents.
Whatever the appeal of this approach, it should be kept in m
is an important tradition of using taxes to redistribute in
equal benefit taxation has no effect on the distribution of uti
sense, is not redistributive. Thus, equal benefit taxation serve
benchmark in that changing the distribution of utility will r
and below those indicated by this paradgim.
2 The model
Consider a set of n agents with the same indirect, cardinal utility function,
u(y,x); y is the agent's income and x is the quantity of a public good that he
consumes.7 The principle of equal sacrifice holds that taxes should impose the
same burden or sacrifice on each agent, where this burden is defined as the
agent's utility when he is taxed minus his utility when he is not taxed. For-
mally then, if taxes imply equal sacrifice,
u(y¡ - thx) - u(yhx) = u(yj - tj,x) - u(ypx) Vi,y (1)

However, if taxes are used to provide agents with a public good, the ith
agent's utility when he pays a tax of U is u(yt - U, x), where x is the quantity
of the public good the tax regime supports. In contrast, if there are no taxes,
his utility is u(yh 0), since without taxes, the government is unable in the long
run to provide the public good. From this perspective, equal sacrifice would
require that taxes be imposed so that
u(y¡ - th x) - u(yh 0) = u(yj - th x) - u(yp 0) V i, j (2)

Now, if the government operates under the Paretian principle, the tax re-
gime and the quantity of the public good provided must be such that at least
one agent is better off than he is without taxation. So then, incorporation of
the benefits from government expenditures and superimposition of the Pare-
tian principle transform the principle of equal sacrifice into the principle of
equal benefit. Thus, the key elements of the benefit and sacrifice principles are
brought together by the paradigm whose formal statement is Equation (2).
The benefit from government expenditures and equity in distributing those
benefits both play a role in determining how taxes will be levied. It is a fairly
6 See for example, Mirrlees (1971).

The prices of private goods are suppressed and thus assumed to be constant. Note
that a Von Neumann-Morgenstern utility function would allow for the comparisons
necessary to apply our paradigm.

65.0.33.20 on Fri, 12 Feb 2021 06:12:16 UTC
120 J. R. Neill
straightforwar
the public good
3 Implications o
When taxes ar
tax regime th
marginal util
increases; 2) the
of income is gr
less than one,
contrast equal s
First, it is imp
and spend deci
tion. And whet
fect of the pub
the marginal ut
spectively, wit
function. Then
Proposition 1: Let e(y) denote the equal sacrifice tax when x units of the public
good are provided. Then u(y - e(y)ix) - u(y,0) is an increasing function of
income ifun > 0. Ifun < 0, this benefit decreases as income rises. Ifu'i = 0,
this benefit is the same for all agents.
Proof: Since u(y - e(y)ix) - u{y, x) is constant as y changes,
0 = u'(y-e(y),x)(' -de/dy) -ux{y,x)
<ux(y- e(y),x){' - de/dy) - mQ;,0)

if un > 0, etc. Thus, to have equal benefits when un > 0, it is necessary to tax
some agents more than they would be taxed under equal sacrifice and to tax
some agents less, with those being taxed less having lower incomes than those
being taxed more Q.E.D.
As for the need for progressive taxation, the magnitude of the elasticity of
the marginal utility of income is not the deciding factor under the principle of
equal benefits. The effect of consumption of the public good on the marginal
utility of income also must also considered. What we discover is
Proposition 2: If the elasticity of the marginal utility of income (EMU) is less

than or equal to one and u'i < 0, equal benefit taxation must be regressive. On
the other hand, if EMU is greater than or equal to one and un > 0, equal ben-
efit taxation must be progressive.
Proof: To prove this claim, we simply need to sign the change in an agent's
utility increment (his benefit) as his income changes keeping his tax rate con-

65.0.33.20 on Fri, 12 Feb 2021 06:12:16 UTC
stant. With a constant tax rate, the change in benefit would b
Ui{y-ty,x){'-t)-ux{y,0) (3)
But
{'-t)ux(y-ty,x)
= ui(y,x)+ -u'(y-xy,x)-{' - T)yuu{y - ryix)dz

J[O,f]
If EMU is greater than or equal to 1 then, the second term in the right hand
side of this equality is non-negative. Therefore, if un > 0, u'(y,x) > u'(y,0)
and so (3) must be positive. Of course, if EMU is less than or equal to one,
this integral is non-positive, etc. Q.E.D.
However more difficult this result may make arguing for or against pro-
gressive taxation, there is at least one case where the principle of equal benefits
is unequivocal. As was noted, equal sacrifice requires a positive relationship
between the agent's tax and his income. Quite interestingly, a tax regime that
equalizes benefits may instead require that an agent's actual tax falls as his
income rises. More precisely, when there is diminishing marginal utility of
income the following is true:
Proposition 3: If a pure public good is not a normal good, the equal benefit
principle requires the agent's tax to decrease as his income increases.
Proof: To keep his utility increment constant, the agent's tax must be such
that
dt/dy='-(ui(y,0)/u](y-t,x)). (4)
Clearly, the effect of the public good on the ma
cial to both the magnitude and the sign of dt/d
of income may be a decreasing function of in
"iCVjO) > u'(y- t,x); if the public good and in
stitutes - in the utilitarian sense - this inequalit
be exactly the case when the public good is not n
To establish this, note that if the public good
d(u2/ui)/dy = («21 /«i - u2uu/u') < 0.

Let w denote the agent's willingness to pay f
and y - w < y - t since each agent benefits fr
x units of the public good. Since
dui/dXuconst = -UU(u2/ui) + U2' < 0
it follows that wi(j>,0) > u'(y - w,x) > u'(y

ginal utility of income. As a consequence, 4)

65.0.33.20 on Fri, 12 Feb 2021 06:12:16 UTC
122 J. R. Neill
4 Discussion
The principle of equal sacrifice has been a fixture in the taxation literature for
well over 150 years. However, the implications of this principle have only been
pursued within a very narrow context. The preceding analysis shows that
when the benefits from taxation are explicitly accounted for, the effect of
income on its marginal utility is no longer the only magnitude which must be
determined to establish if an income tax must be progressive or regressive to
equalize the "burden" of the tax. In fact, our analysis shows that there are
situations where even very regressive taxes (per capita) can be justified on
equity grounds.
This is certainly the most notable conclusion that this note leads us to. Of
course if it happens that non-normal public goods are rarities, this result
would have little more than epistemological value. Given the difficulties in-
herent in determining the demand for non-market goods, it may be hard to
say how relevant this finding is. But there have been a number of empirical
studies of the demand for non-market goods and a review of some of these
suggests that non-normal public goods are very much the exception.
For example, the study by Murdock, Rahmatian, and Thayer (1993) found
that income has a significant, negative effect on the demand for local recre-
ation expenditures. They conclude "the median voter considers recreation
supplied by local governments as inferior goods. This is reasonable because
numerous opportunities to replace public recreation with private facilities
become available with increasing income".8 And an empirical study of the
demand for income-redistribution benefits by Husted (1990) also observed
significant, negative income effects.9
On the other hand, Borcherding and Deacon (1972) estimated the demand
for eight publicly provided goods, and though in eight of their 24 demand
equations, income was not significant, there was not a single case where in-
come had a negative effect on demand.10 Likewise, Bergstrom and Goodman
(1973) failed to uncover evidence of inferiority in their study of the demand
for public goods. They estimated 30 demand equations for general expendi-
tures of municipalities, expenditures on police, and expenditures on parks
and recreation. Though in 1 1 of these equations, income was not significant,
it had a positive coefficient in the other 19 demand equations. The studies
by Grämlich and Rubinfeld (1982) Taylor (1992), Todo-Rovira (1991), and
Chicoine et al. (1989) produced similar results. It was sometimes observed that
income had no effect on the demand for public goods but more typically, there
was a positive effect.
8 Murdoch et al., p. 347.

y Some types of social insurance may very well be inferior. Unemployment insurance
in the United States immediately comes to mind. A survey by Eva Mueller (1963)
found that support for unemployment insurance fell sharply as income increased.
1U These goods are: local education, higher education, highways, health-hospitals,
police, fire, sewers-sanitation, and parks-recreation.

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Certainly these empirical findings cannot be construed to me

normal public goods are a common occurrence since the stat
cance of a coefficient does not allow us to reject normality.11 I
appear that non-normal public goods are a fairly rare comm
this, it would seem then that the assumption of a positive relat
a public good and the marginal utility of income (un > 0)
sonable a priori position. If so, our analysis implies that, a
equal benefit principle, taxes which would equalize the burden o
unfair to lower income agents . Therefore, if equal benefit
fairness in taxation requires more progressivity than is indicat
ciple of equal sacrifice.
References
Aaron H, McGuire M (1970) Public Goods and Income Distributio

38: 907-920
Bergstrom TC, Goodman RP (1973) Private Demands tor mblic uoods. Amer Jbcon
Rev 63: 280-296
Berliant M, Gouveia M (1993) Equal Sacrifice and Incentive Compatible Income
Taxation. J Public Econ 51: 219-240
Blum W, Kalven H (1953) The Uneasy Case for Progressive Taxation. The University
of Chicago Press, Chicago
Borcherding TE, Deacon RT (1972) The Demand for the Services of Non-Federal
Governments. Amer Econ Rev 62: 891-901
Buchholz W, Richter WF, Schwaier J (1988) Distributional Implications of Equal
Sacrifice Rules. Soc Choice Welfare 5: 223-226
Burgat P, Jeanrenaud C (1996) Do Benefit and Equal and Absolute bacnhce Rules
Reallv Lead to Different Taxation Levels? Pubi Finance Q 24: 148-162
Chicione DL, Walzer W, Deller SC (1989) Representative vs. Direct Democracy and
Government Spending in a Median Voter Model. Pubi Finance 2: 225-236
Edgeworth F Y (1910) The Subjective Element in the First Principles of Taxation. Q J
Econ 24: 459-470
Grämlich EM, Rubinfeld DL (1982) Micro Estimates ot Public Spending Demand
Functions and Tests of the Tiebout and Median Voter Hypotheses. J Polit Econ 90:
536-560
Husted TA (199U) Micro-based examination oi me uemana ior income-
Redistribution Benefits. Pubi Finance Q 18: 157-181
Maital S (1975) Apportionment of Public Goods Benefits to Individuals. Pubi Finan
3: 397-415
Mirrlees JA (1971) An Exploration in the Theory of Optimum Income Taxation. Rev
Econ Stud 38: 175-208
Mill JS (1965) Principles of Political Economy. University of Toronto Press, Toronto
Mueller E (1963) Public Attitudes Toward Fiscal Programs. Q J Econ 77: 210-235
Murdoch JC, Rahmatian M, Thayer MA (1993) A Spatially Autoregressive Median
Voter Model of Recreation Expenditures. Pubi Finance Q 21: 334-350
11 Note that even the negative relationships observed by Husted cou

short, it is very difficult using voter models to determine the effec
demand for non-market goods.

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124 J. R. Neill
Musgrave RA (1
Ok EA (1995) On
453-467
Richter WF (1983) From Ability to Pay to Concepts of Equal Sacrifice. J Pubi Econ
20: 211-229
Smith P (1991) Lessons From the British Poll Tax Disaster. Nat Tax J 44: 421-
Taylor L (1992) Student Emigration and the Willingness to Pay for Public Scho
Test of the Publicness of Public High Schools in the U.S. Pubi Finance 1: 131
Todo-Rovira A (1991) Empirical Analysis of the Provision of Local Public Good
Alternative to the Median Voter Model. Pubi Finance 3: 490-511
Young HP (1990) Equal Sacrifice and Progressive Taxation. Amer Econ Rev 80: 253-
266
Young HP (1988) Distributive Justice in Taxation. J Econ Theory 44: 321-335
Young HP (1987) Progressive Taxation and Equal Sacrifice Principle. J Pubi Econ 32:
203-258

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Discerning India's Evolving Conception of Taxable Income - an Interdisciplinary
Perspective
Author(s): Gouri Puri
Source: National Law School of India Review , 2012, Vol. 23, No. 2 (2012), pp. 44-75
Published by: Student Advocate Committee
is collaborating with JSTOR to digitize, preserve and extend access to National Law School of
India Review

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Long Articles
Discerning India's Evolving Conception

of Taxable Income - an Interdisciplinary
Perspective
Gouri Puri*
Abstract
This essay focuses on the conception of taxable income in India and

argues that there is a disconnect between the policy of tax laws and their
judicial interpretation. The author takes an inter-disciplinary approach
to explain that the taxation laws in India are predominantly premised on
the net accretion concept of taxable income whereas the Indian judiciary
has consistently inclined towards the ' source ' based definition of income.
The paper further discusses the impact of each approach on the building o
taxation jurisprudence in India. It concludes with the argument that the
disengagement between the judiciary's perception , the taxation policy and
legislation has resulted in an incoherent understanding of the concept of
' taxable income ' in India.
I. Introduction
II. Conceptions of Taxable Income
A. Source Conception of Taxable Income
B. Other Amplifications of the Concept of Income
C. Net Accretion Conception of Taxable Income
D. Divergence between Source and Net Accretion
III. India' s Conception of Taxable Income
A. Establishing India's Conception of Income - Judiciary takes the lead
* LL.M (Harvard Law School). The author can be contacted at gou

Puri would like to thank Professor Daniel Halperin and Mr. V.
their encouragement and guidance. This paper was published
335: Part 5, Income Tax Reports (2011).
44

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Discerning India's Evolving Conception of Taxable Income
B. Statutory Definition of Income
C. Introduction of the Capital Gains Tax
D. Judiciary's inconsistent application of the Shaw Wallace Conception
E. Fiscal Policy's Evolving View of Income
F. Adoption of the Income Tax Act , 1961
G. Judiciary's Affirmative Departure from the Source Conception
H. From source to net accretion
IV. Taxable Income under the Direct Taxes Code Bill, 2009
V. Conclusion
I. Introduction
In 2009, the Government of India released the Direct Taxes C

substituted by the Direct Taxes Code Bill, 2010). While the pr
new code attracted debate and scholarship from the legal commun
adoption of a "comprehensive conception" of income received little
is surprising, given that the conception of income is the foundatio
tax. However, a perusal of prior legal scholarship reveals ambigu
deliberation surrounding the subject. Kanga, Palkhivala and Vyas
of India's tax jurisprudence concluded that there is no logical
"income" under India's income tax law.1 In his paper Income or C
Bagchi concurred with this.2 A shortcoming of the existing tax sc
it approaches the subject from either an exclusively legal or an exc
based perspective.
1 Kanga et al, The Law and Practice of Income Tax - 1, 202. [Hereinafte
authors observe: "The categories of income are never closed. It wou
to define income precisely... any thing which can properly be descri
taxable under the Act unless expressly exempted. That perhaps is the
of taxable income, from the practical though not from the logical po
2 A. Bagchi, Income or Capital?, 5 Economic and Political Weekly 1
[Hereinafter, "Bagchi"] "'What is income?' was thus left to be decided
each case in the light of ideas rooted in pre suppositions and prejudi
reference to any conceptual framework. "Indeed in many cases" (invol
of "Income or Capital") a British Judge confessed, "it is almost true to s
of a coin would decide the matter as satisfactorily as an attempt to f
45

65.0.33.20 on Fri, 12 Feb 2021 06:14:27 UTC
Vol. 23(2) National Law School of India Review 2012
This paper adopts an interdisciplinary approach to achieve clarity

concept of income under Indian income tax law. It considers in deta
of the two prominent economic conceptions of income, source and n
is articulated within India's income tax law and jurisprudence. Cons
theorizes the following: India's judicial conception of taxable incom
inspired by the source view of income. However, India's tax policy
have been in transition toward the net accretion view of taxable income. This
paper attributes the incoherence in India's conception of taxable income to the

growing disconnect between the fiscal policy's view and the judiciary's view of
taxable income.
II. Conceptions of Taxable Income
This section of the paper introduces the two prominent concep

"taxable income" that underlie fiscal systems: source and net accretion.
discusses the characteristics of these two paradigms which are crucial to an a
of India's conception of taxable income.
A. Source Conception of Taxable Income
The source conception of income was a product of the British "

economy" in the eighteenth and nineteenth centuries.3 Britain was predo
an agricultural society, and its view of income was inspired by the harve
K. Holmes explains it as follows:
" Income was viewed as a physical product; an annual harvest , or the cash
into which the harvest could be converted. Income in this sense recurred
regularly with the passage of seasons. Such income was related to the capit
that produced it. The harvest arose out of farming, which took place on th
land. Land on the other hand was a physical and continuing source of annu
harvest. The harvest was separable from the source and was available fo
unconstrained disposal or consumption without impairing the underlyin
capital 5
From the harvest cycle emanated the perception of income as a flow from
capital and land which produced the income stream, and signified capital in the
3 K. Holmes, The Concept of Income: A multi disciplinary analysis, 174 (2001).

[Hereinafter, "K. Holmes"]
4 174, K. Holmes.
5 174, K. Holmes.
46

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physical sense.6 The gains on the disposal of land were not viewed as income. Some
scholars attribute this to the infrequent changes of ownership in land/ while others
advocate alternative reasoning based on the political clout of landed interests.8
This distinction between income and capital was further grounded in the insti-
tution of trusts. Richardson comments:
" Income Tax was introduced in Britain in 1799 and was developed in the
19th century. . .At that time the United Kingdom had a developed agricultural
economy and a developing industrial society.... Ingrained in English legal
thinking affecting both the political establishment and the judiciary was the
use of trusts and the succession of property."9
Landowners sought to bequeath their estate to their heirs, without giving

the latter the power to dispose of the same.
"Thus, the estates were to be retained within a genealogical lineage where

an estate was held in trust for each succeeding heir, who was entitled only
to the income from the estate during his lifetime. An heir was not entitled
to the capital of the estate, increases of which, during the heir's lifetime,
were accumulated in the estate and passed on to successors. Consequently,
a distinction arose between income, which could be consumed by the life
tenant, and capital, which was to pass to remainder man."™
The courts transposed this distinction in trust law into their understanding
of income.11
Finally, a word must be said about Britain's classical economists' approach

to understanding income and the scheduler mechanism of taxation. Consider the
following paragraph from S. Utz's Ability to Pay and notice the suggested nexus
between scheduler taxation and the view that taxable income arises from the
factors of production:
"Britain followed a scheduler system of taxation wherein the income tax laws
relied on the device of requiring taxpayers to report income in accordance
6 174, K. Holmes.
7 174, K. Holmes.
8 S. Utz, Ability to Pay, 23 Whittier Law Review 867, 904 - 905 (2002). [Hereinafter, "S
Utz"]
9 I.L.M Richardson, The Concept of Income and Tax Policy, 4 Canterbury Law Review 203
(1990) cf K. Holmes at 190.
10 174, K. Holmes.
11 174, K. Holmes.
47

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with scheduled activities or from scheduled sources , which apparently m

sense to the British , because British classical economists had so successf
sold their public on the inevitability of the macroeconomic model tha
distinguished land , capital and labour as ultimately distinct sources o
new wealth"}1
Thus, British classical economists placed emphasis on functional r

"personal" distribution.13
This historical outline provides a contextual introduction to the charac

of the source conception of income.14 The hallmark of the source con
income is the distinction made between income and capital. This dist
analogous to the distinction between the tree and its fruit.
The source is generally linked to capital, in its physical sense. The

capital produces are regarded as income and are subject to tax. Any
capital value is not taxed.
B. Other Amplifications of the Concept of Income
As R.F. Plasschaert observes, the source conception was ofte

combination with other amplifications of the concept of income.15
important of these was periodicity, which envisaged income as a recur
Economists have expressed a distinction between regularity and recu
"Receipts may, and often do, fluctuate in an irregular pattern of rec
While regularity may suggest that a receipt may not fluctuate, recurr
demands the "possibility of future successive wealth."19
Furthermore, the understanding of income as a flow led to the develo

a legal concept divorced from the idea of economic gain.20 The simplest il
12 S. Utz.
13 P. Wueller, The Concept of Taxable Income - 1, 53 Political Science Quarterly 83,

[Hereinafter, "P. Wueller"]
14 For a more detailed history, See P. Harris, Income Tax in Common Law Jurisd
Cambridge Tax Law Series (2006).
15 S.R.F. Plasschaert, Schedular, Global and Dualistic Patterns of Income Taxat
(1998). [Hereinafter, "R.F. Plasschaert"]
16 85, P. Wueller; See also 99, K. Holmes.
17 85, P. Wueller; See also 99, K. Holmes.
18 100, K. Holmes.
19 85, P. Wueller. Periodicity seems to be inspired by Britain's harvest cycle and the life
entitlement of the beneficiary of the trust.
20 379, K. Holmes.
48

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was the purchase of an annuity for a lump sum. The entire annual receipt was held
taxable though a part of it represented recovery of the initial investment. As such,
the fiscal system followed a "net income" concept. However, the idea of income as
an inflow hindered the courts from noticing the corresponding diminution in the
value of the asset that produced the inflow. K. Holmes referred to this phenomenon
as the taxation of "illusory gains."21
Productivity was another test for qualification as income. The receipt should
have arisen from an economic activity undertaken by the recipient of income.22
Noticeably, Britain's scheduler approach to taxation bears semblance to the
productivity criterion.
Further, the British courts saw only cash receipts or receipts convertible into
cash as income, much like the harvest produce.23 K. Holmes notes that the courts'
view was often guided by an ordinary man's perception of income.24
This view of income was not limited to Britain. Literature suggests that it
was adopted by many countries and economists of continental Europe.25 However,
since India was a former colony of Britain, this paper draws on the British version
of the source conception of income, including the already mentioned amplifications
of this.
C. Net Accretion Conception of Taxable Income
Schanz, Haigs and Simons are recognized as the first proponents of the net
accretion approach to income.26 These economists each had a background in fiscal
policy; each was interested in developing a "fiscally useful concept of income"
embedded in the ideals of equity or the "ability to pay" principle.27 Thus, the net
accretion approach was a product of systemized study by economists.28 This is not
to discount the plausible influence of the political and economic factors on their
views of income. Whatever the primary influence, the essence of their perception
of income was "ability to pay."
21 379, K. Holmes.
22 85, P. Wueller.
23 Tenant v. Smith, 1892 AC 150, 156 (House of Lords).
24 233, K. Holmes.
25 85, P. Wueller.
26 P. Wueller, Concepts of Taxable Income - II, 53 Political Science Quarterly 557-583 (1938).
[Hereinafter, "P. Wueller II"]
27 557-583, P. Wueller II.
28 557-583, P. Wueller II.
49

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Vol. 23(2) National Law School of India Revieiv 2012
Schanz defined income as "net inflow of economic ability over a gi

of time/'29 However, he gave no indication as to the measure of the
ability.30
Next, R.M. Haig conceptualized income as "the money value of the net
accretion to one's economic power between two points in time."31 According to
him, the economic power of an individual was his power to satisfy his wants. He
further defined income as "the increase or accretion to one's power to satisfy his
wants in a given period so far as that power consists of (a) money itself, or, (b)
anything susceptible of valuation in terms of money."32
Under R.M. Haig's definition, income, in addition to cash receipts, would

include the following. First , the receipt of any goods or services obtained in kind
which can be valued in terms of money,33 and which would indeed satisfy wants.
Second, accretion in the value of assets, whether realized or not. Like cash receipts,
these accretions empower the individual to fulfill his wants. Third, the value of
benefits obtained from non-market transactions, often referred to as imputed
income.34 For instance, the benefit derived from living in one's own house. This
benefit represents the satisfaction of a want equivalent to that of a person who
rents a house.35
This takes us to H.C. Simon's definition of personal income. He viewed

income as:
"The algebraic sum of(i) the market value of rights exercised in consumption
and (ii) the change in the value of the store of other property rights between
the beginning and the end of the period in question." 36
H.C. Simon's conception is similar to that of R.M. Haig's. Yet, while the latte
measures the economic power at the stage of its accrual, the former measures th
29 G.V. Schanz, Der Einkommensbergijfund die Einkommensteurer gestze, Finanz Archiv 1-3
(1896) as translated in 85, P. Wueller.
30 233, K. Holmes.
31 R.M. Haig, The Concept of Income -Economic and Legal Aspects, The Federal income Tax
(R.M. Haig ed., 1921), as quoted in 174, K. Holmes. [Hereinafter, "R.M. Haig"]
32 R.M. Haig.
33 R.M. Haig.
34 R.M. Haig.
35 R.M. Haig.
36 H.C. Simons, Personal Income Taxation - The Definition of Income as a Problem of Fiscal
Policy, 42 University of Chicago Press (1938) , as quoted in 174, K. Holmes.
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increase in a person's economic power by looking at its disposition (at the stage
of its exercise either for consumption or savings after such expenditure).37 For our
purposes we shall follow R.M. Haig's approach to measuring income.
It is noteworthy that a complete implementation of the net accretion

conception is difficult to achieve. For instance, the United States would like to
apply such principles but is prevented from doing so by administrative hurdles.38
Problems arise especially in the valuation of imputed income and accretions to the
value of assets where such gains have not been realized.39 Consequently, imputed
income remains untaxed and taxes on accretion to the value of assets are paid
upon realization.40 Thus, the net accretion conception has practical drawbacks.
Nonetheless, present-day literature regards it as the most suitable conception of
income for the imposition of an income tax.
D. Divergence between Source and Net Accretion
This paper does not endeavor to reach a conclusion about which of the
foregoing conceptions is superior from a tax policy perspective. Indeed, ample
scholarship exists that evaluates the relative merits and drawbacks of these
conceptions.41 Instead, this paper evaluates how the adoption of either conception
bears on the law and its interpretation. This paper hypothesizes that the Indian
fiscal system is in transition from the source conception to the net accretion
conception. Therefore, it becomes important to gain an understanding of where
these conceptions diverge. R.A. Musgrave's elaboration on the net accretion
approach assists in understanding this divergence:
"According to this definition (net accretion ), income equals gain in net
worth plus consumption during a given period . What matters is total income
thus defined. No distinction is to be made between either sources or uses
of income. Gains may be factor earnings (e.g., wages, interest, and rent) in
the economist's sense ; or they may be mere transfers (e.g., gifts or gambling
gains); they may be expected or unexpected, irregular or regular, accrued or
realized, from business or accident, and so on and so forth. All that matters
is that there exists a gain which gives rise to consumption or to increase in
net worth. Similarly, it is left to the recipient whether he wishes to use his
37 233, K. Holmes.
38 M.J. Graetz, and D.H. Schenk, Federal Income Taxation : Principles and Policies (6th
edn., 2009). [Hereinafter, "Graetz"]
39 Graetz.
40 Graetz.
41 174, K. Holmes. See also 557-583, P. Wueller II.
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gain for one or another type of present consumption , or whether he wish

to postpone consumption and save Z'42
These theoretical observations can be transposed to "actual receip

would be affected by this divergence.
First, receipts arising from transfers do not qualify as income under

conception of income on account of the criteria of periodicity, produ
the income-capital distinction. However, the gains embedded in these
certainly income under the net accretion approach. Even an unrealized
to the value of assets is income under the latter approach.43
Second, windfalls such as lottery, gambling winnings and life in

receipts are not taxed under the source conception because they fail the pe
and productivity criteria. Yet, under the net accretion conception the
an economic gain and are therefore taxable.44
Third, benefits that are not convertible into money, for instance,
accommodation (that cannot be sublet) provided by an employer are
under the British conception. However, under the net accretion appro
benefit satisfies want and is taxable if it can be valued in terms of money
Fourth, benefits derived from non-market transactions (imputed incom

income under the source view. This is because there is no receipt or a
leaving aside their convertibility into money. On the other hand, the n
approach measures the increase in economic power with an incr
satisfaction of wants. Therefore, as long as imputed income can be valu
of money, it is taxable.46
Fifth, the conceptions diverge on annuity receipts. Under t

conception, income is perceived as a flow from a source as opposed to
gain. Despite the fact that a part of an annuity receipt is merely a re
original investment, the entire annuity receipt is considered as inco
taxable. On the contrary, under net accretion, only the gain in excess of t
invested is taxed from an annuity receipt.47
42 R.A. Musgrave, In Defense of an Income Concept , 18 Harvard Law R

(1967).
43 379, K. Holmes.
44 164 and 166, K. Holmes.
45 160, K. Holmes.
46 158, K. Holmes.
47 363, K. Holmes.
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These five receipts are treated differently under the two conceptions of
income. The differences in these conceptions may have a bearing on certain other
receipts. However, we shall confine discussion to these five receipts and, in the
following sections, analyze the bearing they have on Indian income tax law.
III. India's Conception of Taxable Income

This section of the paper chronologically charts India's changing co
of taxable income, within the framework of the two paradigms discuss
previous part: source and net accretion. For several years, tax scholarshi
has critiqued the ambiguous conception of income underlying the India
tax system.48 Studying India's conception within these paradigms helps t
the cause for this incoherence. To do so, the paper looks at India's fisc
legislation and judicial decisions.
A. Establishing India's Conception of Income - Judiciary takes the lead

The Income Tax Act, 192249 [Hereinafter, "the Act"] was enacted du
British Rule in India. Consequently, there is a presumption that the Ac
the British conception of income. To ascertain this, we peruse th
provisions.
The Act did not originally contain a definition of income. Unlike the British
law, it followed a global system of income taxation.50 However, it contained a
provision enumerating the "sources of income." These sources resembled the
schedules of the British income tax law and the four factors of production. The
provision reads as follows.51
"Save as otherwise provided by this Act , the following heads of income, profits
and gains shall be chargeable to income tax 52 in the manner hereinafter
appearing namely:
48 202, Kanga; 1781-1787, Bagchi.

49 The Income Tax Act was first imposed in India in 1860. A scheduler system of taxation
was adopted in 1886. Subsequently the 1918 Act introduced the global system of
taxation. See O.P. Chawla, Personal Taxation in India 1947 - 1970, 39-47 (1972).
[Hereinafter, "O.P. Chawla"]
50 The scheduler income tax system is one where, "each of the various categories of
income, or (partial) incomes. . .flowing to the same taxpayer, is subjected to a separate
tax rate." A global income tax is one where, "all incomes, from whatever source derived,
accruing to the same taxpayer, are treated as a single mass of income and subjected to
a single rate formula." See 17, R.F. Plasschaert.
51 § 6, The Income Tax Act, 1922.
52 § 6 was initially interpreted in Probhat v. Emperor, AIR 1924 Cal 668 [Calcutta High
Court] to be the charging section. Later, the Supreme Court departed from this position
and held that the provision merely classified income.
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(i) Salaries
(ii) Interest on Securities
(iii) Income from Property
(iv) Profits and gains of business, profession or vocation
(v) Income from other sources"
As such, there was no specific head for gains arising from the transfer of
assets. Yet, that did not preclude taxing those gains under income from property,
business, or employment or, in any case, under the head of income from other
sources.
Thus, the Act followed a global method of taxation an

that enumerated sources reminiscent of the British schedules.
Further, § 4 (3) (vii)53 of the Act excluded casual54 and non-recurring receipts55
not arising in the course of business or profession from total income. Similarly, §
4 (3) (v) excluded capital sums received in commutation of pension income or in
payment of insurance policies.56 These exclusions could signify the use of a statute
to relieve items that would otherwise be income. Alternatively, the provision could
be a restatement of the "conception of taxable income," giving statutory effect to
the criteria of periodicity, productivity and the income-capital distinction. Either
way, § 4 had the effect of exempting gains arising from transfers and windfalls.
These exclusions were characteristic of the source conception of income.
At one instance, the Act provided for the taxation of imputed income, where
rental income was imputed to an owner occupying her building.57 Furthermore,
53 § 4 (3) (vii), The Income Tax Act, 1922: "Any receipts not being receipts arising from
business or the exercise of profession, vocation or occupation, which are of a casual
and non-recurring nature or are not by way of addition to the remuneration of an
employee/'.
54 Casual has been defined by the courts to mean "subject to or produced by chance,
accidental, fortuitous". See Cossimbazar v. Commissioner of Income Tax, 1946 14 ITR
377 Cal, 395 [Calcutta High Court].
55 Some courts construed non-recurrence to imply the impossibility of recurrence See
In Re: Chunnilal Kalyandas, [1924] 1 ITC 419 (AU) [Allahabad High Court]. Others
interpreted the term to mean that there is no claim or right in the recipient to expect
its recurrence See Amrit Kunwar v. Commissioner of Income Tax, 1946 14 ITR 561, 591
[Allahabad High Court] [Hereinafter, "Amrit Kunwar"] as quoted in 446, Kanga.
56 § 4 (3) (v), The Income Tax Act, 1922: "Any capital sum received in commutation of
the whole or a portion of a pension, or in the nature of consolidated compensation for
death or injuries, or in payment of any insurance policy, or as the accumulated balance
at the credit of a subscriber to any such provident fund."
57 § 9, The Income Tax Act, 1922.
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in 1923, the Act was amended to tax rent-free accommodation provided by an

employer to his employee, as the latter's salary income. This was despite the fact
that the employee could not sublet the accommodation and convert the benefit
into money. These provisions departed from the British conception of source.
Against this legislative backdrop, the Privy Council rendered a decision on

the meaning of "income" in Shaw Wallace v. Union of India.58 The issue was whether
receipts received in lieu of cessation of an agency could constitute income. The
Court held that these receipts were not income and noted:
"Income... in this Act connotes a periodical monetary return ' coming in'
with some sort of regularity, or expected regularity , from definite sources.
The source is not one which is expected to be continuously productive , but
it must be one whose object is the production of a definite return , excluding
anything in the nature of a mere windfall. Thus income has been likened
pictorially to the fruit of a tree, or crop of a field. It is essentially the produce
of something which is often loosely spoken of as 'capital'. But capital , though
possible the source in the case of income from securities , is in most cases
hardly more than an element in the process of production."59
This decision was the beginning of the judicial conception of income. The
Court did not cite any policy statement supporting its view.60 Further, the only
statute quoted was § 6 of the Act. According to the Court, "it enumerated the
sources from which taxable income could be derived under the Act."61 Inferably,
the court was importing Britain's scheduler philosophy of income vide § 6 of the
Act.
Furthermore, it clarified that receipts received in lieu of cessation of an

agency had not arisen under the head of income from business.62 This was because
"the head" contemplated the continuation of business.63 Since the receipt arose to
substitute the source itself, it was not income.64 The Revenue argued for a broader
conception of taxable income. It drew support from § 4 (3). As seen, the provision
excluded casual and recurrent receipts and certain capital sums from the definition
58 Commissioner of Income Tax v. Shaw Wallace, (1932) L.R. 59 I.A. 206 (P.C.) [Privy
Council]. [Hereinafter, "Shaw Wallace"]
59 Shaw Wallace.
60 Shaw Wallace.
61 Shaw Wallace.
62 Shaw Wallace.
63 Shaw Wallace.
64 Shaw Wallace.
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of income. Revenue's proposition was that these items had to be

excluded because the Act envisaged them as income.65 The Cour
attributed the enactment of the provision to the anxiety of the draftsma
Furthermore, the Court denied the influence of the British con

income and English judicial decisions.67 Yet, it recited the same. It
amplifications to the concept of income under the Act such as "com
monetary return (money or anything being capable of turned into money
own nature)69, periodicity, productivity and the distinction between
capital. From a practical standpoint, such a conception excluded win
arising from transfers (capital receipts), benefits in kind that were not c
into money, and imputed income from the scope of income.
A review of the Privy Council's decision in Gopal Saran Narain

Commissioner of Income Tax 70 confirms the judiciary's adoption o
conception of income. The facts of this case were as follows. A taxpayer t
an estate worth Rs. 20,000,000 for a relatively small annuity of Rs. 2, 40,
It was argued that the annuity in toto could not constitute his income as
no "profit" or "gain" to him. A part of the installments merely represen
of capital. The Privy Council, however, held that the entire annuity
income in the hands of the taxpayer, "as the term income was not qu
notion of profits or gains. Anything which can properly be describe
65 Shaw Wallace.
66 Shaw Wallace.
67 The Privy Council observed: "Again their Lordships would discard altogethe
law which has been so painfully evolved in the construction of the English
tax statutes- both the cases upon which the High Court relied and the flood
decisions which has been let loose in this Board. The Indian Act is not in par
it is less elaborate in many ways, subject to fewer refinements, and in arr
and language it differs greatly from the provisions with which the Court
country have had to deal. Under these conditions their Lordships think that
be gained by attempting to reason from one to the other, at all events in th
case in which they think that the solution of the problem lies very near th
of the Act, and depends mainly on general considerations." However, in lat
the Supreme Court acknowledged the influence of the British legal interpr
income.
68 The Court did not explain the taxation of owner-occupied houses provided for under
the Income Tax Act, 1922.
69 The Court did not explain the provision in the Income Tax Act, 1922 for the taxation
of rent free accommodation provided to the employee by the employer, even thoug
the latter could not sublet and hence convert it into money.
70 Gopal Saran Narain Singh v. Commissioner of Income Tax, 3 ITR 237 (P.C.) [Privy
Council]. [Hereinafter, "Gopal"]
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is taxable under the Act unless expressly exempted."71 This case completed Shaw
Wallace's articulation of the British conception of income. The judiciary perceived
income as a "flow from a source" rather than an economic gain. This perception
led to the taxation of "illusory gains," as in this case.
B. Statutory Definition of Income
In 1939, the Act was amended to insert an "inclusive"72 definition of income.73

The definition specifically included dividends and perquisites or profits received
in lieu of salary as income. These inclusions were consistent with the judicial
conception of income.74 The specific mention of dividends was to ensure the
taxation of all distributions by corporations.75 Further, by the Finance Act, § 4 (3)
(v),76 which excluded capital sums received in commutation of pension income or
in payment of insurance policy, was deleted.
Post the insertion of the statutory definition of income, the court broached
the subject in Kamakshya Narain Singh v. Commissioner.77 This case is marked for
its critique of the Shaw Wallace definition of income. The case revolved around
the taxability of royalties arising from the leasing of coal mines. The taxpayer
argued that coal on his land was capital, and the sums that he received from time
to time for each ton raised and despatched was a capital receipt, being the price in
exchange for a capital asset. Alternatively, he argued on grounds of equity, stating
that coal was a wasting property and was gradually exhausted as each ton was
71 Gopal.
72 The law of statutory interpretation in India accords a special significance to an inclusive
definition. In N.D.P. Namboodripad v. Union of India, AIR 2007 SC 1782 [Supreme
Court of India] the Supreme Court noted "When the word 'include' is used in a
definition clause, it is used as a word of enlargement that is to make the definition
extensive and not restrictive". Further, on several occasions, the Indian courts have
commented on the 'inclusive' aspect of the definition as implying a broad statutory
concept of income: "Income includes not only those things which this clause declares
that it shall include, but such things as the word signifies according to its natural
import ..." See Commissioner of Income Tax v. Kiranbhai, 1999 235 ITR 635 Guj [Gujarat
High Court].
73 § 4 (6C) , The Income Tax Act, 1922 defined income as follows: "Income includes
anything included in 'dividend' as defined in clause (6A) and anything which under
Explanation 2 to subsection (1) of section 7 is a profit received in lieu of salary for
purposes of that sub-section ..."
74 209, Kanga.
75 45, O.P. Chawla.
76 See § 4 (3) (v), The Income Tax Act, 1922.
77 Kamakshya Narain Singh v. Commissioner, 11 ITR 513 (1942) (PC) [Privy Council].
[Hereinafter, "Kamakshya Narain Singh"]
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raised and disposed off. In other words, as the taxpayer was experien
with the royalty receipts, he was simultaneously facing a decline in t
the mine. And hence his gain was illusory. The Court, however, held t
to be taxable.
As regards the first argument, the Court rejected royalties as the purchase
price paid for coal. The Court held that the royalties, in substance, were rent: the
compensation which the occupier paid the landlord for the species of occupation
which the contract between them allowed. The court classified the consideration
received under the lease into three categories (1) the premium; (2) the minimum
royalty; (3) the royalties per ton. The premium was held to be a capital receipt,
received for parting with "the right to enjoy the benefits (a capital asset)." But
the royalties were seen on a different footing. The minimum royalty was payable
only if, in any year, the royalties on coal raised and despatched were less than the
sum fixed as the minimum royalty. This, according to the Court, amounted to a
species of annual guarantee: it did not correspond to any coal actually extracted
and taken away; it was simply "income" flowing from the covenants in the lease.
It would be payable if, in any year, the lessees took no coal at all, or if the coal
was exhausted before the termination of the lease. On the other hand, the royalty
payable on each ton of coal was a fluctuating amount and, as such, the Court faced
a dilemma on account of the periodicity criterion laid down by the Privy Council
in Shaw Wallace. Also, relying on Shaw Wallace's tree and fruit analogy, the taxpayer
argued that in his case, "There was no fruit; that is to say, there was no increase,
there was no sowing or reaping in the ordinary sense of the term; and there were
no periodical harvests."
In this context, the Court critiqued the conception of income discussed in

Shaw Wallace:
" Sir George Lowendes speaks of income being likened pictorially to the
fruit of a tree or the crop of a field. But it is clear that such picturesque
similes cannot be used to limit the true character of income. . . .Income is not
necessarily the recurrent return from a definite source, though it is generally
ofthat character. Income again may consist of a series of separate receipts ,
as it generally does in the case of professional earnings "78
At first glance, it appears that the Court was departing from the Shaw Wallace
definition of income. Scholarship interprets this decision as such. However, on a
closer evaluation, the Court's decision in substance adheres to Shaw Wallace .
78 Kamakshva Narain Singh.
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Consider the Court's purported rejection of the "periodicity" criterion and

the preceding discussion where the Court classifies the lease consideration into
three categories. The Court held that the guaranteed minimum royalties were
income. Critical to the Courťs reasoning was the fact that these guaranteed amounts
clearly met the criteria of periodicity as they represented "regular" flows from
a source (covenants of the lease). However, the Court perceived the fluctuation
in the royalty payable per ton as a hindrance to the fulfilment of the periodicity
criterion of Shaw Wallace . As discussed previously, periodicity demands recurrence
of receipts or the possibility of future successive wealth. It does not impose the
condition of regularity. Therefore, the royalty payable per ton met the periodicity
criterion. The Courťs observations could then have two plausible explanations.
One, the Court misconceived periodicity to imply regularity. Two, Shaw Wallace
envisaged periodic flows as both recurrent and regular receipts, and the Court
limited periodicity to the mere "possibility of future successive flow".
Now, consider the Courťs critique of Shaw Wallace's simile of the tree and
its fruit. The Courťs observations arose in the following context. The taxpayer
contended that in a mining lease, there was no fruit; no reaping or sowing in the
ordinary sense. Here, the taxpayer was referring to coal as the tangible capital
asset or source, which he argued was the subject of sale with the royalties being
consideration for the same. The Court characterized the transaction as one where
the source was the right to enjoy the benefits of the lease and the royalty payments
were its fruit. The premium paid for acquiring this right was held to be a capital
receipt. Hence, the Court agreed to the simile of the tree and its fruit, conforming
to the capital-income distinction.
In dealing with the taxpayer's second argument, the Court followed the source
conception of income. It was argued that royalty payments did not represent a
gain because they were accompanied by a simultaneous decline in the value of the
mining lease. The Court briskly dismissed the argument and observed, "The fact
that mines are wasting assets is irrelevant." A net accretion perspective of income
would have appreciated the taxpayer's claim. Under the net accretion approach,
the royalty receipts would remain taxable. However, the tax would be accompanied
by a deduction for the economic decline in the value of the mine.
If the Court adhered to the Shaw Wallace view of income, how does one
explain its formal critique of the same? Plausibly, the Court misinterpreted the
proposition laid down in Shaw Wallace . Alternatively, the Court may have sought
to retract the prescriptive formulation of income under Shaw Wallace because of
the existence of the more inclusive definition of income in the statute. Judicial
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propriety warrants that the courts follow legislation. However, the

judicial self-restraint on one occasion does not mark a change in th
perception of income. This is evident from subsequent cases, where t
continued to follow the source view.
C. Introduction of the Capital Gains Tax
The most important digression from the source conception was the
introduction of "capital gains tax" in 1948.79 The definition of income under the Act
was amended to include capital gains and a new head of income was introduced
in § 6 of the Act.80 Further, § 4 (3) (vii) which excluded casual and non-recurring
receipts from income was amended to deny the benefit to capital gains.81
Capital gains were defined to include gains arising from the sale or exchange
of a "capital asset."82 Further, capital asset was defined broadly to mean property
of any kind (excluding stock in trade, personal effects and agricultural land).83
From the set of capital receipts, a small subset arising from the sale or
exchange of "capital asset"84 was made taxable. Other gains that represented
accretions to capital remained non- taxable. Thus, the term "capital gains" came
to signify "taxable gains" or "taxable capital receipts."85 In addition, a lower rate
of taxation was extended to the entire set of taxable gains.
While introducing the capital gains tax, the Finance Minister noted in his
budget speech:
"My next proposal is a tax on capital gains. Honourable members must be
well aware of the extent to which large capital gains have been made in recent
years and are still being made owing to prevailing conditions . These profits
are, as the law stands , outside the scope of the Income Tax Act. I feel very
strongly that this lacuna in our legislation should be filled. There is stronger
79 Set The Indian Income Tax (Amendment) Act, 1941.

80 See The Indian Income Tax (Amendment) Act, 1941.
81 See The Indian Income Tax (Amendment) Act, 1941.
82 § 12 B, The Income Tax Act, 1922.
83 § 4 A, The Income Tax Act, 1922.
84 § 4A, The Income Tax Act, 1922.
85 Gains arising from the transfer of an asset that formed the inventory of a business,
for instant receipts arising from sale of land in a real estate business, were taxable
even under the source conception of income. This is because the land in this context
did not represent the source but a trading asset. The receipts arising therefrom were
categorized as revenue receipts, and land as a trading asset.
6o

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justification for taxing these profits than there is for taxing ordinary income
since they represent what is properly unearned increment. The U.S.A. taxes
such profits."86
The introduction of capital gains tax was justified on grounds of equity. For
India's fiscal policy, the inclusion of capital gains in "taxable income" signified the
beginning of a changed perception of income- accretions to capital enhance the
ability to pay and should be taxed as income. A tax on capital gains diverged from
the income-capital distinction, periodicity and productivity. India's fiscal policy
took its first step toward the net accretion conception of income.
Because income had acquired a meaning under the source conception,

the constitutionality of the capital gains tax was challenged before the Supreme
Court.87 It was argued that the Constitution empowered the Central Government
to impose "taxes on income" and income did not embrace capital gains either
according to its "natural import"88 or common usage or according to judicial
interpretation of relevant legislation in England or India. Further, it was contended
that a clear line of demarcation had always been observed by English lawyers and
English jurists between income and capital, that the English legislative practice
had always recognised this difference and that as the word had come to acquire
a certain meaning and a certain connotation by reason of such legislative practice
in England, the British Parliament which enacted the Government of India Act,
1935 must be regarded as having understood and used the word "income" in the
Constitution in that sense.
Observations made by the Court in response to these arguments assist our

cause. First , the Court confirmed that the basis of the Privy Council's decision in
Shaw Wallace had been inspired by the scheduler philosophy. It observed:
" The truth of the matter is that while Income-tax legislation adopts an
inclusive definition of the word ' income ' the scheme of such legislation is
to bring to charge only such income as falls under certain specified heads
(e.g., the 5 Schedules of the English Act of 1918 and our section 6 read with
the following sections) and as arises or accrues or is received or is deemed
to arise or accrue or to be received as mentioned in the statute. The Courts
86 Finance Minister's Budget Speech, (1947) 15 ITR (St.) 10.

87 Navinchandra Mafatlal v. Commissioner of Income Tax, (1954) 26 ITR 758 (SC)
[Supreme Court of India]. [Hereinafter, "Navinchandra Mafatlal")
88 Income in its natural import signified income as was understood in the source
conception of income.
6l

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have striven to ascertain the meaning of the word "income" in the con
of this scheme "
Indeed, the courts were following the source conception of income to

income under the income tax law.
Second, the Court sanctified the capital gains tax by drawing a distinction
between the meaning of income under the Act and the Constitution:
"There is no reason to suppose that the interpretation placed by the Courts
on the word in question was intended to be exhaustive of the connotation
of the word " income " outside the particular statute . If we hold, as we are
asked to do, that the meaning of the word "income" has become rigidly
crystallised by reason of the judicial interpretation ofthat word appearing
in the Income-tax Act then logically no enlargement of the scope of the
Income-tax Act, by amendment or otherwise, zoili be permissible in future.
A conclusion so extravagant and astounding can scarcely be contemplated
or countenanced Z'89
In effect, the Court concluded that the source view was limited to
understanding income under the Act. As regards the Constitution, income was
to be interpreted according to its meaning in English, "coming in," whereby any
receipt could be made chargeable to tax. Two points should be noted here. First,
the Court respects the source conception of income, holding it valid under the Act.
Second, by drawing a distinction between income under the Act and under the
Constitution, it assures policymakers the freedom to tamper with the source view
of income. To rephrase, source conception was followed in interpreting income
under the Act. However, if the legislature wished to tax receipts outside the source
view vide a specific enactment, the courts would respect it.
Consequently, there emerged the practice of addressing items specifically

included in income by the legislature, in deviation from the source view, as
"artificial income" (a term that commonly appears in the income tax commentaries
of Kanga, Palkhivala and Vyas).
D. Judiciary's inconsistent application of the Shaw Wallace Conception
In 1952, the Supreme Court rendered its next noted decision on the meaning
of income in Raghuvanshi Mills v. Commissioner of Income Tax,90 The case entailed
89 Again, income in its natural import signified income as was understood in the source
conception of income.
90 Raghuvanshi Mills v. Commissioner of Income Tax, (1952) 22 ITR 484 (SC) [Supreme
Court of India]. [Hereinafter, "Raghuvanshi Mills"]
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the question of the taxability of insurance proceeds received for the loss of profits
occasioned by the destruction of the taxpayer's factory in a fire. The insurance
proceeds were received pursuant to a policy taken specifically to cover the loss
in profits.
The Court attached significance to the fact that the insurance proceeds were
received in lieu of profits. These profits, if earned, would have been operating
revenue and taxable income. On the other hand, had the insurance compensated
for the loss of the factory (a capital asset), the proceeds would have been non-
taxable as they were capital receipts.91 The Court thus followed the income-capital
distinction.
In addition, it was argued by the taxpayer that the insurance proceeds would
not qualify as income because they did not recur. Nor did they directly arise from
an economic activity.92
The court responded by referring to § 4 (3) (vii) of the Act, which excluded
casual and non-recurring receipts from the tax net, provided these receipts did
not arise from business or the exercise of a profession or vocation. It then held that
the insurance receipt was inseparably connected with the ownership and conduct
of the business, and arose from it.93
§ 4 (3) (vii), however, was an exclusion. It did not render casual and non-
recurring receipts arising in the course of an economic activity, or insurance
receipts, expressly taxable. These receipts would remain non-taxable if they did
not qualify under the general conception of income. The taxpayer proposed the
definition in Shaw Wallace as the general conception of income: "income comes in
with some sort of regularity or expected regularity from definite sources/'94
Confronted with a situation where a strict reading of Shaw Wallace would

prevent the taxation of these insurance receipts as income, the Court observed:
"It is true the Judicial Committee attempted a narrower definition in
Commissioner of Income-tax v. Shaw Wallace & Co., by limiting income to
" a periodical monetary return ' coming in' with some sort of regularity, or
expected regularity, from definite sources " but, in our opinion, those remarks
must be read with reference to the particular facts ofthat case
91 Raghuvanshi Mills.
94 Shaw Wallace.
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Vol. 23(2) National Lazo School of India Review 2012
think their Lordships had in mind a case of this nature when they
Shaw Wallance & Company's case"95
The following proposes two plausible explanations for the cou

read down Shaw Wallace .
First, consistent with its approach in Kamakshya Narain Singh, the Supreme
Court attempted to seek a more flexible definition of income than that given in Shaw
Wallace, such that it would yield to the legislative mandate where required. The
statute itself exempted receipts that did not meet the productivity and periodicity
criteria. The Shaw Wallace definition of income simply overlay these limitations and
rendered them meaningless. To give effect to the statute, the Court would have to
read down the Shaw Wallace definition of income.
Second, independent of the statute, the Court perceived these insurance

receipts as income. The Court observed:
"The assessee is a business company. Its aim is to make profits and to insure
against loss. In the ordinary way it does this by buying raw materials,
manufacturing goods out of them and selling them so that on balance there
is a profit or gain to itself. But it also has other ways of acquiring gain, as
do all prudent businesses, namely by insuring against loss of profits"96
The Court's view was that a receipt arising in the ordinary course of an
economic activity fulfilled the productivity criteria. The non-recurrence of the
receipt was inconsequential. However, the decision did not rid the judicial
conception of income of the periodicity criteria. A more appropriate presentation
of the holding is, "Gains arising from isolated transactions are not income unless
they are part of a pattern of transactions undertaken in the carrying on of a trade
or business."97
The dicta of the case gave rise to several decisions that were inconsistent with
the Shaw Wallace conception, but only with regard to periodicity and productivity.
The income-capital distinction, the hallmark of the source conception, was always
strictly observed. In addition, income was still viewed as an inflow in the form of
money or benefits convertible into money.
Consider the following illustrations. The Bombay High Court adjudged the
issue of whether monthly alimony received under a court decree was income.98
97 164, K. Holmes.
98 Maheshwaridevi v. Commissioner of Income Tax, 1984 147 ITR 258 Bom [Bombay
High Court]. [Hereinafter, "Maheshwaridevi"]
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Although these receipts were recurrent, they did not arise from any economic
activity. Nor did these receipts represent windfalls. The Court regarded the right
to receive alimony as a capital asset and a source." This case is cited as an example
where periodic flows from an enforceable obligation were regarded as income, and
where the criterion of productivity was rendered inconsequential. On the other
hand, a voluntary gift was regarded as a casual payment even if it was repeated
and took the form of a regular annual allowance. According to the Court, the gift
represented a windfall.100
On another occasion, the Supreme Court remarked that winnings from

horse-racing would be taxable under the Act, but for the exception made for
casual and non-recurrent receipts. It rendered both periodicity and productivity
inconsequential to the meaning of income.101 Furthermore, in due course, the
legislature deleted the provision excluding casual and non-recurring receipts.102
Despite the deletion, Courts have held personal gifts to be non-taxable under the
general conception of income.103 Similarly, the gains embodied in the life insurance
receipt were held to be non-taxable. A capital receipt (not being a capital gain)
remained untaxed on account of the income-capital distinction.104
E. Fiscal Policy's Evolving View of Income
The Finance Act, 1955 brought several changes to the definition of income
which deviated from the source conception of income. Again, these legislative
changes signified the changing perspective of the policymaker.
A number of "artificial incomes" were made taxable. First , capital receipts

compensating for the loss of certain sources of income were included in the
definition of income. The compensation for loss of office as a managing agent or
99 Maheshwaridevi.
100 574, Amrit Kunwar.
101 Syed Jalal v. Commissioner of Income Tax, 1960 39 ITR 660 Mad [Madras Hig
671-672.
102 The provision was deleted vide The Finance Act, 2003.
103 Commissioner of Income Tax v. Sarbamangala Devi, 1987 163 ITR 898 Patn
Court]; Lohtse Co-op. Housing Society Ltd. v. Income Tax Officer, (1994) 1
13; Department of Finance, Ministry of Finance, Government of India, C
158 (27th December, 1974).
104 Commissioner of Income Tax v. B.K. Roy, 248 ITR 245 (SC) [Suprem
India].
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cessation of agency was made taxable as business income.105 Compe

for loss of employment became taxable as salaries.106 These receipt
to be non-taxable by the Courts, pursuant to the income-capital distin
several benefits enjoyed by employees and directors of corporat
taxable as income, despite the fact that some of these benefits wer
being converted into money.107
As noted previously, the 1948 capital gains tax covered gains f

arising vide a sale or an exchange. This tax was withdrawn in 19
because of its adverse effect on investment, the resultant hindran
movement of securities in the capital market and the small yield.
given reasons had a bearing on the conception of income. In 1956, t
tax was reintroduced. Once more, the Finance Minister justified t
capital gains within income on account of the ability to pay. He n
" Capital gains are an important factor in aggravating economic ineq
and there is no justification for regarding capital gains as a species of
not liable to tax."m
This time the scope of the tax was widened. Earlier gains arising f
or exchange of capital assets were made taxable. The provision n
arising from the sale, exchange, transfer or relinquishment of a capit
the Act enlarged the subset of taxable gains realized from certain
assets. From the policymaker's perspective, the move marked a fu
of the source conception of income.
F. Adoption of the Income Tax Act, 1961
Act of 1922 was replaced by the Act of 1961, which is the law
force in India. The new Act did not mark a change in India's philos
tax. The provisions discussed hitherto were retained in the new A
105 O.P. Chawla states, "The general principle accepted in the Indian Inco
1955 had been that compensation for wrongful repudiation of a servi
for loss of office or employment or cessation of business was a capital r
the payment might be entirely voluntary and the recipient might ha
to any compensation at all". See 1972, O.P. Chawla. See also Explanatio
Income Tax Act, 1922 and §10 (5A), The Income Tax Act, 1922.
106 See 1972, O.P. Chawla. See also Explanation 2, § 7(1), The Income Ta
§10 (5A), The Income Tax Act, 1922.
107 § 2 (6C), The Income Tax Act, 1922.
108 39-47, O.P. Chawla.
109 39-47, O.P. Chawla.
110 39-47, O.P. Chawla.
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The 1961 Act extended the policymakers' resolve to tax gains arising from
every kind of disposition of property. Capital gains were re-defined as gains arising
from the "transfer" of a capital asset.111 In addition to a sale or an exchange, the
term "transfer" was defined to include artificial categories such as relinquishment,
the extinguishment of any rights, and the conversion of an asset into stock in
trade. 112 This, coupled with a broad definition of capital asset113 as property of
any kind, ensured that almost no gains arising from the disposition of property
would go tax-free. This new definition of transfer practically diluted the income-
capital distinction. Situations arose where Courts expressed doubts regarding the
taxability of certain gains that the formal letter of the law did not capture clearly.
For instance, the Courts stood divided on whether insurance proceeds received
for a capital asset lost in fire, arose vide a transfer as formally defined.114 On such
occasions, the legislature would promptly insert a statutory provision to confirm
the taxability of the impugned gain.115 Thus, whilst the income-capital distinction
remained ingrained in the minds of the judiciary and in scholarship, policy steadily
moved toward its abolition.
Ill § 45, The Income Tax Act, 1961 states that "any profits or gains arising from the transfer
of a capital asset effected in the previous year shall... be chargeable to income-tax under
the head "Capital gains", and shall be deemed to be the income of the previous year
in which the transfer took place."
112 § 2 (47), The Income Tax Act, 1961 defined 'transfer' as follows:
""transfer", in relation to a capital asset, includes,-
(i) the sale, exchange or relinquishment of the asset; or
(ii) the extinguishment of any rights therein; or
(iii) the compulsory acquisition thereof under any law; or
(iv) in a case where the asset is converted by the owner thereof into, or is treated by him
as, stock-in- trade of a business carried on by him, such conversion or treatment; or
(iva) the maturity or redemption of a zero coupon bond; or
(i>) any transaction involving the allowing of the possession of any immovable property
to be taken or retained in part performance of a contract of the nature referred to in
section 53 A of the Transfer of Property Act, 1882 (4 of 1882); or
(vi) any transaction (whether by way of becoming a member of, or acquiring shares in,
a co-operative society, company or other association of persons or by way of any
agreement or any arrangement or in any other manner whatsoever) which has the
effect of transferring, or enabling the enjoyment of, a"
113 §2(14), The Income Tax Act 1961.
114 Vania Silk Mills v. Commissioner of Income Tax, 191 ITR 647 (SC) [Supreme Court of
India]; Commissioner of Income Tax v.Grace Collis, 248 ITR 323 (SC) [Supreme Court
of India].
115 § 45 (1 A) was inserted by 1 he Mnance Act, IW, which provided that where any person
receives insurance money on account of damage or destruction of a capital asset due to
the circumstances specified therein, the same shall be taxable in the year of receipt.
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Next, the Finance Act, 1964 further eroded the judiciary's underst
income as a receipt necessarily convertible into cash. In the past, the legisl
targeted benefits received by employees. This taxable treatment was no
to non-monetary benefits arising in the course of business or profession.1
in 1972, windfall gains in the form of winnings from lotteries and
included in the definition of income.117 The Central Board of Direct Taxes
in the provision, "the exemption from tax of such receipts is not in k
the principle of taxing equally persons with equal capacity to pay."118
explanation conformed to the net accretion view of income.
G. Judiciary's Affirmative Departure from the Source Conception
In 1981 and 1993, the Supreme Court rendered decisions that

an affirmative departure from the judicial conception of income
far. The first of these cases was Bhagzuandas Jain v. Union of India, 11
constitutionality of tax imposed on imputed rent was under chal
was reminiscent of Navinchandra Mafatlal' s case (previously discussed
challenged the constitutionality of the capital gains tax. In the insta
taxpayer argued that he was not deriving any monetary benefit by
his own house and, therefore, no tax could be levied on the grounds t
deriving income from that house. The argument was supported by the
that income meant the realization of a monetary benefit and that, in the
any such realization, the inclusion of any amount by way of notional
impermissible. The Court justified the tax on the reasoning that imput
been taxed as income since the inception of the Act in 1922. Thus, when th
Parliament enacted the Government of India Act, 1935 (which forms
the Indian Constitution), it must have perceived income as including
rent. The court also relied on the rationale of its earlier decision in Navinchandra
Mafatlal.
The observation relevant to our purpose is as follows:

"Even in its ordinary economic sense , the expression ' income ' includes not
merely whut is received or what comes in by exploiting the use of a property
but also ivhat one saves by using it oneself That which can be converted into
116 §§ 28 (iv) and 2 (24) (vd), The Income Tax Act, 1961 .
117 § 2 (24) (ix), The Income Tax Act, 1961 .
118 Central Board of Direct Taxes, Circular No. 108, (20th March, 1973).
119 Bhagwandas Jain v. Union of India, (1981) 128 ITR 315 (SC) [Supreme Court of India].
[Hereinafter, "Bhagwandas Jain"]
120 Navinchandra Mafatlal.
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income can be reasonably regarded as giving rise to income. The tax levied
under Act is on the income (though computed in an artificial way) from
house property in the above sense and not on house proper fy."121
This was the first time that the Supreme Court considered the meaning
of income in the "economic sense." Recall Simon's definition of income under
the net accretion perspective, i.e., as the sum of an individual's saving and
consumption. Furthermore, the Court did not let the existing conception of income
as an 'incoming' hinder its decision. Unfortunately, this observation was not the
mainstay of the Court's decision, and was subsequently viewed in the context of
imputed rent alone.
The second decision was rendered in Commissioner of Income Tax v. G.R.

Karthikeyan }12 The statute rendered winnings from "lotteries, card games and
crossword puzzles and other games" specifically taxable under the Act.123 The
issue in this case was regarding the taxability of winnings from a car race. The
taxpayer argued that a car race did not fall within the purview of "other games"
and hence, the resultant winnings were non-taxable under the specific clause.
Note that §10 (3), 124 which exempted casual and recurring receipts from tax, had
been amended to provide for an exemption limit. The winnings in this case fell
outside that exemption limit.
The Court held that winnings from a car race were income irrespective of
whether they qualified under the specific clause as "winnings from other games." It
reasoned that the definition of income under the Act was inclusive. Consequently,
the meaning of income under the Act should be synonymous with its meaning
under the Constitution of India.
The Court was here referring to the case of Navinchandra Mafatlal, which
had drawn a distinction between the meaning of income under the Act and
the Constitution.125 As regards the Act, income could be interpreted within the
boundaries of the source conception. But, under the Constitution, income was to
be understood in the broadest sense, according to its ordinary meaning in English,
as anything that comes in or rather any profit or gain.
121 Bhagwandas Jain.

122 Commissioner of Income Tax v. G.R. Karthikeyan, AIR 1993 SC 1671 [Supreme Court
of India]. [Hereinafter, "G.R. Karthikeyan"]
123 § 2 (24) (ix), The Income Tax Act, 1961.
124 The provision was amended vide The Finance Act, 1986 - 1987. A ceiling of Rs. 2500/-
was introduced for exemption.
125 Navinchandra Mafatlal.
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In G.R. Karthikeyan, the Supreme Court abolished this distinction.

the Court held that the casual nature of the receipts would have n
decision. According to the Court, the very fact that casual receipts
exempted under the statute signified that they otherwise would have b
Thus, the Court disregarded the criteria of periodicity and produc
Unlike the previous case of Bhagwan Das , the Supreme Court i

did not show a leaning toward an economic view of income. In fact, it
the judiciary have no view of income, source or otherwise. In essence,
any profit or gain as income under the income tax statute unless it wa
exempted.
Despite these decisions, the source view of income persisted

case law and tax scholarship.
H. From source to net accretion
From a pragmatic perspective, the last phase of legislative changes to t

definition of income brought India's conception of income to the net accret
end of the spectrum.
In 2002, the definition of income was amended to include compensation

paid for restraint on trading or on the exercise of profession.128 This provis
was introduced to cover cases where such compensation did not fall within
purview of capital gains.129
Furthermore, in 2003, § 10 (3), which had exempted casual and non-recurr

receipts from the levy of income tax, was deleted from the Act.130 This provi
had already been diluted to a considerable extent. First, capital gains had be
removed from its scope and, subsequently, so were winnings from lotteries
due course, a ceiling for exemption under this clause was introduced for all ca
and non-recurring receipts. The Department of Revenue circular explaining
omission specified that the purpose of the omission was to bring these rece
in the tax net. More importantly, the reason cited was the rationalization of
definition of income.131
126 G.R. Karthikeyan.

127 G.R. Karthikeyan.
128 § 28 (va), The Income Tax Act, 1961.
129 § 28 (va), The Income Tax Act, 1961.
130 The Finance Act, 2003.
131 Department of Revenue, Ministry of Finance, Government of India, Circular No. 7/2003,
(9th September, 2003).
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Finally, in 2006, any gift of money exceeding Rs. 50,000 was rendered taxable
under the Act.132 However, broad exceptions were created under this rule to exclude
gifts received from relatives133 and on the occurrence of certain events.134 In 2009,
the provision was extended to tax gifts received in kind.
Currently, the following receipts remain non-taxable under the new Act of
1961: personal gifts, life insurance receipts and the residue of any capital receipts
not falling within the purview of capital gains or any other specific provision.
In addition, the problem of taxation of illusory gains (as in the case of annuities)
still persists under the Act. While fiscal policy moved toward the net accretion
conception, it failed to address this issue.
TV. Taxable Income under the Direct Taxes Code Bill, 2009
In 2009, the Government released the new Direct Taxes Code,135 accompanied
by a discussion paper which explained the underlying fiscal policy. As regards the
conception of income, the discussion paper stated the following:
"If equitable taxation should be in accordance with the capacity to pay of the
taxpaying unit, and if income is to be taken as a measure of the capacity to
pay, it must be so defined for tax purposes as to reflect adequately the potential
economic welfare of the individual concerned i.e., the capacity has to spend
during a year without affecting his net worth at the beginning of the year.
This means that definition must be comprehensive enough to include all
accruals to spending power. The conventional definition of income does not do
so. Ideally, we need a comprehensive definition of 'income' for tax purposes.
Such a definition of income, would include apart from gifts received,
132 § 56 (2) (vi), The Income Tax Act, 1961 .

133 Relative was defined to include:
"(a) spouse of the Individual;

(b) brother or sister of the individual;
(c) brother or sister of the spouse of the individual;
(d) brother or sister of the either of the parents of the individual;
(e) any lineal ascendant or descendant of the individual;
(f ) any lineal ascendant or descendant of the spouse of the individual;
(g) spouse of the person referred to in clause (ii) to (vi)".
134 On the occasion of marriage of the individual; or under a will or by way of inheritance;
or in cöntemplation of death of the payer.
135 See Direct Tax Code (2009), Department of Revenue, Ministry of Finance, Government
of India available at http://finmin.nic.in/DTCode/Direct%20Taxes%20Code%20Bill%20
2009.pdf.
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(a) All earnings including labour, investment and business income net
cost of earning and depreciation
(b) Net accrued capital gains i.e. net increases in capital assets owned
(c) Value of services or utility of non-business assets owned;
(d) Imputed value of the services rendered by the members of the fami
(e) Windfall gains

(f) Casual receipts
The conceptual basis of the definition of income is clear: the definition equ
to change in net worth. However, in practice it is not possible to measure sat
the elements included. . . ."136
The discussion paper identified these elements as: imputed incom

of services or utility of non-business assets and the imputed value o
rendered by members of the family), unrealized accretions in the valu
and economic depreciation and taxation of shareholders on the undi
profits of the company.137 Finally, it concluded:
" In line with the principles and problems discussed , the Code seeks to ad
to the extent possible , a comprehensive definition of income. Therefo
income for the purposes of the code will, in general, include all accruals
receipts of revenue and capital nature unless otherwise specified"138
For the first time, India's conception of income was clearly stated in
policy. Furthermore, this was accompanied by the explicit adoption
accretion view of income. This marked a major change in India's inco
Yet, it drew little attention in scholarly circles. This was because n
changed on the surface of the new code. Recall that policy had been
moving toward the net accretion view of income. Consequently, the A
amended several times to reflect this evolving view of income. Most r
were not income under the source view but qualified as such under n
had been made taxable under the 1961 Act.139 As such, from a prac
perspective, there would be little practical significance to the explicit
the net accretion approach.
136 Discussion Paper on Direct Taxes Code (2009), Department of Revenue,

Finance, Government of India available at http://finmin.nic.in/DTCode/D
Paper.pdf. [Hereinafter, "Discussion Paper"]
137 Discussion Paper.
138 Discussion Paper.
139 With the exception of gifts, life insurance receipts and capital receipts.
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Discerning India's Evolving Conception of Taxable Income ...
However, the explicit adoption of a comprehensive conception of income

under the Direct Taxes Code Bill would synchronize the judiciary's and the
policymaker's views of income. In addition, there are a few notable changes
from the 1961 Act. First, all receipts that enhance a person's ability to pay, such
as life insurance receipts, are now recognized as income.140 Exemptions, if any,
have been made on the considerations of positive externalities, encouraging
human development and reducing risk, equity, and reducing compliance and
administrative burden. Second, illusory gains should not be taxable under the
proposed Direct Taxes Code Bill. As discussed, under the source conception,
income was perceived as a flow rather than an economic gain, leading the judiciary
to tax the inflow without considering the corresponding diminution in the value
of assets such as annuities. In contrast, net accretion taxes the economic gain
alone as income. As such, the Direct Tax Code contains no provision to guide the
computation of a taxable annuity.
Finally, under the 1922 and 1961 Acts, the legislature had made inroads into
the income-capital distinction by taxing accretions to property on their realization
as capital gains. Thus, "capital gains" became synonymous with "taxable
accretions" or "taxable capital receipts." However, under the new code, as is the
case in the United States, all accruals and receipts, whether revenue or capital in
nature, are regarded as income, in consonance with the net accretion view. The
United States' Internal Revenue Code taxes all accretions to property on their
realization (arising from the sale or disposition of property).141 However, from
these economic gains, it creates a subset called capital gains. The object behind
creating this subset is to tax certain gains at a preferential rate, namely the gains
realized from the transfer of investment assets. Several policy objectives such as
the promotion of savings are cited to justify such a preferential rate.142 Thus, two
concepts emerged under the U.S. law: ordinary gains and capital gains (a subset
of ordinary gains that are taxed at preferential rates). As Graetz notes, "capital
gain is a creature of the tax law, without a direct analogue in either economics or
accounting."143 The explicit adoption of the net accretion approach makes India's
taxation of accretions to property comparable to that of the United States. The
Direct Taxes Code, 2010 draws a distinction between business capital assets144 and
140 § 56, The Direct Tax Code, 2010. Although a deduction is provided for these amounts
if certain condition are met.
141 Graetz.
142 Graetz.
143 Graetz.
144 § 248 (42), The Direct Tax Code, 2010 defines a "business capital asset" as:
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investment capital assets.145 The gains arising from the former are taxed
head of 'income from business' and are subjected to ordinary rates of t
gains). Gains arising from the transfer of investment assets are called cap
Interestingly, India seeks to tax capital gains at ordinary rates. Conse
question arises as to why the Direct Taxes Code Bill creates these two
- ordinary gains and capital gains. Plausibly, this distinction has been
for the purposes of computation and to grant certain capital gains th
indexation and roll-over benefit.
V. Conclusion
India's judicial conception of taxable income has been inspired by th
view of income. The judiciary began with a strict adoption of the source con
of income. However, over the years, it attempted to recede from this. P
this was a consequence of the introduction of an inclusive definition of
followed by legislative amendments that departed from the source view. The
sought a neutral stance and took the aid of a formalist interpretation o
Yet, in cases involving interpretation, the Courts resorted to the source conc
Moreover, the Courts were flexible with regard to the criteria of perio
productivity. However, the income-capital distinction remained entren
the judicial mind.
On the other hand, India's tax policy and statutes have been in tran
the net accretion view of taxable income. Noticeably, India's fiscal policy
the net accretion view in a piecemeal fashion. This piecemeal approach
subserved the idea of source conception as the norm. The fact that every
from the source view required a special enactment confirmed the app
of the source view of income. Further, the legislature abstained from e
(a) any capital asset self -generated in the course of business;

(b) any intangible capital asset in the nature of;
(i) goodwill of a business;
(ii) a trade mark or brand name associated with the business;
(iii) a right to manufacture or produce any article or thing;
(iv) right to carry on any business;
(v) tenancy right in respect of premises occupied by the assessee and used b
the purposes of his business, or
(vi) licence, right or permit (by whatever name called) acquired in connect
or in the course of, any business;
(c) any tangible capital asset in the nature of a building, machinery, plant or fu
(d) any other capital asset connected with or used for the purposes of any busin
assessee.
145 § 245 (151), The Direct Tax Code, 2010 defines 'investment
which is not a business capital asset.
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sweeping amendment that would define income from the net accretion perspective.
Nor did it issue a policy statement confirming its commitment to the net accretion
perspective of income. Inferably, this was because India's fiscal policy itself was
only in transition from the source view.
Consequently, this paper attributes the incoherence in India's concept of

taxable income to the growing disconnect between the fiscal policy's view of income
and the judiciary's view of income. The following are some closing thoughts on
attributing responsibility for this incoherence.
One view is that economic policy must be clearly reflected in legislation.

The Courts may only interpret the law as it exists. Given the transitioning fiscal
policy and the vague definition of income, the judiciary had little choice but to
seek support from precedent.
An alternative view could argue on the impossibility of defining a concept

such as income in the law. Income tax law does not exist in a vacuum. Its object is
the implementation of a fiscal system. Consider the following passage:
"the legal concept of income is not something that can ultimately be defined
by law because it is not something that exists either as a physical fact or as an
abstract thought . . . [Oļne cannot identify the borders of the concept because ;
at its borders, income is a fiction, invented for the purposes of income tax
legislation, that does not have independent existence in the world physical
fact or abstract thought ."146
Consequently, the judiciary must keep pace with fiscal policy and further the
economic conception of income. Consider R.M. Haig's comments on this subject
in the context of the U.S. Supreme Court's decision in Eisner v. Macomberu? :
"if the legal concept established by court interpretation... departs
in any fundamental fashion from the economic concept, injustices
may arise of such magnitude as to necessitate an abandonment of
the income tax. . ."148
146 John Prebble, Philosophical and Design Problems that Arise From the Ectopic Nature of
Income Tax Law and Their Impact on the Taxation of International Trade and Investment, 13
Chinese Yearbook of International Law and Affairs, 111 (1995) as quoted in 174,
K. Holmes.
147 Eisner v. Macomber, 252 U.S. 189 (1920) [Supreme Court of the United States]. The case
centred on the issue of the taxability of stock dividends. The Supreme Court declared
that realization was essential to the concept of income. Haig advocated the net accretion
perspective of income and viewed realization as an unnecessary qualification to the
concept of income.
148 15, R.M. Haig.
75

65.0.33.20 on Fri, 12 Feb 2021 06:14:27 UTC
Income Tax Changes: What Is the Objective and What Are the Implications?
Author(s): R KAVITA RAO
Source: Economic and Political Weekly , AUGUST 9, 2014, Vol. 49, No. 32 (AUGUST 9,
2014), pp. 16-18
Published by: Economic and Political Weekly
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COMMENTARY :
non-violence as a tactic of resistance. REFERENCES http://www.nytimes.com/2oi4/o7/2o/opinion/

sunday/nicholas-kristof-whos-right-and-wrong
The costs of violence are simply tooErakat, Noura (2012, 2014): "No, Israel Does Not
in-the-middle-east.html?_r=i
Have the Right to Self-Defense in International
high. And we really do not know how ef Sheizaf, Noam (2014): "Why Do Palestinians Con
Law against Occupied Palestinian Territory",
fective non-violence can be here because tinue to Support Hamas Despite Such Devastat
Jadaliyya, http://www.jadaliyya.com/pages/
ing Losses" çy2mag, 22 July http://972mag.com/
it has not been tried at scale. It has not index/8799/no-israel-does-not-have-the-right
why-do-palestinians-continue-to-support-ha
to-self-defense
mas-despite-such-devastating-loses/94080/
been tried, in turn, largely because the Kahlidi, Raja and Sobhi Samour (2011): "Neoliber Sussman, Sam (2014): "Dear Nick Kristof: Your Pales
internal political conditions prevent such alism as Liberation: The Statehood Programme tinian Gandhis Are Already Here", 26 July, Dis
and the Remaking of the Palestine National sent, http://www. dissentmagazine.org/blog/
exploration. The Palestinian people have Movement", Journal of Palestine Studies, Vol 40, dear-nick-kristof-your-palestinian-gandhis-are
to change these conditions now by re No 2, www.palestine-studies.org/files/pdf/jps already-here
/io924.pdf Zeveloff, Naomi (2012): "The Five-Star Occupa
claiming their half-state and refashion
Kristof, Nicolas (2014): "Who's Right and Wrong in tion", Guernica, 15 August, http://www.guerni
ing it into a real weapon of resistance. the Middle East?", New York Times, 19 July, camag.com/features/the-five-star-occupation/
Income Tax Changes

the marginal taxpayer, the benefits from
the savings scheme and the housing
investment scheme would accrue to tax
What Is the Objective and What Are payers who have enough of a surplus
the Implications? to save, and in the case of the housing

incentive it is meant for people who
have an income above Rs 4.75 lakh per
annum. Whether one considers people
R KAVITA RAO with annual incomes above Rs 4.75 lakh
as low income requiring support from
The Union Budget for 2014-15 the government is one's own perspective
Democratic Alliance (nda) gov
offered a number of concessions and perception.
The first budget
ernment was of onethe National
a very pleasing (2) If inflation continues to be a concern
to income taxpayers. But in the
for the income taxpaying citizens of for the government, especially when
interest of rational tax policy
India. There is an increase in the exemp there is a drought, does putting more
reforms, two questions we tion threshold,
need an increase in the sav money in the hands of the people help
to ask are: does changing ings
theincentives and if one were to take a rein in inflation or augment growth?
loan to buy a house, well, some more re Specifically, does the present govern
exemption threshold for
lief on that count. Sounds like a good ment perceive the economy to be
personal income tax affect
thing, for the taxpayer. If we can achieve demand or supply-constrained? If the
collections and does a change
this with nobody being worse off, clearly latter, then additional incomes in the
this is a win-win. Is it? hands of the taxpayer may not really be
in savings incentives influence
The rationale for reducing the thresh addressing the key concern.
saving behaviour?
old is to provide relief to small and But these are not the only issues that
marginal taxpayers and the rationale for one needs to be concerned with. One is
increasing the savings incentives, as tempted to ask two other questions.
enunciated in the budget speech, was First, does changing the exemption
to encourage investment in long-term threshold affect personal income tax
savings and, implicitly, to increase the (pit) collection, and, second, does a
level of saving in the economy from the change in savings incentives influence
current 30.5% of gross domestic product saving behaviour?
(gdp). The fiscal deficit continues to be a This note is an attempt to ask these
concern for the government, and as questions and explore the implications
mentioned by the finance minister him of observable trends in India.
self, the revenue targets set by his pred Turning to the first question, if the
ecessor and adopted by him are "ambi answer is yes, does a new government,
tious". In this context, how does one which has come with a thumping major
assess the relief provided to the taxpayer. ity and with a stated mandate to kick
To begin with, a few implications of start the economy and generate jobs,
the provisions that are not the focus of need to reward the voter or provide re
R Kavita Rao (kavita@nipfp.org.in) the
isarticle:
at the lief to the taxpayer? This brings us back
National Institute of Public Finance (1)and Policy,
While the increase in the exemption to the question: is the economy demand
New Delhi.
threshold would benefit the small and or supply constrained? If the former, we
ι6 august 9, 2014 vol xlix no 32 13253 Economic & Political weekly

65.0.33.20 on Fri, 12 Feb 2021 06:17:11 UTC
; COMMENTARY
Figure1:HouseholdSavingsasProportionofGDPandTaxlncentives
Figure 1: : Household
1 Household Savings
Savings as
as Proportion
Proportion of
of GDP
GDP and
and Tax
Tax Incentives
Incentives that there is more effort welcome, since higher
(%) (in Rs)
3Q1 I ! : _. 35^000 from the tax department would facilitate higher leve
30,000 t0 reach their targets? ment and growth in the economy. G
·.·*' **·'*/> S ·
Total Savings .·**
ι -··" 25,000 There are references to that a significant part of household
:.Χ.·· —Saving Tax Incentives 20,000 concerns about "static ing in India is in the form of phys
15,000 revenue targets" in the assets, it is also possible to argue th
10,000 Tax Administrative Re- centives which encourage the house
τ
Financial Savings 5,000 forms Commission which to move from physical assets to fin
ο
ο place a lot of pressure on assets could help in making availab
1993- 1995- 1997- 1999- 2001- 2003- 2005- 2007- 2009- 2011- , ,, r ,
1993- 1995- 1997- 1999- 2001- 2003- 2005- 2007- 2009- 2011
94
94 9696 98982000
2000 0202 040406 0608 08io 1210 the
12 tax officers. Could funds for investment elsewhere in the
LHS: As % of GDP, RHS: Maximum amount saved at highest marginal tax rate.
LHS: As %ofGDP,RHS: Maximum amount saved at highest marginal tax rate. this Suggest that at least economy. It
may be on the right track. So does the a part of the tax collection in the country whether either
change in the exemption threshold is a "negotiated settlement"? If so, this witnessed in In
change pit collections in the country? could be considered a mechanism of In order to exa
bringing some of the black money into recent past, an attempt o
Impact on Collections the mainstream, but such a process would made to construct
To answer this question, we can construct make the tax department oppressive the maximum in
a "statutory tax rate" (str) variable1 and the buoyancy of the tax revenue saving in any g
and examine the relation between pit non-sustainable in the medium and long which the incent
collections, the gdp and the tax rate run. Further, it would also mean a replace- income deducti
variable. Whether one takes total gdp ment of a stable known source of receipts highest marginal
or gdp from sectors other than agricul- with more uncertain receipts requiring ing the value of
ture, whether one considers the relation more effort by the tax department. ing tax incentive
in levels, log, growth or change, the In other words, it is important to ask of household saving
results suggest that changes in the str and find the answer to the question - gdp shown along
do not have a significant impact on pit!2 does the tax rate affect revenue collec- tives. It suggests
Somewhat surprising! What can we tions in the country? The initial analysis in saving tax incen
infer from this? undertaken for this piece may not be nied by a significant change in the levels
If we look at the composition of pit adequate to conclusively answer this of either total savings or financial savings
collections - Tax Deduction at Source question, but it sure raises the need to of households. While total savings show
(tds), advance tax, self-assessment tax, ask and answer the question in the a marked increase prior to the change in
regular assessment - only the first is interest of more rational tax policy incentive, subsequent to the change
related to the str. An increase in the reforms in the future. however, there is no clear increase. If
exemption threshold reduces the str one regresses household savings on gdp
which in turn reduces the tds collec- Influence of Savings Incentives and saving ince
tions. The other three categories are not The second question that merits analysis revealed imp
significantly affected by rates of tax. as mentioned earlier is: Will changes in examined in l
(These results are reported in Table At the savings incentives bring in more Total savings se
in the Appendix.) Can this mean that savings from the household sector or at not to incenti
changes in the tax rate stimulate gdp least draw more savings into financial here.5 (Th
which results in enhanced collections, instruments? It has often been argued Table A3, ρ i8.)
the impact being captured by gdp rather that changes in incentives only change In other w
than the tax rate? This could be one the allocation of total savings but do not tives do not seem
thing to look for - the bivariate relation change the level of savings. Increase in role in indu
between gdp growth and str or change the level of total savings would be saving or higher
in str, however, does not reveal any
relation. If one examines the relation Appendix
Appendix Table A1:
Table Al Explaining IncomeIncome
: Explaining Tax Collections
Tax Collect
Form
Form of Personal
Personal
of Equation
Equation IncomeTax
Income Tax In
In Levels
Levels (Revenue
(Revenuefrom)
from)
between gdp and gross capital forma
Dependent Levels First Difference
Difference TDS Advance Tax
AdvanceTax Self-Assessment
DependentVariable
Variable Regular Assessment
tion, trade deficit, governmentGDPNA
final con
GDPNA 0.506 0.438 1.85 0.592 0.261 0.156
sumption expenditure and the str, then (20.75) (3.96) (27.18) (10.096) (16.869) (7.89)
the str does not have a significant
STR -1149.75 -8569.42 31738.03 8666.08 3798.63 57.24
impact.3 (These results are reported in (-0.18) (-0.78) (1.79) (0.566) (0.94) (0.01)
Constant
Constant -807.927 31.03 -18575.9 -3093.24 -1869.21 -284.74
Table A2, ρ i8 in the Appendix.)
(-0.34) (0.06) (-2.83) (-0.545) (-1.25) (-0.15)
If the relation is not through a stimu
AdjRSq
AdjRSq 0.9839 0.399 0.9893 0.927797 0.97301 0.895465
lation of gdp, how can we explain the . . . . . . , , . JCTD
Figures in parenthesis are t-ratios. GDPNA stands for gross domestic pr
impact or the lack of it? Could it mean statutory tax rate.
Economic & Political weekly E3SE9 august 9, 2014 vol xlix no 32 17

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COMMENTARY
3 The relation is examined in first differences

in total saving. At least that is the conclu to
determinant of savings behaviour in India.
minimise the impact of multicollinearity.Hence we have not included the same here.
sion that emerges from the last significant
4 Studies on the behaviour of Indian savings
Further exploration however can be undertaken.
increase savings incentives introducedsuggest
in that interest rate is not a consistent
There is not much change in the composition of
financial instruments chosen by households ei
2003-04 by the previous nda government.
Table A2: Impact of STR on GDP ther. If one considers the ratio of bank deposits,
It will manifest as revenue foregone. Do Equations
Equations in in
First Difference
First Difference non-bank deposits, life insurance fund, provi
Case 1 Case
Casel Case 2 2 CaseCase33 dent and pension funds, shares and debentures
we need to go back to the drawing board and units of UTI over total financial assets net
Constant
Constant4121.303 4265.063 70241.2
for reformulating tax policy? of claims on government, the ratio fluctuates
(4.94) (4.93) (2.37)
around 90% with no perceptible trends.
STR 5546.802 0.158893 579729
NOTES (0.21) (0.86) Table A3: Savings Behaviour of Households
and Taxes
STR(-I)
Taking a representative taxpayer assumed to 4269.128
Total Savings Financial
nildllUdl Savings
OdVlliys
have an annual income of Rs to lakh during (0.159)
2009-10, the statutory tax rate is GFCE
the tax Constant
Constant 224.34 344.91
4.94929
payable on this income divided by income. (0.81) (1.33)
(5.19)
This exercise does not incorporate any exemp 3DPNA
GDPNA 0.185644 -0.0028
GDCF
GDCFstruc
tions and incentives apart from the rate 0.77205
(4.07) (-0.066)
ture prescribed by law. For all the other years, (3.59)
the annual income is corrected for inflation by STR
str -1113.63 -1194.88
BOT -0.5611
using the wholesale price index. We will get (-0.17) (-0.202)
(-0.97)
slightly different series if we take different 0.006 -0.016
Saving
saving incentives
levels of income from the representative
AdjRSq -0.048 -0.051 0.9327
(0.111) (-0.293)
(-0.293)
taxpayer. Figures in parenthesis are t-ratios. GFCE is government
Adj
4dj R Sq 0.432768 -0.18845
The exercise relates to the period 1990-91 to
final consumption expenditure, GDCF is gross domestic
2012-13. capital formation, BOT is balance of trade. Figures in parenthesis are t-ratios.
Financial Sector, Monetary

departures are going to happen over the
rest of the year. There is yet another but
Policy and Budget 2014

related view that the nda government
had got hardly 60 days to make the
budget and Budget 2014 is merely a
trailer. Thus, one may have to wait till
PARTHA RAY February 2015 for the real budget to
come up.
1 Introduction
The announcements in the union In all objectivity, at the current
juncture, these views are difficult to
budget relating to the financial
2014-15 is fraught with a multi validate. Any commentator on the
sector were incremental in nature
Any analysis of theAfterUnion Budget
plicity of interpretations. current budget is, thus, constrained by
and can be seen as a continuation the sheer small sample size of the obser
all, in generic terms, there are a number
of the policies of the United of distinct ways to see Budget 2014. vations and any comment from this
First, there is a view that the Bharatiya standpoint could be premature. With
Progressive Alliance government.
Janata Party-led National Democratic this caveat, the rest of this note is going
A critique.
Alliance (nda) Budget looked remark to attempt some conjectures on the pro
ably familiar to the one that could have nouncements of the budget insofar as
been made by the United Progressive monetary policy and financial sector
Alliance (upa) - so much so that the are concerned.
ghost of Ρ Chidambaram seemed to have

2 Financial Sector
completely captured the mind and
thought process of Arun Jaitley. There What have been the announcements of
is, however, a more generous take the budget on financial sector? Despite
on the budget. It is believed in some its banality, it is perhaps best to start
quarters that the hype and hoopla with a laundry list.
associated with the budget is an Indian
phenomenon and that the budget Agriculture Credit: As far as agricul
needs to be stripped off its frivolities ture credit is concerned, the budget has
and it should not be seen as much more made quite a few announcements. Illus
than the annual income-expenditure of tratively, in an effort to provide institu
the union government. The finance tional finance to landless farmers, it has
minister should be complimented for proposed to provide finance to five lakh
Partha Ray (pray@iimcal.ac.in) teaches at the taking the budget back to the basics. joint farming groups of landless farmers
Indian Institute of Management Calcutta.
From this standpoint, major policy (bhoomi keen kisan) through the National
ι8 august 9, 2014 vol xlix no 32 EE32Z Economic & Political weekly

65.0.33.20 on Fri, 12 Feb 2021 06:17:11 UTC
Direct Tax Code and Taxation of Agricultural Income: A Missed Opportunity
Author(s): D P SENGUPTA and R KAVITA RAO
Source: Economic and Political Weekly , APRIL 14, 2012, Vol. 47, No. 15 (APRIL 14, 2012),
pp. 51-60
Published by: Economic and Political Weekly
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SPECIAL ARTICLE
Direct Tax Code and Taxation of Agricultural Incom

A Missed Opportunity
D P SENGUPTA, R KAVITA RAO
Given the pressures on government expenditure and the

need to generate additional revenues without to tax. While agriculture accounted for about 12.3%
Most agricultural
of gross domestic income
product (gdp) in Indiaits today is not subject
in 2009-10,
generating too many distortions, it is important to bring
contribution to taxation is limited to the value added tax (vat)
back to the discussion table the need to deal with
paid on some of the products and the agricultural income tax
taxation of agricultural incomes. The issue has been paid on a few plantation crops like tea. The other sectors in the
discussed at length by a number of reports on taxationcountry usually face income tax in addition to indirect taxes
such as vat and Cenvat/service tax. A hypothetical question of
as well as in the literature on tax policy in India. This
how much additional revenue could have been mobilised, if
paper seeks to reignite this debate at two levels: one by
agricultural incomes too were treated on par with other
asking for a more comprehensive taxation of incomes,incomes and subject to income tax, yields an answer of a
implying thereby taxation of agricultural incomes as potential revenue in the range of Rs 50,000 crore for 2007-08,
i e, about 1.2% of gdp or about 9% of the gdp of agriculture
well. The second is the need to use current legislation
(see Appendix (p 59) for some computations). While additional
to ensure that the exemption base of agricultural revenues of this size would not substantially alter the profile
income from taxation is kept as narrow as possible as of overall government receipts in India, it represents a
against expanding it. sizeable amount of revenue for states, adding about 19% to
the revenues of the states.
Apart from revenue considerations, it is commonly accepted
that exemptions generate incentives to under-report taxable
incomes, thereby undermining the revenues from taxable
sources as well. The Report of the Taskforce on Direct Taxes
(Kelkar Committee), for instance, discusses the under-reporting
of incomes under the guise of exempt agricultural income.
Given the pressures on government expenditures and the
need to generate additional revenues without generating too
many distortions, it is important to bring back to the discussion
table the need to deal with taxation of agricultural incomes.
These issues have been discussed at length by a number of
reports on taxation in India as well as in the literature on tax
policy in India. This paper seeks to reignite this debate at two
levels: one, by reiterating the more established argument,
asking for more comprehensive taxation of incomes implying
thereby taxation of agricultural incomes as well. The second
is the need to use current legislation to ensure that the base
referred to within exemption of agricultural income is kept
as narrow as possible, as against expanding it. The paper is
organised as follows: Section 1 provides a background to the
study by highlighting the changes in the structure and organi
sation of agricultural operations in India in recent times.
These changes indicate that the agricultural sector now has
players who cannot solely be described as small farmers strug
D P Sengupta (dpsengupta@gmail.com) and R Kavita Rao (kavita@nipfp.
gling to meet the food security challenge of India. There is an
org.iri) are with the National Institute of Public Finance and Policy, increasing presence of both commercial crops and commercial
New Delhi.
participants in this sector. Section 2 provides a summary of the
Economic & Political weekly BESS april 14, 2012 vol xlvii no 15 5*

65.0.33.20 on Fri, 12 Feb 2021 06:19:15 UTC
SPECIAL ARTICLE
state of taxation of agricultural incomes today. Section 3

Figure 3: Share in Value of Output of Agriculture (%)
briefly presents some of the current controversies in the treat Cereals
ment of this sector. While recognising the difficulty of achiev

✓*x- J. Fruits and v egetables
ing a pan India reform of comprehensive state level taxation
/\of ... \.
agricultural income, Section 4 brings to light the dilution of

Other crops
I Sue ars Condiment
and spices
provisions within the Direct Taxes Code (dtc), which defeats r /"-■'" N""
L..S
the purpose of more comprehensive taxation. Section 5 presents

a summary of policy options available.
1950-51 1956-57 1962-63 1968-69 1974-75 1980-81 1986-87 1992-93 1998-99 2004-2007
1 Change in Structure and Organisation 05 08
Source: Computed from the National Accounts Statistics, 2011.

The conventional view of Indian agriculture is that of a sector
producing largely foodgrains, meant for self-consumption
outputandhas declined over the years, especially since the
for the market. This is considered a sector which supports
these65%
crops have been systematically yielding space to t
duction
of the population for livelihood. Over the years, however, there of fruits and vegetables. The share of cereal
is some change in the composition of the crops cultivated
creasedasto almost 30% from over 45%, while the share o
well as in the forms of organisation in the agricultural sector.
and vegetables has increased from 15% in the 1970s to
There is an increase in mechanisation in this sector which is recent times. It should be mentioned that this category of
changing the pattern of livelihood. The number of tractors per and vegetables includes the value of output from flor
100 sq km has increased from 50 in the late 1980s to about 200 as well. Some available details of the composition of thi
by 2008 (Figure 1). While the total cropped area has increasedsuggest that while the traditional crops of potato and
from 185 to 195 million hectares since 1990-91, the share of have seen some increases in production, floriculture as
foodgrains has remained static around 122 to 125 million an expanded range of horticultural crops has contrib
hectares. This suggests that there has been some increase inthis increase in value of output somewhat disproportio
the area devoted to non-foodgrain crops (Figure 2). This would the increase in acreage. This is an interesting trend, in
include the fibre-yielding crops, like cotton and jute, oilseeds that in terms of value of output there is a larger share of
and spices as well as the entire range of horticultural crops liketural output which is responding to market signals a
fruits and vegetables and in recent times, floricultural crops. bracing diversification and higher value generation.
Figure 1: Tractors Per 100 Sq Km of Gross Cropped Area Another important dimension in Indian agriculture,
is finding a lot of place in discussions on this sector
growing presence of the corporate sector in various act
associated with this sector. There are corporates/com
reporting agricultural income and income from the
various agricultural products. (Table 1 (p 53) provid
summary statistics of companies from the prowess
of companies which reported agricultural income.) W
number of companies is not large, the corresponding in
are not inconsequential, with over 50 companies rep
Source: Computed using Table 3.33 of Agriculture Research Data Book 2007 and Table 24 of agricultural incomes of over Rs 100 crore, with their to
Handbook of Statistics on Indian Economy 2011.
cultural incomes amounting to Rs 31,313 crore in 200
Figure 2: Percentage of Land Cultivated may be noted that all the companies in this compilation
specialise in agricultural products alone. They include a
of companies, for some of whom agricultural income i
60 f small fraction of the total sales. It should also be mentioned
Foodgrains
here that the incomes reported here would be an underesti
mate to the extent these companies have integrated operations
and are utilising their own agricultural produce in their non
agricultural operations. For instance, any company which
0 , , , , , produces cotton and uses it to produce yarn or fabric for sale in
1960-61 1970-71 1980-81 1990-91 1995-96 2000-01
the market, may not report the same as income from cotton.
Source: Computed from Handbook of Statistics on Indian Economy 2011, Tables 19 and 24.
Further, since this compilation does not include firms and indi
While the change in the acreage is notwith
viduals dramatic, it has
similar operations, the quantum of agricultural
increasingly been reported that the returns on the
income reported cultivation
by taxpayers reporting both categories of
of non-foodgrains are significantly higher than
income too wouldthose from
be larger. cul
What this does underscore is the
tivation of foodgrains.1 This is borne noticeable out by presence
evidence of thefrom
corporatethesector in agricultural
composition of the value of agricultural output
operations. as well.
The presence Figure
of corporates 3 field suggests that
in this
shows that while the share of cereals in the total value of the traditional notion of agriculture as a small farmer cultivating
52 april 14, 2012 vol xlvll NO 15 033 Economic & Political weekly

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SPECIAL ARTICLE
for his sustenance alone is undergoing some change. While it

products to be procured by the contracting company or by
is true that the small farmer and agricultural labour house
providing support in marketing the product. While the jury
holds may not have been assimilated into this process ofis cor
still out on whether this move is necessarily beneficial to
porate farming, these do not remain the only categories inthe farmers in India, what seems to be clear is that new
the
agricultural sector today. institutions have emerged to address some of the concerns
Table 1: Corporates Reporting income
Income from Agriculture of the cultivators and thereby improving the returns to
2007-08 2008-09 2009-10
cultivators. The PepsiCo initiative in potato, it is argued, has
1 Number of companies with positive income 617 682 608
been able to protect the farmers from the effects of a sharp
2 Number of companies with agricultural income
above Rs 100crore 51 65 68
fall in potato prices in the local market.2 The initiative of
2a Total agricultural income ofthese companies
the Tata Group, through its company Rallis India, provides
(Rs crore) 23,580 27,850 31,313 technical inputs as well as support to market the produce.
3 Number of companies with over 50% Appachi Cotton provides a third model where the price of the
of income from agriculture 270 296 252
product is not pre-negotiated, but the farmers, as a group, can
3a Total agricultural income ofthese companies
negotiate with the company for the price, the market price
(Rs crore) 17,630 20,689 25,777
Taxes forgone corresponding to 2a 4,716 5,570 6,263
being the benchmark. All of these initiatives indicate that
Taxes forgone corresponding to 3a 3,526 4,138 5,155 there are changes in the structure of agricultural operations
Taxes forgone are computed assuming an effective tax rate of 20%. in India with an increase in the focus of technological inputs
Source: Compiled from Prowess.
and some interventions to stabilise the price or at least to
Another form of interaction of the corporate sector with reduce price uncertainties.
the agricultural sector is through propagation of contract
farming. (Table 2 provides a list of some of the well-known 2 Present System of Taxation
interventions in the form of contract farming.) This interven
tion of the corporate sector into agriculture has two main 2.1 Definition of Agricultural Income
components. The first component involves providing techni Entry No 82 of the Union List of the Seventh Schedule read
cal inputs into cultivation, thereby improving the quality and with Article 246 of the Constitution empowers Parliament to
quantity of the crop produced. The second component relates make laws with respect to taxes on income "other than agri
to providing some form of cushion from the fluctuations in cultural income". Similarly, Article 246(3) read with Entry 46
the price for the crop - either through prefixed prices for in List 11 of the Seventh Schedule empowers the state legisla
ture to make laws relating to tax
Table 2: Contract Fanning in India: Some Initiatives
SrNo Name of the Company States Commodity on agricultural income. Accord
1 Appachi Cotton Company Tamil Nadu (TN), Karnataka Cotton ingly, Section 10(1 a) of the Income
2 AVT Natural Products Karnataka Marigold Caprica Chilly Tax Act, 1961 provides for exclu
3 Cargill India Madhya Pradesh (MP) Wheat, maize and soybean sion of agricultural income in the
4 Escorts Punjab Basmati computation of total income. Simi
5 The Global Green Company (Naan) Karnataka, Andhra Pradesh (AP) Gherkin, babycorn, paprika lar was the position relating to
6 Hindustan Lever MP Wheat
taxation of agricultural income
7 Ion Exchange EnviroFarms TN.MP, Gujarat, Haryana, Maharashtra Organic products of banana, pineapple, even under the Government of
papaya, wheat, basmati, cotton
ITC-IBD MP
India Act, 1935 and the Income
8 Soybean
9 Ken Agritech Karnataka Gherkin Tax Act, 1922. Vide Article 366(1)
10 Marico Maharashtra, MP, Gujarat, Karnataka, Safflower of the Constitution, the expres
Chhattisgarh, Rajasthan sion "agricultural income" for the
11 Mahindra Shubhlabh services Maharashtra, Punjab Many crops above entries means agricultural
12 Natural Remedies Karnataka Coleus
income as defined for the purpose
13 Nestle India Punjab Milk
of the enactments relating to
14 Nijjer Agro Foods Punjab Tomato and chilly Indian income tax.
15 Pepsi Foods Punjab, TN, West Bengal Chillies, groundnut, seaweed, tomato
and basmati rice Except for some occasional
16 Rallis India Punjab, UP, MP, Maharashtra, Basmati, wheat, fruits, vegetables changes, which we shall discuss
Karnataka, TN subsequently, the core definition of
17 Satnam Overseas Basmati
Punjab "agricultural income" both under
TN Cotton
18 Super Spinning Mills the 1922 Act and the Income
19 The Ugar Sugar Works Karnataka Barley
Act, 1961 remains remarkably
20 Unicorn Agrotech Karnataka Gherkin
unchanged. Accordingly, although
21 United Breweries Punjab Barley
there have been many litigations
22 CG Herbals Chhattisgarh, Orissa Patchouli, veiver, aromatic crops for
essential oil in regard to what constitutes agri
23 Sanjeevani Orchards MP Pomegranate cultural income, the jurisprudence
Source: http://agmarknet.nic.in/ConFarm.htm in this regard has been more or
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which income is derived should be assessed to land revenue or

less settled. The seminal case in this regard is the case of citvs
Raja Binoy Kumar Sahas Roy.3 The essential elements of any
agrilocal rate.
cultural income as has been laid down by the Supreme Court
in that decision are as follows: 2.2 Change in the Definition of Farmhouses
• The primary sense in which the term agriculture is under Agricultural income also includes income attributable to farm
stood is the cultivation of the field and in that sense relates to
buildings which is required by farmers for residence, storage
basic operations like tilling of the land, sowing of the seeds
of grains and such other purposes. Hence, income from such
and planting and similar operations on the land. These basic
farmhouses was also allied to the definition of agricultural
operations require expenditure in terms of human labour and
income and was exempt. By the tla Act, 1970, another change
skill upon the land itself. was brought about. While the condition of the land being
• There are operations which are not basic in nature butsubject
are to land revenue was dropped in the case of agricultural
land, per se, in respect of farmhouses, this was a condition
performed after the produce sprouts from the land like weeding,
digging of the soil around the growth, preservation against
precedent. Where the land was not subject to land revenue,
insects and pests, tending, pruning, cutting, harvesting,the
etc,farmhouse was to be situated outside urban areas to enjoy
or rendering the produce fit to be taken to the market. These
the benefit of the exemption.
The effect of this modification was that income attributable
subsequent operations must necessarily be in conjunction with
to farmhouses situated in such "urban areas" was not treated
and a continuation of the basic operations. One cannot dissociate
the basic operations from the subsequent operations andas agricultural income unless the land on which the farm
say
that the subsequent operations can constitute agricultural
house was situated was assessed to land revenue or any local
operations by themselves. rate. However, in the case of farmhouses situated in "rural ar
• The nature of the produce raised is not relevant, eas",
the the income there from was treated as agricultural income
produce could be either vegetables or fruits necessary even
for where the land on which the farmhouse was situated,
human consumption or pastures grown for beasts or for items
was not assessed to land revenue or any local rate.5
like betel, coffee, tea, spices or tobacco or for the growth of
commercial crops. 2.3 Change in the Definition of Capital Asset
• Mere association with land as in the case of breeding
By the same tla another change was brought about though
and rearing livestock, dairy farming, butter- and cheese
not in the definition of agricultural income. This concerned
making and poultry-farming cannot be treated as constitut
the definition of a "capital asset". Prior to 1 April 1970 capital
ing agriculture. gains from transfer of agricultural land were not subject to
Almost all subsequent decisions have been rendered in tax
the as agricultural land was excluded from the definition of
touchstone of the test as laid down in the aforesaid judgment.
"capital asset". Through the amendment, it was laid down that
the agricultural land situated in any urban area would be
1970 Amendment: The definition of agricultural incomeconsidered
in as capital asset, and hence, any gain arising from
the transfer of such agricultural land in urban area was
the Income Tax Act, 1961, inter alia, contained the following:
brought within the purview of capital gains taxation.6
any rent or revenue derived from land which is used for agricultural
purposes and which is either assessed to land revenue in India or Thus,
is agricultural land in urban areas would henceforth
subject to a local rate assessed and collected by the officers of the constitute
Gov capital asset subject to capital gains taxation.
ernment as such;...
Assessment to land revenue, etc, was the condition prece

1973 Amendment: The Committee on Taxation of Agricul
dent before the income could be categorised as agricultural
tural Wealth and Income (Raj Committee) suggested several
income. Thus, where the land in question was not assessed to
measures for mobilising resources from the agricultural sec
land revenue or local and it was situated within the jurisdic
tor. The committee, inter alia, observed:
tion of the municipality of Dehradun, it was held that the in
The temptation to dress up large chunks of taxable income as agricul
come derived from such land could not be treated as agricul tural in origin would be curbed to a considerable extent if the tax
tural income and the sale of lychee fruits was not agricultural
liability in respect of non-agricultural income is linked in some way
income and was not exempt from taxes.4 with the aggregate income of an assessee comprising the receipts from
By the Taxation Laws (Amendment) (tla) Act, 1970,both

a agricultural and non-agricultural sources. In other words, eva
sion through the device of camouflaging taxable income as gains from
change was made in the above said definition of agricultural
agriculture would cease to be paying if the disclosure of agricultural
income. It was pointed out that in the recent years, agricul
incomes entails a heavier burden of tax on non-agricultural incomes.
tural operations were extended to the Terai areas or canton
We, therefore, propose that both the agricultural and non-agricultural
ment, where land is not assessed to land revenue and is not
components of a taxpayer's income be aggregated and the tax on the
non-agricultural portion be levied as if it were placed in the top slabs
subject to any local rate and accordingly, income derived by
of the aggregate income...
agricultural operations of such land was outside the scope of
the agricultural income, and hence, liable to central income
The committee thus suggested that agricultural and non
tax. The definition of agricultural income was, therefore,
agricultural components of a taxpayer's income should be
amended so as to drop the condition that the land from
aggregated and the tax on the non-agricultural portion levied
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the definition of agricultural income for the purpose of

as if the latter were placed in the top slabs of the aggregate
enhancing or contracting the scope of agricultural income.
income. Integration of agricultural and non-agricultural incomes
should take effect only if a taxpayer has taxable non-agricultural
2.4for
income exceeding the minimum exemption limit laid down Taxation of Agricultural Income
the levy of income tax. Within the present constitutional assignment of tax powers in
The Finance Act, 1973 accepted this recommendation India, and taxation of agricultural income is placed within the State
provided for partial integration of agricultural income.List. TheHowever, though the states have the right to tax agricul
same situation continues till date although with the gradual tural income, very few states have attempted to enter this
flattening of the top tax rates, its effectiveness is doubtful.arena. Table 3 shows the number of states that have a system
The validity of this provision was challenged in some of taxation of agricultural income in place today. Of these, for
cases
but has been upheld by the courts.7 the most part, the tax is on plantation crops. While Assam
does have a comprehensive levy, the revenue it gets is largely
from
1989 Amendment: Despite the change in the definition of tea. The rest of agriculture remains outside the purview
capital asset by the tla Act 1970, certain courts, however,ofheld
taxation at the present juncture.
that profits from sale of agricultural land itself constitutedterms of the revenue that these states have been able to
In
mobilise from this tax, Table 4 shows that none of the states
agricultural income and since agricultural income was exempt,
have been able to mobilise even 0.5% of their gross state
the capital gains could also not be bought to charge. Therefore,
domestic product (gsdp) from this source. The maximum
an explanation was inserted by the Finance Act, 1989 to clarify
revenue mobilised is that by Assam at 0.3% of gsdp for only
that revenue derived from land shall not include any income
arising from the transfer of such land. This provision tooone of the five years covered in the table. In nominal terms, the
was
challenged but was upheld - the Madhya Pradesh High Court revenue collections of the states have varied between Rs 8 crore
for Karnataka and West Bengal and Rs 78 crore in the case of
held that under Article 366(1), the Constitution has adopted
Assam
the definition of "agricultural income" as has been defined in for the year 2009-10.
the Indian Income Tax Act. Therefore, the amendment which Table 4: Receipts from
from Agricultural
Agricultural Income
Income Tax
Tax as
as aa Percentage
Percentageof
ofGSDP
GSPP(in
(in%)
%)
was made by Parliament by inserting an explanation was
States 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
within the competence of Parliament.8 Assam 0.045 0.049 0.018 0.020 0.093 0.336
Karnataka 0.008 0.005 0.004 0.008 0.023 0.017
2000 Amendment: The definition of agricultural income,

Keralaas 0.029 0.032 0.046 0.099 0.049 0.105
0.015 0.007 0.007 0.005 0.000 0.000

we have seen, includes any income derived from any building
Tripura
0.004 0.003 0.002 -0.005 0.006 0.012
owned and occupied by the cultivator or receiver of rent,West
etc.Bengal
Maharashtra 0.000 0.000 0.000 0.000 0.000 0.000
As a measure of widening the tax base, the Finance Act intro
0.000 0.000 0.000 0.000 0.000 0.000
Rajasthan
duced an explanation in 2000 to clarify that any income from
Sikkim 0.000 0.000 0.000 0.000 0.000 0.000
such building or land arising from the use of the building or
Tamil Nadu 0.003 0.001 0.000 0.000 0.000 0.000
land for any purpose other than agriculture shall not be
Source: Computed from budgets of individual states.
included in the definition of agricultural income. For example,
if a person has income from using such building or land for While the revenue from agriculture can be substantial,
purposes such as letting out for residential purposes or for the is very little possibility of any individual state attempting
there
purpose of any business or profession, then, such income to explore this option and mobilising revenue there from.
shall
not be treated as agricultural income. Given the considerable strength of the agricultural lobby in all
A conspectus of the legislative amendments and the casemajor states, no state government can individually attempt to
laws emerging out of the challenge to such amendments introduce a comprehensive tax on agricultural income. The
only
indicate that the centre has the power to bring in changes in way such a reform can be implemented by the states is if
Table 3: Coverage and Rates of Tax

States Coverage Single or Multiple Rates? Exemption Threshold Categories of Taxpayers
Assam All agricultural income (revenue from tea) Multiple rates Rs 30,000 for individuals Individual, companies, firms
Karnataka Cardamom, coffee, linaloe, orange, pepper,

rubber and tea Multiple rates 30 to 50% Companies, firms
Kerala All agricultural income excluding crops like

paddy, tapioca, plantain, ginger, ragi, pulses,
sesame, sweet potato, tubers, sugar cane,
jackfruit, mango, pineapple, orchid or other
flowers, vanilla, turmeric and guava Multiple rates 20 to 60% Rs 40,000 for individuals Individual, companies, firms
Total agricultural income Multiple rates 20 to 60% Rs 1,500 Individual, companies, firms
Tripura
Tea Single 30% Individual, companies, firms
West Bengal
Maharashtra Abolished on 1 April 2004
Tamil Nadu Abolished on 1 April 2004
Rajasthan Inoperative
Source: Compiled from the notes submitted to the 13th Finance Commission.
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majority of the states agree to take on the reforms simultaneously.

may be noted here that for a number of nurseries, the primary
Coordination among the states, however, has not proved to be
activity is procurement and sale of plants and saplings rather
an easy process, as is demonstrated by the process of introduction
than the cultivation of saplings and plants per se.
Surprisingly, however, through the Finance Act, 2008, an
of state vat in place of existing sales taxes, and now in the context
of the introduction of the Goods and Services Tax. Another
explanation was added to the definition of agricultural income
alternative route that has often been recommended by various
to the effect that any income derived from saplings or seed
studies is for the states to adopt a tax rental agreement with
lings grown in a nursery shall be deemed to be agricultural
the union government, where the latter collects tax on income
income. Accordingly, irrespective of whether the basic opera
tions
from agriculture as well, with the receipts being passed on to have been carried out on land, such income will be
the respective states. While administratively this wouldtreated
be as agricultural income, thus qualifying for exemption
under Sub-section (1) of Section 10 of the Act.
easier than the states attempting to set up the entire regime
individually, it still requires the concurrence of majority of the
states to be implemented. 3.2 Tissue Culture
The taxpayer was in the business of growing and exporting of

3 Change in the Composition of Agriculture: ornamental plants and claimed entire income as exempt.10 The
Recent Controversies
ao, after visiting the premises came to the conclusion that the
Agriculture has undergone a massive change in India.taxpayer
There was carrying on tissue culture methodology and some
are many activities in this sector now which are either of
akin to activities were non-agricultural and accordingly, he
the
or allied to manufacturing activities. Considerable research
bifurcated the income. In appeal, the tribunal held that the plant
and development activities also are taking place. Naturally,
tissue culture is used to reproduce clones of a plant with the
such activities beyond the traditional farming methodssame
create
traits by placing various tissues of the mother plant in
tension with the tax department with the latter tryingcontainers
to deny and required medium which is definitely not land
the benefits of the exemption to income from such activities.
or soilIn and that when any operation is not carried out on land,
this connection, we examine some of the case laws relating
such to
an operation cannot be called as an agricultural operation.
such emerging activities.
3.3 Seed Companies
3.1 Nurseries and Pot Cultivation
In recent years, there have been quite a few tax cases, involv
One of the important issues of dispute relates to the treatment
ing seed companies which employ modern methods of genera
of nurseries and the related sale of saplings and plants.9 tion
In one
and propagation of seeds. While the Mumbai Tribunal in
of the notable cases, the assessing officer (ao) found thatthe the
case of Monsanto has held the income from sale of seeds
assessee was maintaining a nursery at his residence. The aoagricultural income, the Delhi Tribunal in the case of
to be
was of the view that the nursery was maintained and run as a Overseas and Proagro Seeds has held the same to be
Pioneer
business quite independently of agriculture and that even if
non-agricultural in nature.11
keeping of the nursery necessarily involves the use of some
In the case of Pioneer Overseas, the multinational used to
land and earth for the purposes of rearing plants, that make
wouldscientific studies of parent seeds and through hybridisa
not by itself amount to carrying on a primary agricultural
tion of different varieties of the parent seeds evolve the high
operation in the sense of cultivation of the soil. The aoyielding
noted variety of hybrid seeds, which were then sold to the
from the photographs produced before him that all thefarmers.
plants The sale proceeds were claimed to be exempt for
were grown in earthen pots and these pots were placed on agricultural
being a income in nature. It was found that the
concrete structure, which was either on the floor of thehybrid
house seeds are so engineered that when the crops from it are
or terrace. He also noted that most of the plants were placed inseeds, the yields are much less. The seeds are thus gen
used as
polythene bags and no use of land was evident fromerated
these by certain involved processes, which an ordinary
photographs. Hence, he was of the view that the activities
farmerof cannot do and he has to again revert back to the pro
the nursery were being carried out in earthen pots and noof the hybrid seeds for a subsequent crops if he wants
ducer
agricultural process was involved. In this case, the tribunal held results of high production in the subsequent crops. The
similar
that the ao should bring on record the nature of operations,
claim of exemption was thus denied.
viz, primary as well as secondary on the specific land area, and
thereafter, apply the law laid down in the decided cases 3.4 Contract Farming
to the
facts of the present case; he has to examine how the assessee
In the case of Namdhari seeds, the taxpayer declared income
can be said to be carrying on agriculture in the primarygenerated
sense, from the sale of hybrid seeds on land taken for
i e, tilling of the land, sowing of seeds and planting andcontract
doing farming as agricultural income.12 It was in the busi
other operations of the land. After examining this aspect, ness
he has
of cultivation, production and marketing of open-hybrid
seeds both for domestic and international markets and it
to examine the secondary operation carried out by the assessee.
Such direction issued by the tribunal was upheld by the high into an agreement with farmers for production of
entered
open-hybrid tomato seeds. The farmer owned the land and
court observing that mere performing of the secondary operation
will not make the assessee's activity an agricultural activity.
agreedItto cultivate the hybrid seeds specified by the assessee.
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agriculture. The current law also restricts the process that can
He also undertook to observe all the conditions regarding the
cultivation and other incidental matters; agreed to allow the
be applied to agricultural produce by stipulating that the proc
personnel of the company to operate on the land, machinery, ess should be such as ordinarily employed by a cultivator to
implements and accessories. He further undertook to hand render the produce fit to be taken to the market. It is also stipu
lated that the sale of the final produce should not be subject to
over all the hybrid seeds and not to sell or part with or retain
any process other than that necessary for rendering the pro
for himself any portion of the seeds. In exchange, the company
agreed to pay him compensation at the rate of Rs 3,200 per duce fit to be taken to the market. It is by reference to these re
quintal for hybrid tomato seeds. strictions that courts and tribunals have, in cases involving
On an analysis of the agreement and the terms, the Karnamodern-day agriculture, turned down the claim of exemption.
However, the language used by the dtc in this regard is "any
taka High Court held that the entire terms of agreement would
only indicate that the foundation seeds grown by the farmer profits and gains derived from cultivation of agricultural land".
would be purchased by the assessee at the end for a certainThe language is completely different and is capable of encom
price provided the seeds qualify the specifications as per thepassing within its fold all incomes which might be derived from
agreement. In the words of the high court: the cultivation of the land. The restriction that the process em
ployed must not be beyond what is employed by a cultivator to
It is nothing short of a fertile womb being offered by a surrogate mother
for the growth of child of someone else. The assessee supervises andrender the produce fit to be taken to the market, no longer finds
oversees the sowing, cultivation right from the process of sowing till the place. Accordingly, it can be concluded that the ambit of
the end in order to get the qualified foundation seeds as per the speci agricultural income has been significantly extended.
fications so as to carry on his trade in selling certified seeds. The main
Agricultural land has been defined in the dtc as land which
interest of the assessee is to see that good and healthy seeds are pro
is used for agricultural purposes and is assessed to land revenue
duced by the farmer meeting the requirement specified by it.
in India. The assessment to land revenue was a condition prior
The court held that such input or scientific method in givingto 1970. As we have seen above, the tla Act removed this con
dition, on the ground that there may be land itself not assessed
advice to the farmer cannot be termed as either basic agricultural
operation or subsequent operations ordinarily employed byto land revenue. Accordingly, it is possible to take a view that
the farmer or agriculturist. If the basic operations of agriculturein respect of those states where no land revenue is charged,
the income from agricultural land will no longer be considered
are not carried on by the assessee-company, then the harvested
as agricultural!
foundation seeds purchased by him and converting them to
Insofar as the farmhouses are concerned, the existing condi
certification seeds cannot be termed as integrated part of the
foundation activity of agriculture. tion for treating income therefrom as agricultural in nature is
that the building must be in the immediate vicinity of the land
3.5 Changes Proposed by the DTC and that the same must be required by the cultivator as a
Having seen the development of the law and having observed dwelling house, store house or outhouse and the land must be
the judicial analysis, the following features can be noted. The assessed to land revenue. Where it is not so assessed, the farm
legislature in the past has restricted the meaning of agricultural houses must not be situated in any urban area. In the dtc,
income and such measures have passed muster. Courts have"farmhouse" has been separately defined and incorporates the
condition of being in the vicinity of the agricultural land and
also not given a very wide meaning to the term "agricultural
income" and have in many cases adopted a restrictive meanexclusively for dwelling house, store house or outhouse or for
ing. Thus, when a new beginning was being made in the dtc,carrying out any process for taking the agricultural produce to
it was possible to make intelligent use of the leeway given bythe market. However, the condition of being subject to land
the judiciary and bring in provisions which would restrict therevenue is absent as also the stipulation that where the land is
scope of agricultural income particularly in areas like hybridnot subject to land revenue it should be outside the urban areas.
seeds, where the market is immense and scope of profits large.As we have seen, an explanation was inserted in the Finance
It is against this backdrop that we can now examine the Act, 2000, whereby the income from house of farmhouse for
changes proposed by the dtc in this regard. any purpose other than agriculture was not considered as
agricultural income. This explanation or components thereof
4 Implications of DTC Provisions do not find a place in the dtc. Accordingly, it is possible to argue
that any income from any farmhouse whether rural or urban,
The current definition of agricultural income has three com
ponents: (1) the rent from the agricultural land; (2) the incomewhether used for the purpose of renting out for marriage party
derived from such land by agriculture; and (3) income fromor not, will now be considered as agricultural income.
farmhouses (Table 5, p 58). The dtc also specifically gives exemption from the income
Insofar as the first element is concerned, there is no differencederived from saplings or seedlings grown in a nursery. This
was an explanation introduced in 2008 and has been carried
between the current definition and the definition that has been
proposed in the dtc except for the fact that the reference to over in the dtc.
"revenue" from the agricultural land does not find place in To sum up, it is not clear whether the stipulation of the
the new definition. The main component of the definition of agricultural land being subject to land revenue is a deliberate
agricultural income is the income derived from the land by attempt to change the coverage of agricultural income. There
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Table
Table 5: A5:Comparison
A Comparison
of the Provisions
of the Pertaining
Provisions
to Agricultural
Pertaining
Income to Agricultural Income
Present Provisions Provisions as per PTC
(1 A) "agricultural income" means (11) "agricultural income" means

la] any rent or revenue derived from land which is situated in India and is (a) any profits and gains derived
used for agricultural purposes; (b) any rent derived from any
[b] any income derived from such land by (c) any rent derived from any f
(i) agriculture-, or (d) any income derived from sa
(12)
(ii) the performance by a cultivator receiver of rent in kind of any process "agricultural land" means any
ordinarily employed by a cultivator or receiver of rent in kind to render, agricultural purposes" and: -
the produce raised or received by him fit to be taken to market; or (a) is assessed to land revenue
(iii) the sale by a cultivator or receiver of rent in kind of the produce raised (b) is subject to a local rate asse
or received by him, in respect of which no process has been performed the government as such;
other than a process of the nature described in paragraph (ii)
of this sub-clause;
314(96)
[c] any income derived from any building owned and occupied by the receiver "farmhouse" means any bu
conditions,
of the rent or revenue of any such land, or occupied by the cultivator or the namely:
(a)
receiver of rent-in-kind, of any land with respect to which, or the produce it is situated on, or in the imm
of which, any process mentioned in paragraphs and (ii) of sub-clause (b)(b) the building is used exclusive
is carried on: (i) as a dwelling house, store-house, o
[Provided that — purpose; or
(i) the building is on or in the immediate vicinity of the land, and is a(ID to carry out any process to render the produce raised or received by the
building which the receiver of the rent or revenue or the cultivator, owner fit to be taken to the market; and
the(c)building is
or the receiver of rent-in-kind, by reason of his connection with the
land, requires as a dwelling house, or as a store-house, or other (i)
occupied by the cultivator or the receiver of rent-in-kind; or
out-building, and (ii) owned and occupied by the receiver of rent.
(ii) the land is either assessed to land revenue in India or is s
local rate assessed and collected by officers of the governm
or where the land is not so assessed to land revenue or sub
local rate, it is not situated—
(A) in any area which is comprised within the jurisdiction of
(whether known as a municipality, municipal corporation,
committee, town area committee, town committee or by any
or a cantonment board and which has a population of not l
10,000 according to the last preceding census of which the
figures have been published before the first day of the previ
(B) in any area within such distance, not being more than ei
from the local limits of any municipality or cantonment boar
to in item (A) as the central government may, having regard
extent of, and scope for, urbanisation of that area and other
considerations, specify in this behalf by notification in the O
Explanation 1 - For the removal of doubts, it is hereby declared that revenue derived
from land shall not include and shall be deemed never to have included any income
arising from the transfer of any land referred to in item (a) or item (b) of sub-clause
(iii) of clause (14) of this section.
Explanation 2 - For the removal of doubts, it is hereby declared that income
derived from any building or land referred to in sub-clause (c) arising from the use
of such building or land for any purpose (including letting for residential purpose
or for the purpose of any business or profession) other than agriculture falling
under sub-clause (a) or sub-clause (b) shall not be agricultural income.
Explanation 3 - For the purposes of this clause, any income derived from saplings
or seedlings grown in a nursery shall be deemed to be agricultural income.
The portions in italics refer to content that has undergone change.
is no discussion in the discussion draft or the revised discus had never filed any return of income.13 Most probably, all
sion draft released at the time of introduction of dtc, as also these persons would have shown income from agriculture.
no discussion in the press in this regard. It is possible that this There is absolutely no justification for such a state of affairs
could be a mistake. However, apart from the above, the other to continue. Considering the division of legislative power
changes discussed above increase the scope of agricultural between the centre and the states, the following are the alter
income rather than restricting the same. natives available:
(1) Within the present dispensation of tax powers, the right to

5 The Way Forward tax agricultural income lies with the state governments. How
A recent report at the time of the Punjab elections indicated ever, it is well recognised that while most of the state govern
that there are candidates from political parties across the ments can benefit from the additional revenue this could pro
spectrum who had income of more than Rs 100 crore, but vide, it may be politically unacceptable for any political party
58 april 14, 2012 vol xlvii no 15 (3259 Economic & Political weekly

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SPECIAL ARTICLE
dtc provided an ideal opportunity to attempt an exercise in

to attempt such a measure unilaterally. State-level reforms
that direction. Unfortunately, no attempt has been made. The
would, therefore, need either a consensus to jointly implement
the tax on some common agreed norms, or even to enter intodiscussion
a paper released at the time of the introduction of
tax rental arrangement with the union government. If this theisdtc is completely silent in regard to this vital aspect of
taxation. Obviously, no suggestions have also been received
considered a significant enough source of revenue, it might
even be worthwhile for the finance commission to assess the
in this regard. To begin with, income from cash crops and
similar produces can be taken out of agricultural income by
potential and find some means of incentivising the introduc
tion of such a tax. This route clearly worked for the adoption ofstipulating that the processes involved therein would not con
Fiscal Responsibility Acts by the state governments. stitute agricultural income. Of course, for this purpose, a
thorough study has to be made to properly identify the proc
Here it may be mentioned that while the state governments do
esses and describe the same. The income of multinationals
seek to safeguard their autonomy, the right to choose not to
from growing and selling hybrid seeds has been held to be
levy a tax should be accompanied by the responsibility to bear
the cost of the resultant short fall in revenue as well! non-agricultural by some courts. It is necessary to actually
(2) In the absence of the above, it may be a difficult proposi
spell this out in the form of an explanation rather than leave
tion for the centre to bring all such people under the tax net.
the litigation to fester. The dtc, by using a different language,
To tax such income, therefore, one has to explore the possi seems to bring such income also under "agricultural income".
bilities of taxing at least a part of agricultural income withinWherever there is a significant value addition after the
the present parameters. It is in this context that the definition
produce is brought out from the soil, it can be kept out. On the
of "agricultural income" under the Income Tax Act can be
contrary, the dtc seems to omit any reference to the "process"
itself.14 Similarly, there is absolutely no reason why income
used to at least bring a part of the income from agriculture to
tax by restricting the ambit of agricultural income to only
from farmhouses, particularly those in the vicinity of urban
some crops or processes. In the past, attempts have been areas should not be taxed. The dtc, in fact, is quite regressive
made to restrict the income from farmhouses. Such legislain this regard in that instead of restricting the scope, it seems
to have enhanced the same.
tions have also withstood judicial scrutiny. Therefore, the
NOTES
of eight kms from such limits as notified by the reason of his larger income and to make his tax
central
1 Sushil Kumar et al (2001), "Higher Yields andgovernment. liability heavier is not arbitrary, but is only an
7 In if J Joseph vslTO, mITR 178, the Kerala High
Profits from New Crop Rotations Permitting attempt to proportion the payment to capacity
Court in
Integration of Mediculture with Agriculture held that the charge of tax is still on non to pay and then arrive, in the end, at a more
agricultural income. No part of the agricultural
the Indo-Gangetic Plains", Current Science, genuine quality.
"Canis subjected to tax. For the purposes of 8 Singhai Rakesh Kumar vs Union of India [227
income
80 (4), pp 563-66. Surabhi Mittal (2007),
determining rate at which non-agricultural in
Horticulture Be a Success Story for India?", ITR81].
ICRIER Working Paper No 197. come is to be taxed, the agricultural income is 9 Jugal Kishore Arora vs Deputy Commissioner of
taken into account. This and the differential
2 See http://www.livemint.c0m/2010/03/25213353 Income-Tax [269ITR133].
/Problems-of-plenty-for-West-Be.html. rates are based on the different sources of in 10 Invitro International vs Deputy Commissioner of
3 32 ITR466(SC). come available to the persons concerned. It is Income Tax [2ou-TI0L-445-ITAT-Bang],
4 Smt Anand Bala Bhushan vs CIT [217ITR 144 only in respect of persons who have agricultural
11 Monsanto India vs Addl Commissioner of Income
(Allahabad)]. income, in addition to non-agricultural income Tax [2on-TIOL-i6g-ITAT-Mum], Proagro Seeds
5 Any area which is outside the jurisdiction of any that the mode of computation of the rate of tax Company Limited vs Joint Commissioner of
municipality or cantonment board having a as provided by the impugned provisions is Income Tax [2003-TIOL-50-ITAT-Del], Pioneer
population of not less than 10,000 persons and adopted. This classification is reasonable and Overseas Corporation vs Dy Director of Income
also beyond the notified distance outside the limits based on the intelligible differentia. Tax [20i0-TI0L-54-ITAT-Del].
of any such municipality or cantonment board. In KV Abdulla vs Income-Tax Officer and Another12 The Commissioner of Income Tax vs M/s Namd
6 Area comprised within the jurisdiction of a 161ITR 589, the Karnataka High Court held that hari Seeds Pvt Ltd[ Manu/KA/1614/2011].
municipality or a cantonment board (having a making the burden of tax on the net income 13 "Punjab Crorepati Politicians Don't Fill IT Returns"
population of not less than 10,000) or in any heavier in proportion to the increase in the ag =Timeshttp://timesofindia.indiatimes.com/
area outside the limits of any municipality or ricultural income cannot be said to be unrea india/Punjab-croreppati-politicians-dont-fill
any cantonment board (having a population of sonable. An assessee with agricultural income it-returns/articleshow/ii630574.cms
not less than 10,000) up to a maximum distance occupies a position of economic superiority by14 Except in the case of farmhouses.
Appendix crop-specific agricultural income (per unit of

Total Potential Agricultural Income Tax Revenue in India: An Estimate area) is calculated by adjusting revenue for
these costs.3 Area at which the activity breaks
This exercise is an attempt to estimate the total for double cropping (assuming there are no even for tax purposes is calculated for every
potential income tax revenue from agriculture multi cropping). This is done by obtaining the crop, based on the following formula:
in India. The estimation is done through a land "span" for each crop, i e, the time required for a (Rs i,5o,ooo/Income per unit of area).
based, crop-specific, agricultural income calcu crop to mature from seed to crop. Then, for The assumption applied on the above calculation
lation for all major crops: foodgrains, pulses, crops with span less than six months, we double is that the threshold at which income becomes
cereals, oilseeds, fibre crops, horticulture and the yield. For annual crops, the yields are kept taxable is Rs 1,50,000.
floriculture. The estimate is for all India and is unchanged. We call this new set of yields "ad The analysis, hereinafter, is divided into two
for the year 2007-08. justed yield". The adjusted yield for every crop parts. Crops are divided into two categories:
First the area, production and yield1 figures is then multiplied with the annual average of Crop Group I: (Foodgrains, Pulses, Cereals,
are obtained for each crop. Since cropping their respective mandi (market) prices.2 This Oilseeds)
intensity affects the yield, yield of crops, that gives us crop-specific revenue (per unit of area). Crops in these group yield moderate income
are sown more than once a year, are adjusted Assuming costs are 15% of the total revenue, (- Rs 25,800 per hectare on an average), and
Economic & Political weekly BB3 April 14, 2012 vol xlvii no 15 59

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SPECIAL ARTICLE
breakeven (lower limit of tax bracket) at For

an Crop Group n, the area at which theoverall average tax rate works out to 1
area ~ 6 hectares on an average. total income.
cultivators of these crops cross the exemption
threshold is small. The total income from
Crop Group II: (Horticulture and Floriculture)
these crops is derived by multiplying the area
Limitations
These crops yield very high income (— Rs 2,68,840
under cultivation by the income per hectare.
These estimates need to be read with some cau
per hectare on an average), and breakeven
Further, it is assumed that all these households
tion, for the following reasons: (1) The analysis
(lower limit of tax bracket) at two hectares on
pay tax at 10% rate. This provides the is
first
based on household income, while the tax
an average.
approximation of the tax that can potentially
brackets are based on individual income, (2) the
It may be mentioned that tea and coffee and
be collected. However, it is not possible to of data relating to span of some crops
reporting
rubber have been kept out of this exercise,
get information on the size classification of
are informal, and (3) agricultural cost is as
since they face some form of taxation even
households cultivating these crops. Therefore,
sumed to be 15% of total revenue (yield X
within the present regime.
it has been assumed that the distribution of
For Crop Group I, we then look into the price). Agricultural costs in reality may vary
households by size class in these cropsacross
is crops and regions.
estimated number of household with opera
the same as that for cereals and pulses. So as
tional landholdings greater than 7.5 hectares in
to exclude the small taxpayers even in this
rural India from the National Sample Survey NOTES TO APPENDIX
category of crops, the share of land cultivated
report (2002-03) on operational landholding.4 1 Area, Production and Yield Source: Agricultu
by households cultivating over two hectares
It also provides us with average operational
in the total land cultivated is used to derive Statistics at a Glance 2010, Department of Ag
landholding for every landholding class. culture and Cooperation, Ministry of Agric
the income tax that can justifiably be anticiture; CMIE Agriculture, 2010, FAO Statisti
Assuming income per hectare = Rs 20,000
pated. Given that the average tax rate is asfor India 2007.
(Rs 1,50,000/6) and given, the average opera
sumed to be 10%, which is the lowest statu
2 Average mandi prices for 2007 are calculated f
tional area, we calculate total income of house
tory rate, this may be considered a fair estievery crop, using the commodity wise daily pric
hold, for each operational landholding class, data available in Agricultural Marketing Inf
mate, since it does not attribute higher revenue
which is greater than six hectares. Appropriate
from higher rates of tax as well. For the tax mation Network, Directorate of Marketing an
rates of taxation are applied to the taxable income Inspection (DMI), and Ministry of Agriculture
able households in the case of cereals, the
(where income is greater than Rs 1,50,000) to 3 The computation of domestic product fr
obtain average tax revenue for each operational agriculture in the national accounts statisti
1 Total potential agricultural income
gives an overall number of 29% for agricultu
landholding class. These average tax revenuestax revenue (in Rscrore) (2+3) 50,395 and livestock put together. After segregatin
for each operational landholding class are then
2 Total potential agricultural income the inputs for these two sub-sectors of activit
multiplied to the respective estimated number and proportionately allocating any commo
tax revenue from majorfoodgrains,
of households in that class to obtain total tax inputs like electricity, the ratio of inputs to val
cereals, pulses and oilseeds 12,701
revenue for every operational landholding class. of output for agriculture works out to 17.56%
3 Total potential agricultural income These inputs however include seed. Since see
This is done separately for both kharif and rabi
tax revenue from vegetables, fruits, are also a part of the agricultural sector,
crops. The sum of the total income from rabi spices and flowers 37,694
inputs are corrected for this overstatement, t
and kharif crops give us the total potential agri costs reduce
4 Percentage oftotal direct tax revenue 2007to 15% of total output.
15.8
cultural income tax revenue from Crop Group 1: 4 NSS Report No 492: "Some Aspects of Op
major foodgrains, pulses and oilseeds. 5 Percentage of GDPmp (at constant price) 2007 1
tional Landholdings in India, 2002-03".
Economic Reforms and Growth in India

Essays from the Economic and Political Weekly
Edited by PuLAPRE BALAKRISHNAN
This volume investigates the nature of economic growth in India, its pace over time, its relationship to c
the role of the external sector, and uses data to evaluate the policies that have implicitly underpinned
Presenting a range of approaches, views and conclusions, this collection comprises papers published in th
between the late 1990s and 2008 that are marked by an empirical awareness necessary for an understan
articles reflect a certain groundedness in their approach in that they privilege content/context over m
This volume is an important addition to the literature on post-liberalisation economic growth in India. It
scholars of economics and management.
Authors include Deepak Nayyar • Rakesh Mohan • Atul Kohli • Arvind Panagariya • Kunal Sen • Neeraj Hatekar • Jessica
• Ravindra Dholakia • Ramesh Chand • R Nagaraj • Montek Ahluwalia • Shashank Bhide • Amit Bhaduri • Pranab Bard
Readings on the Economy, Polity and Society

This series is being published as part of a University Grants Commission project to promote teaching and resea
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Adivasis and Rights to Forests, ed. Indra Munshi • Gender and Employment, ed. Padmini Swaminath
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European Centre for International Political Economy
Unintended and Undesired Consequences: The Impact of OECD Pillar I and II Proposals on
Small Open Economies
Author(s): Matthias Bauer
European Centre for International Political Economy (2020)
Stable URL: https://www.jstor.org/stable/resrep26313
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ECIPE OCCASIONAL PAPER • 04/2020
Unintended and Undesired

Consequences:
The Impact of OECD Pillar I and II Proposals
on Small Open Economies
By Matthias Bauer, Senior Economist at ECIPE
ecipe occasional paper — no. 04/2020
EXECUTIVE SUMMARY
Corporate tax laws vary significantly between different jurisdictions. Over the past four dec-
ades, governments globally competed for business activity by lowering statutory and effective
corporate tax rates. Many governments provide special tax incentives for businesses to invest
and expand employment. Special economic zones often grant full corporate tax exemptions to
stimulate commercial development. Corporate income tax incentives for research and develop-
ment activities are common across countries’ corporate tax codes reflecting governments’ desire
to stimulate innovation and business development.
While corporate tax competition is common government practice in the world economy, the
OECD currently aims to curb international corporate tax competition. The OECD’s corporate
tax reform proposals officially aim to address “corporate tax avoidance” and “unfairness in tax-
ation”. The policy debate is driven by some governments’ motivation to increase revenues from
taxes on corporate income. Economic impact assessments of the OECD’s current Pillar I and
II proposals are still scarce. Individual governments have so far failed to conduct impact assess-
ments or are hesitant to make their assessments available to the general public. The OECD’s
secretariat expects additional tax revenues of 100bn USD annually, which are said to be evenly
distributed among the 137 countries comprising the Inclusive Framework. The narrow focus
on changes in governments’ revenues and the static nature of the OECD’s analysis is in various
respects misleading.
This paper highlights that the proposed reforms would shift taxing powers (tax sovereignty) and
economic activity away from small open economies to the world’s largest countries, of which
most (currently) apply very high statutory corporate tax rates. The implementation of Pillar I and
II proposals would pave the way for a global tax redistribution framework transferring financial
funds away from governments that embrace free international trade and investment to the many
of the world’s worst-performing governments with respect to economic openness, acceptance of
the rule of law, corruption, state interventionism, and the recognition of basic human rights (e.g.
Argentina, Brazil, China, India, Indonesia and Russia). Conversely, the OECD’s proposed cor-
porate tax reforms would punish the world’s best performing economies with regard to economic
freedoms, trade and investment openness and the rule of law (e.g. Estonia, the Czech Republic,
Ireland, the Netherlands, Slovakia, Slovenia, Switzerland, including small city and island states,
such as Hong Kong, Luxembourg and Singapore).
The reforms proposed by the OECD would have a significant impact on how much and where
multinational enterprises would have to pay corporate income tax in the future. The proposed
measures would therefore impact where large companies produce and invest in the future. Con-
tinued tax competition would contribute to a narrowing of international corporate tax rate dif-
ferentials up to the 12.5% minimum tax threshold level proposed by the OCED. The narrowing
of tax rate differentials between today’s high-tax jurisdictions, of which most are very large coun-
tries, and today’s low-tax jurisdictions would direct international and domestic investments and
investment-induced tax revenues away from small countries. Estimates show that inward FDI
in today’s high-tax countries would increase and outward FDI would decrease. In a symmetrical
way, inward FDI in today’s low-tax countries would decrease and outward FDI would increase.
Overall, the shift in effective taxing powers would undermine small countries’ relative attractive-
ness to international businesses and, on top of that, would induce domestic businesses to relocate
to larger countries with the gravity of larger markets.
Contrary to claims made by the OECD, the implementation of Pillar I and II proposals would
not improve the global allocation of capital. Global trade and investment flows would still be
subject to tax competition and prevalent trade and investment barriers. The OECD’s current
proposals would likely incentivise the governments of large countries to maintain long-standing
barriers to trade and investment. The economic gravity of large countries may even incentivise
large country governments to erect additional barriers that would restrict market access for com-
panies from small open economies. For small open economies that are home to research- and
knowledge-intensive multinational companies, the OECD’s proposed tax reforms would under-
mine future investments in R&D, innovation and business model development, with adverse
implications for existing research clusters, education systems and high value-added jobs.
Policymakers should reconsider whether taxes on corporate income actually contribute to gov-
ernments’ overall social and economic policy objectives, such as economic development, redis-
tribution and fairness in taxation. Replacing tax systems that include taxes on corporate income
by systems that rely more or exclusively on direct taxes on labour income, capital income and
consumption (VAT/sales taxes) would increase transparency about the distributional effects of
taxation and significantly improve governments’ tax manoeuvrability in response to citizens’
preferences for fairer taxation. A regime change towards greater use of VAT/sales taxes would
also have a positive impact on global capital allocation. Companies would no longer have to pay
attention to corporate tax rate differentials, while governments would have additional incentives
to embrace foreign trade and investment, materialising in lower barriers to trade and investment
and a more efficient allocation of global capital respectively.
1. INTRODUCTION
The OECD’s Inclusive Framework (IA), which comprises the governments of 137 highly diverse
countries, discusses new international rules for the taxation of multinational enterprises. In May
2019, the Framework agreed a program of work for addressing the “Tax Challenges of the Dig-
italization of the Economy.” The program sets out two pillars of work:
• Pillar I aims to design new rules for the (re)allocation of taxing rights between
jurisdictions. It considers several new mechanisms for profit allocation and new
nexus rules. Pillar I proposals are framed as a policy remedy to corporate income
that is currently not taxed in the countries where it is generated. Recent proposals
indicate that the new rules under Pillar I go beyond digital companies, i.e. they
will affect more companies in more industries.
• Pillar II (also referred to as the “Global Anti-Base Erosion” or “GloBE” or “Min-

imum Tax” proposal) aims to design a new set of rules for a minimum taxation
of corporate income. It is framed as an attempt to address “ongoing risks” from
corporate structures that allow multinational enterprises to shift profits to juris-
dictions where they are subject to no or low taxation. Rules resulting from Pillar II
would provide (high-tax) jurisdictions with a right to “tax back” where (low-tax)
jurisdictions have not exercised their primary taxing rights or the payment is oth-
erwise subject to low levels of effective taxation.
The reforms proposed by the OECD would have a significant impact on how much and where
multinational enterprises would have to pay corporate income tax in the future. The proposed
measures would impact where companies invest and locate in the future, impacting the revenues
collected from sales taxes, labour-income taxes and taxes on corporate income. From a geopolit-
ical perspective, the reforms proposed by the OECD would shift taxing powers and economic
activity away from small countries to large, populous countries. This shift in the balance of
power would impact how governments formulate domestic economic policies as well as trade
and investment policymaking.
The aim of this study is to discuss major economic implications of the OECD’s Pillar I and II
proposals on small open economies. The analysis will go beyond the few existing impact assess-
ments, which almost exclusively focus on potential changes in governments’ revenues from taxes
on corporate income. While the focus of this analysis will be on small open economies, the
analysis and its conclusions are particularly relevant for governments that generally support good
governmental institutions, the rule of law and open markets for trade and investment.
Section 2 will begin with an overview of potential economic impacts outlined by existing impact
assessments. Section 3 provides an overview of key economic and institutional features of large
countries and small open economies. The analytical focus will be on the Inclusive Framework’s
top 30 most and top 30 least export-intensive (or, generally, trade-intensive) economies and
how they perform with regard to corporate tax rates, the legal manifestation of economic free-
doms, the level of existing trade and investment barriers, and the domestic state of the rule of
law. Accounting for the tax sensitivity of international investment and governments’ continuing
incentives for tax competition to maintain foreign investment and/or prevent divestment, Sec-
tion 4 analyses the impact of a narrowing or international corporate tax rate differentials on the
reallocation of FDI and FDI-induced tax revenues changes. Section 5 concludes that Pillar I and
II are much more impactful than presented by the OECD and national governments.
2. POTENTIAL IMPACTS OF THE OECD’S REFORM PROPOSALS
Both the OECD’s Pillar I and Pillar II proposals have been described in rather broad terms. The
impacts of Pillar I critically depend on the final design of the reallocation rules and the future
definition of residual profits. For Pillar I, the OECD’s own (rudimentary) impact assessment
estimates that a) effective average corporate tax rates (EATRs) are going to rise between 0.6%
and 1.9%, and b) that governments of low-income (developing) countries would be the main
beneficiaries of the reform proposals. The estimated effects from Pillar II are particularly sensitive
to the minimum effective corporate tax threshold, which was set at 12.5%. Referring to its pre-
liminary impact assessment from February 2020, the OECD claims that the combined effects
from Pillar I and II would result in revenue gains that would be “broadly similar” across high,
middle and low-income economies, amounting to some 4% of current corporate tax revenues
(OECD 2020b).
Public statements and official publications demonstrate that the policy debate about OECD’s
reform proposals is centred around the overarching objective to combat “corporate tax avoid-
ance”. The narrow focus on avoidance and governments’ future revenues is reflected by recent
impact assessments. Comprehensive economic impact assessments of the OECD’s reform pro-
posals are still scarce. Those that are available merely focus on the changes in corporate tax reve-
nues and aggregate corporate tax bills. Due to the vagueness of the latest proposals, all obtainable
assessments are based on a number of assumptions, and they generally suffer from a lack of
available data. Individual governments have so far failed to conduct impact assessments or are
hesitant to make their assessments available to the general public. So far, the debate has paid little
attention on the proposals’ effects on countries’ economic activity, investment (incl. R&D) and
innovative capacities, including effects on small and open economies. Virtually no attention has
been paid to the impact on the future development of the quality of governmental institutions,
governments’ future incentives to increase their countries’ attractiveness for entrepreneurs and
investors, and governments’ own capacities to improve the quality of infrastructure, education,
professional qualifications and basic research in their countries.
An IMF Working Paper from 2019 (No. 19/287) investigates the impact of internationally
operating companies’ profit shifting behaviour on investment activities and the implications of
restraints on profit shifting on future tax competition (Klemm and Liu 2019). Following the
empirics as well as their own analysis, they conclude that “profit shifting opportunities unam-
biguously reduce the cost of capital in all countries [analysed].” It is stressed that profit shifting
opportunities raise the global stocks of capital. It is concluded that “[g]iven the ambiguity of
many of the findings, the recent strength of international [OECD BEPS] efforts at curbing
profit shifting may appear surprising.” They also argue that a “permissible attitude” towards
profit shifting is a component of tax competition and that governments are unlikely to give up
on tax competition in the future.
A study published by the Oxford University Centre for Business Taxation analyses the impacts of
Pillar II (Devereux et al. 2020). It is emphasised that the proposals suffer from a “lack of obvious
principles”. It is also argued that the proposals are inconsistent with the objective to tax corporate
income where value is created. The authors point to flaws in the notion of “taxation according
to the place of value creation”. It is outlined that the global decline in statutory corporate tax
rates is the result of tax competition and governments’ interest to attract real economic activity
and “mobile profit”. It is cautioned that tax competition will continue irrespective of an OECD
agreement: “many countries […] implemented many forms of anti-avoidance rules at the same
time as competing on other aspects of their tax systems,” while corporate tax revenues have not
fallen considerably. The authors demonstrate that “[t]here is a clear trade-off between the aims
of reducing profit shifting and supporting investment.” It is argued that Pillar II policies would
increase the cost of capital, with adverse implications on overall investment activity.
A study conducted by tax practitioners looks into the likely impacts of Pillar I, i.e. changes
in nexus and income allocation rules for internationally operating companies’ taxable income
(Singh et al. 2020). The authors estimate the extent of change the OECD’s unified approach will
bring about. The numbers estimated indicate that the new formulaic elements of the OECD’s
unified approach may directly govern the allocation of a large portion of an MNE’s pre-tax
income. However, the impact on changes in the allocation of pre-tax profits and tax revenues is
modest compared to the status quo. The authors highlight that existing nexus and income alloca-
tion rules grounded in the permanent establishment concept and the arm’s-length principle will
continue to be relevant in the future. It is stated that “[r]umors of the arm’s- length principle’s
demise may have been somewhat exaggerated”.
In a recent opinion note released by ZEW (2020), it is argued that the OECD’s latest propos-
als stand in opposition to the OECD’s stated policy objectives. The authors highlight that the
OECD is currently pursuing a “fundamental and potentially overshooting corporate tax reform”.
For Pillar I, the authors argue that the proposals would increase arbitrariness in determining the
amount of profit subject to taxation and increase the risk of double taxation. For Pillar II, the
authors highlight that the “proposed coexistence and reinforcement of the residence and source
based taxation principle […] could also increase tax competition between OECD member states
with the coordinated minimum tax level being the lower bound.” It is also highlighted that “the
risk of double taxation increases if all jurisdictions try to expand their access to the tax base of
multinational enterprises.” It is concluded that the OECD should focus on “indirect taxes to
generate tax revenues at the location of user participation. The value added tax (VAT) is an
already existing suitable tool to tax consumption in market countries.”
3. IMPACTS ON SMALL OPEN ECONOMIES
This Section will discuss the potential impacts of the OECD’s reform proposals on small open
economies. Various stakeholders report that the Inclusive Framework is not as inclusive as its
name suggests. Expert opinion as well as media coverage suggest that the policy reform debate is
to a large extent shaped by the governments of large countries, such as the US, China and India.
The Covid-19 situation has put small country governments even more on the side-lines as it
became more difficult for their representatives to participate in ongoing discussions.

The economic interests of smaller countries are at risk of being swept under the rug by a political
consensus crafted by the governments of the world’s largest economies. The negative implica-
tions from the OECD’s reform initiative are likely to be strongest for small open economies,
including (but not exclusively) countries that are home to innovative and internationally com-
petitive businesses. The negative implications go beyond direct impacts on the tax burden of
multinational companies and governments’ corporate tax revenues. They are also about future
incentives for governments to strive for good governmental and legal institutions and a political
culture that embraces commerce, entrepreneurship, and open markets in support of economic
development and high standards of living. This section continues with a discussion of character-
istics of small open economies, followed by an outline of major institutional characteristics of
countries comprising the OECD’s Inclusive Framework.
3.1. Characteristics of “Small Open Economies”
The term “small open economy” is frequently used in the economic literature. The expression is
referred to characterise a set of countries that are, on aggregate and compared to other countries,
“too small” to affect world interest rates, world prices or labour incomes.1 Similar considerations
apply for international political relations. In international economic diplomacy, the political
influence of a government is generally based on the economic clout of the country this govern-
ment represents. Political influence is positively correlated to a country’s aggregate purchasing
power, its overall production capacity and the amount of capital available for investment.
More generally, a country can be considered an “open economy” if its government allows its cit-
izens to engage in international exchange, i.e. trade across national borders. Exchange is largely
about trading goods and services, but can be more intangible, e.g. exchanges in procedural
know-how, managerial practices and technological knowledge. Another important feature of an
open economy is that its government allows citizens to invest their savings abroad and foreigners
to invest in the domestic economy, which in economics lingo is described as free flow of capital.2
Economic history demonstrates that countries whose governments embrace international trade
and investment also benefit from knowledge spillovers, which positively impact on the quality of
governmental institutions and the rule of law. In addition, exposure to international trade and
investment improves, over time, the effectiveness and efficiency of domestic market regulations,
the ease of doing business and, as a result, economic development, structural economic change
and standards of living.
For the purpose of this paper, it is useful to distinguish economies on the basis of their involve-
ment in the international economy. A traditional measure of “trade openness” is the ratio of
trade to GDP (overall economic activity in a given year). A relatively high trade-to-GDP ratio
1
For example, consider the case of the USA and Canada. Although Canada is larger in geographical terms, it is much smaller
in economic terms. In fact, Canada is so small that, compared to the rest of the world, the interest the Canadian government
and Canadian citizens pays on its debts cannot be influenced by Canadian market participants themselves. By contrast, the
market of the USA is large enough, compared to the rest of the world, that the decisions inside the USA actually do affect
the interest rate at which the USA is able to borrow. Similarly, a huge surge in demand in the US for an internationally traded
commodity might well increase world prices and incomes in the commodity-producing sector, while a surge in demand in
Canada would leave world prices and incomes rather unchanged. Similar considerations apply for the supply side, i.e. the
provision of capital that is made available for foreign borrowers or domestic production that is made available for foreign
buyers.
2
By contrast, the main characteristic of a “closed economy” is self-sufficiency. Individuals and companies in a closed economy
are not willing or not allowed to take part in any exchange with actors from other countries. An economy that is to a large
extent closed to foreign exchange and investment relies solely on domestic activities without exposure to foreign products,
services, technology and knowledge. The world of 2020 does not know fully closed economies. Although North Korea could
be thought of as an example for a closed economy, North Koreans’ are also trading with partners from other countries,
namely with companies and individuals from China.
is a sign of a more open country. The trade-to-GDP ratio also functions as a rough indicator of
how much a country’s citizens and companies engage in international trade and to what extend
they are participating in the international division of labour. Economic evidence demonstrates
that as individuals and companies engage more in foreign trade (exporting, importing, invest-
ing), the more they and their counterparts benefit in terms of productivity growth and income
generation.
The world’s most open economies in terms of trade/GDP, imports/GDP and exports/GDP are
small – often very small – economies. The OECD’s Inclusive Framework is generally comprised
of countries, which show a high variation in terms of the state of economic development, open-
ness to foreign trade and investment, the state of the rule of law and the quality governmental
institutions. As concerns trade openness, Inclusive Framework countries are characterised by a
high degree of heterogeneity with regard to their participation in international trade, both in
exports and imports.
Figure 1 shows the Inclusive Framework’s top-30 most export-intensive and the top-30 least
export-intensive economies for the past 5 years. The numbers show that the Inclusive Frame-
work’s 30 most export-intensive economies are generally relatively small countries, e.g. Esto-
nia, the Czech Republic, Hungary, Ireland, the Netherlands, Slovakia, Slovenia, Switzerland,
Thailand and Vietnam, and very small city and island states, e.g. Hong Kong, Luxembourg
and Singapore. By contrast, the Inclusive Framework’s 30 least export-intensive countries com-
prise many of the world’s largest countries, including Argentina, Brazil, China, India, Indonesia,
Japan, Russia, and the US.3 Many more Inclusive Framework countries, of which most are also
relatively small in terms of population and overall economic output, are somewhere in the mid-
dle range of trade, export and import intensities.
It should be noted that the export-intensities depicted in Figure 1 generally reflect countries’
dependency on international trade. Due to their sheer size, large countries are generally more
self-sufficient with regard to natural resources and the products and services that are or could
be produced in these countries. In addition, due to market size effects, large countries are much
more attractive to investors than small countries.
3
The patterns are largely similar for import intensities and overall trade (import plus export) intensities.
FIGURE 1: TOP-30 “INCLUSIVE FRAMEWORK” COUNTRIES WITH THE HIGHEST AND LOWEST
EXPORT INTENSITIES
Highest export intensities (5Y) Lowest export intensities (5Y)
Hong Kong 279% -41% Turkey

Luxembourg 272% -41% New Zealand
Singapore 237% -41% Italy
Malta 212% -43% Burkina Faso
Ireland 123% -44% Uruguay
Slovak Republic 96% -44% Benin
Seychelles 86% -48% Russian Federation
Aruba 78% -49% Bermuda
Bahrain 76% -50% Sierra Leone
Slovenia 74% -52% Dominican Republic
Netherlands 71% -53% Sri Lanka
Hungary 71% -54% Peru
Belgium 65% -55% Djibouti
Macao 62% -56% Cameroon
Maldives 60% -56% China
Czech Republic 58% -58% India
Thailand 55% -58% Senegal
Estonia 54% -59% Australia
Cayman Islands 53% -60% Indonesia
Malaysia 43% -63% Haiti
Switzerland 43% -66% Japan
Vietnam 41% -68% Colombia
Antigua and Barbuda 40% -69% Kenya
Lithuania 40% -69% Liberia
Bulgaria 33% -70% United States
Trinidad and Tobago 30% -72% Nigeria
Belize 25% -72% Argentina
Curacao 25% -72% Egypt, Arab Rep.
Oman 24% -76% Brazil
St. Lucia 23% -77% Pakistan
Source: World Bank data. Note: export intensities have been calculated on the basis of 5Y average export to
GDP ratios. The numbers depicted in the chart represent the distance from the sample mean, which is 0.49 for
the countries participating in the Inclusive Framework.4
A large body of economic research demonstrates that country size matters most for foreign inves-
tors. A country’s population size is generally positively correlated with market size. Market size is
the key determinant of FDI, as firms can expect to benefit from higher economics of scale as well
as a larger potential demand (ECB 2017, World Bank 2011). Figure 2 outlines several aspects
that are also critical for foreign investors, amongst them the quality of legal and governmental
institutions and regulations governing international trade and investment.
4
A list of countries is available at https://www.oecd.org/tax/beps/inclusive-framework-on-beps-composition.pdf (as of May
2020, last updated: December 2019).
As will be shown in more detail below, the Inclusive Framework’s most export-intensive coun-
tries (as outlined by Figure 1) are generally much more tax competitive than large countries,
much freer with respect to domestic regulations and at the same time much more open to inter-
national trade and investment. In other words, the degree of “trade and investment dependence”,
on the one hand, and “self-sufficiency”, on the other hand, is reflected in domestic regulations
for commerce and policies governing trade and investment.
FIGURE 2: KEY DETERMINANTS OF FOREIGN INVESTMENT
Market size and potential 17
Institutional and regulatory quality 15
Trade opennes 9
Infrastructure quality 8
Labour quality and costs 7
Economic and political stability 7
Cultural links 5
Source: World Bank (2011).
3.2. Corporate Taxation and Economic Freedom in Inclusive Framework Countries
Empirical data indicates that governments of large economies have less incentives to compete
for business activity on characteristics of the corporate tax system, e.g. the headline corporate tax
rate. Indeed, the Inclusive Framework’s most export-intensive countries, of which all are small
countries, are on average much more tax competitive than the least export-intensive economies,
of which most are large and very large countries. The average statutory corporate tax rate of the
IF’s most export-intensive economies was 19.3% in 2019. Half of the most export-intensive
economies applied a statutory corporate tax rate below 20%. By contrast, the average statu-
tory corporate tax rate of the IF’s least export-intensive countries was 27.2%. Half of the least
export-intensive countries applied a statutory corporate tax rate that exceeded 29.5% in 2019.
Moreover, from 1990 to 2019, half of the most export-intensive economies reduced their stat-
utory corporate tax rates by more than 15 percentage points, compared to a median of only 7.3
percentage points for the group of least export-intensive (large) economies (see Figure 3 and, for
a detailed overview, Table 3 in Appendix II.
EXPORT INTENSITIES, 2019 STATUTORY CORPORATE TAX RATES AND 1990 – 2019 CHANGES IN
STATUTORY CORPORATE TAX RATES, MEDIAN VALUES
2019 statutory corporate tax rate Change 1990 - 2019 in percentage points
30%
20%
-7%
-15%
Top 30 Inclusive Framework countries with highest export intensities (small open economies)
Top 30 Inclusive Framework countries with lowest export intensities (large economies)
Source: World Bank and Tax Foundation.
Empirical data also shows that the Inclusive Framework’s most export-intensive countries show
on average a substantially higher degree of economic freedoms. Half of the Inclusive Frame-
work’s most export-intensive countries rank higher than position 40 of 162 countries studied by
the Fraser Institute. By contrast, half of the least export-intensive (large) countries rank worse
than position 100 of 162 countries. In addition, the Inclusive Framework’s most export-inten-
sive economies are generally much less restrictive to international trade than the least export-in-
tensive countries. As concerns the state of the rule of law, numbers presented for the stringency
of the enforcement of contracts and the state of the general legal system and property rights
demonstrate that the IF’s most export-intensive economies generally perform better than the 30
least export-intensive countries. This result can be attributed to the high number of large coun-
tries among the 30 least export-intensive countries that perform poorly with respect to the state
of the rule of law, e.g. Turkey, Italy, India, Indonesia, Egypt, Argentina, Brazil and Nigeria (see
Figure 4 and, for a detailed overview Table 7, 8, 9 and 10 in Appendix II).
10
EXPORT INTENSITIES, QUALITY OF DOMESTIC LEGAL INSTITUTIONS, MEDIAN VALUES
7,85
7,51 7,43
6,68
6,22
5,72 5,76
5,04
4,57
3,64
Overall economic Regulatory trade investment State of rule of law State of rule of law
freedom barriers barriers - LEC - LSPI
Top 30 Inclusive Framework countries with highest export intensities (small open
economies)
Top 30 Inclusive Framework countries with lowest export intensities (large economies)
Source: World Bank and Fraser Institute. For the state of the rule of law, numbers are presented for the strin-
gency of the enforcement of contracts (LEC) and the state of the general legal system and property rights
(LSPI).
11
BOX 1: KEY INSTITUTIONAL CHARACTERISTICS OF THE OECD INCLUSIVE FRAMEWORK’S TOP

30 COUNTRIES WITH THE HIGHEST AND THE LOWEST EXPORT INTENSITIES
DEVELOPMENT OF STATUTORY CORPORATE TAX RATES

Table 3 in Appendix II outlines the development of statutory corporate tax rates in the top-30 Inclusive
Framework countries with the highest and lowest export intensities. As with all economic data, the picture
is not 100% clear with regard to differences in economic indicators between certain groups of countries.
However, the Inclusive Framework’s most export-intensive countries, of which all are small countries, are on
average much more tax competitive than the least export-intensive economies, of which many are very large
countries. The average statutory corporate tax rate of the most export-intensive economies was 19.3% in
2019. Half of the most export-intensive (small open) economies applied a statuary corporate tax rate below
20%. By contrast, the average statutory corporate tax rate of the least export-intensive (mostly large and
very large) countries was 27.2%. Half of the least export-intensive countries apply a statutory corporate
tax rate that exceeds 29.5%. Moreover, from 1990 to 2019, half of the most export-intensive economies
reduced their statutory corporate tax rates by more than 15 percentage points, compared to only 7.3 per-
centage points for the group of least export-intensive economies. Obviously, corporate tax competition is a
very important pillar of economic policymaking in small open economies, while it is much less important in
large countries.
DEVELOPMENT OF ECONOMIC FREEDOMS

Table 4 in Appendix II shows that the Inclusive Framework’s most export-intensive (small open) economies
show a higher degree of economic freedoms, as measured by the Fraser Institute.5 The ranking of countries
is based on five areas: size of government, legal structure and security of property rights, access to sound
money, freedom to trade internationally, and the regulation of credit, labour and business. On average, eco-
nomic freedom in the most export-intensive economies takes the value 7.54. Half of the Inclusive Frame-
work’s most export-intensive countries rank higher than rank 40 of 162 countries. Thailand and Vietnam are
the worst performing countries in the group of the Inclusive Framework’s most export-intensive economies.
By contrast, the average economic freedom index value is only 6.73 for the least export-intensive (mostly
large and very large) countries. Half of the least export-intensive countries rank worse than rank 100 of
162 countries. Australia, Japan and the US are the best performers in the group of least export-intensive
economies.
DEVELOPMENT OF BARRIERS TO INTERNATIONAL TRADE AND INVESTMENT

Table 5 in Appendix II shows the level of regulatory trade barriers in the top-30 Inclusive Framework coun-
tries with the highest and lowest export intensities. The Inclusive Framework’s most export-intensive (small
open) economies are generally less restrictive to international trade than the least export-intensive (mostly
large and very large) countries. At the same time, for the period 2010 to 2017, the numbers demonstrate
that the governments of many of the least export-intensive economies increased the number of trade barri-
ers, most of them governments of large and very large countries. By contrast, the number of regulatory trade
barriers remained largely unchanged (even a minor improvement) since 2010 for the most export-intensive
economies.
Table 6 in Appendix II shows the level of investment barriers in the top-30 Inclusive Framework countries
with the highest and lowest export intensities. Similar to trade barriers, the Inclusive Framework’s most
export-intensive (small open) economies are generally less restrictive to international investment than the
least export-intensive (mostly large and very large) countries. At the same time, for the period 2010 to 2017,
the data demonstrates that the governments of many of the least export-intensive economies increased
the number of investment barriers. The number of investment trade barriers remained, on average, largely
unchanged (even a small improvement) since 2010 for the most export-intensive economies.
DEVELOPMENT OF THE RULE OF LAW

Table 7 in Appendix II shows how the top-30 Inclusive Framework countries with the highest and lowest
export intensities perform with regard to domestic state of the rule of law. Numbers are presented for the
stringency of the enforcement of contracts (LEC) and the state of the general legal system and property
rights (LSPI). The numbers demonstrate that the Inclusive Framework’s most export-intensive (small open)
economies generally perform better than the top-30 least export-intensive (mostly large and very large)
countries. Both averages and median values are higher (i.e. indicating stronger acceptance/enforcement of
the rule of law) for the top-30 most export-intensive countries. It is noteworthy that for both indicators the
differences in the median values are quite significant. This result can be attributed to the high number of
(large) countries among the top-30 least export-intensive countries that perform poorly with respect to the
state of the rule of law, e.g. Turkey, Italy, India, Indonesia, Egypt, Argentina, Brazil and Nigeria. For the period
2010 to 2017, the state of the rule of law remained largely unchanged for the majority of the top-30 most
export-intensive economies, while it slightly deteriorated for the majority of the top-30 least export-intensive
countries.
5
Economic Freedom of the World: 2019 Annual Report is the world’s premier measurement of economic freedom, ranking
countries based on five areas: size of government, legal structure and security of property rights, access to sound money,
freedom to trade internationally, and regulation of credit, labour and business. See Fraser Institute: https://www.fraserinsti-
tute.org/studies/economic-freedom.
12
4. IMPLICATIONS FOR INTERNATIONAL INVESTMENT AND TAX REVENUES
According to the OECD’s own impact assessment from February 2020, Pillar I and II com-
bined would “overall significantly impact on global tax revenues”. It is further stated that most
governments’ tax revenues would increase, with “investment hubs experiencing some loss in
tax revenues”. It is also claimed that the “overall direct effect on investment costs is expected to
be small in most countries, as the reforms target firms with high levels of profitability and low
effective tax rates.” The OECD further claims that “the reforms would also reduce the influence
of corporate taxes on investment location decisions”.
The OECD’s own analysis does not account for governments’ responses to the shift in taxing
rights under Pillar I and limitations on tax competition imposed by Pillar II. In other words, the
OECD’s analysis is comparative-static. It does not take into account future changes in individual
governments’ tax policymaking behaviour, particularly the future path of tax competition and
how internationally-operating companies would react to new developments in tax competition,
e.g. lower statutory corporate tax rates in some jurisdictions and/or greater use of tax incentives
by governments to drive down effective corporate tax rates. As both Pillar I and II aim to change
governments’ tax policy behaviour, assessments should be forward-looking in the sense that they
account for trade-offs and consistency problems over time. This has also been suggested by the
theory of international tax competition. Keen and Konrad (2012), for example, state that “[t]ax
competition takes place, in practice, in a dynamic framework. This has several implications. […]
[D]ecisions are made sequentially. Some early decisions may generate stock effects that deter-
mine the environment in which later decisions take place. Today’s capital stock is the result of
earlier decisions on savings and consumption, and this may generate time consistency problems
for the optimal tax policy that interact with the effects of tax competition. A third aspect is the
relationship between stocks and flows and the trade-off between taxing stocks and attracting an
inflow of new capital. (p. 36)
Despite the existence of dynamic effects, expert discussions often disregard the relevance of tax
policies for companies’ investment decisions. Similarly, media coverage and the public debate
often fall short to reflect on the impacts of tax policymaking and tax competition on the devel-
opment of commerce and investment over time. Dynamic effects on companies’ commercial
and investment activities should be addressed by impact assessments of the OECD’s proposals.
The literature on the theory of international tax competition suggests that governments will
continue to compete for investment and business activity in the future (see, e.g. Kee and Konrad
2012 for an extensive coverage of the theory of international tax competition and cooperation).
Governments’ past behaviour strongly suggests that tax competition will continue with Pillar I
and II implemented.
Tax competition may even intensify under the limitations of OECD’s Pillar I and II proposals.
The degree of tax competition can be captured by the development of differences in effective tax
rates over time (henceforth tax rate differentials). The differentials between statutory corporate
tax rates and effective corporate tax rates recently outlined by ZEW (2019), for example, indi-
cate that EU and non-EU governments implemented various tax incentive polices. Similarly,
tax policy measures outlined by the recent World Investment Report confirm that governments
of developing and emerging market economies consider tax incentives a key policy measures to
stimulate domestic investment and to attract foreign investors (UNCTAD 2019; Box 2 below).
13
BOX 2: TAX AND OTHER FISCAL INCENTIVES STILL IMPORTANT INVESTMENT PROMOTION
TOOLS (UNCTAD)
The United Nations Conference on Trade and Development highlights that tax incentives are key policy
measures adopted by governments to stimulate domestic investment and to attract foreign investors. UNC-
TAD (2019, p. 87) finds that: “[n]umerous countries expanded their systems of fiscal investment incen-
tives. For instance, Burkina Faso reduced by one quarter the threshold for incentives to invest in strategic
sectors. China expanded income tax benefits for overseas investors, exempting them from withholding of
income tax on the reinvestment of profits made in China. Ecuador revised its investment law, establishing
new incentives to promote FDI and providing a new arbitration route for settling disputes arising out of
investment contracts. Italy introduced a reduced tax rate for profits reinvested to acquire assets or to in-
crease employment. Mauritius introduced a five-year tax holiday for companies to collaborate in developing
infrastructure in SEZs. Poland extended the fiscal incentive schemes previously available only in SEZs to
the entire country. Thailand enacted the Eastern Economic Corridor Act, which provides fiscal incentives
for investors in the Corridor. Uganda introduced tax incentives to promote both domestic and foreign in-
vestment focusing on industrialization, exports and tourism. In January 2019, Cameroon introduced, inter
alia, several tax incentives for the rehabilitation of an economic disaster area. In February 2019, Guatemala
established fiscal incentives for companies operating in its new SEZs called special public economic de-
velopment zones. Among the tax benefits provided are an exemption for 10 years from income tax and a
temporary suspension of taxes associated with imports. To promote investment in hotels and recreation
activities, in February 2019 Panama extended its fiscal incentives for the tourism industry until 2025. Also
in February 2019, Poland introduced financial incentives aimed at boosting the audio-visual industry.”
Moreover, the OECD itself highlighted in 2008 that “[v]irtually all governments are keen to
attract foreign direct investment (FDI). It can generate new jobs, bring in new technologies
and, more generally, promote growth and employment. The resulting net increase in domestic
income is shared with government through taxation of wages and profits of foreign-owned com-
panies, and possibly other taxes on business (e.g. property tax). FDI may also positively affect
domestic income through spillover effects such as the introduction of new technologies and the
enhancement of human capital (skills). Given these potential benefits, policy makers continually
re-examine their tax rules to ensure they are attractive to inbound investment. […]” The OECD
(2008, p. 1)
As suggested by ZEW (2020), Devereux et al. 2020) and others, the OECD’s tax reform pro-
posals could increase tax competition, with the proposed minimum threshold tax level of 12.5%
being the lower bound. A global minimum effective tax rate may even accelerate tax-cutting
competition for countries that already apply relatively low corporate tax rates (Langenmayr
(2020). The simple reason is that companies’ investment behaviour is influenced by the financial
burden imposed by corporate taxes. Governments will likely anticipate that changes in countries’
effective corporate tax rates would trigger decreases in inward investment (less companies invest-
ing in the country) and increased in outward investment (more and more companies leaving the
country. Governments, small and large, can be expected to lower effective corporate tax rates in
order to contain negative effects on outward investment (less divestment of domestic businesses)
and inward investment (maintaining/increasing attractiveness for companies from abroad.
The following analysis shall inform policymakers about the direction and potential magnitude
of the impacts from the OECD’s Pillar II proposals on investment positions and investment-in-
duced changes in tax revenues over time. The focus is on changes in investment and tax revenues
that would result from continuing tax competition over time, taking into consideration a lower
bound 12.5% minimum effective corporate tax rate on global corporate profits.
4.1. Methodological Considerations
The aim of this analysis is to show the direction and magnitude of effects on investment and tax
revenues that would result from a gradual narrowing of OECD countries’ effective corporate tax
rates – a process that may intensify as a result of the imposition of a lower effective corporate
tax bound rate of 12.5%, which is anticipated by governments that compete for investment and
14
business activity, mainly small open economies. The results are in various respects also relevant
for an assessment of the potential implications of Pillar I on FDI positions and tax revenues.
For the group of OECD countries, the following analysis provides estimates for the investment
and revenue impacts of changes in the differential of effective tax rates for three scenarios:
Scenario 1:
In Scenario 1, we assume that investors’ “home countries” unilaterally reduce their effective cor-
porate tax rate to 12.5%, while the effective corporate tax rates in the partner countries remain
unchanged.
Scenario 2:
In Scenario 2, we assume that investors’ FDI destinations reduce their effective corporate tax
rate to 12.5%, while the effective corporate tax rate of the home country remains unchanged.
Scenario 3:
All OECD countries reduce their effective corporate tax rates to 12.5%, which represents a full
elimination of present tax rate differentials (“full narrowing”) within the group of OECD coun-
tries – similar to the estimations conducted in OECD (2017).
Scenarios 1 and 2 are included for illustrative purposes, highlighting governments’ need to react
to changes in other countries’ corporate tax regimes if they wish to maintain domestic invest-
ment in their country and/or attract additional investment from abroad. For example, ceteris
paribus, a unilateral reduction of the effective corporate tax rate to 12.5% would increase invest-
ment in the tax-cutting country when all other countries continue to apply previous tax rates.
By contrast, maintaining a high effective corporate tax rate would reduce domestic investment
in the respective country if the effective tax rates decreases in all other countries.
Scenario 3 is considered the most relevant scenario. It outlines the potential end state of a pro-
cess of sequential tax competition up to the lower bound of 12.5%. Scenario 3 represents the
aggregation of effects from scenarios 1 and 2. It can be interpreted as a new equilibrium after a
period of gradual and, for some countries, intensified tax competition where neither small nor
large countries can compete on effective corporate tax rate differentials anymore. An important
implication for small open economies is that in this equilibrium, ceteris paribus, large countries
would be more attractive to investors than small countries due to market size and economic
gravity effects.
While a global minimum effective tax rate is only foreseen under Pillar II, the incentives and
investment relocation mechanisms at work are similar for Pillar I. The government of a country
that is home to large internationally operating companies may have an incentive to lower the
effective corporate tax burden at home if these companies face a higher total tax burden due to
additional taxation in market jurisdictions. Additional or higher taxes in market jurisdictions
may increase the effective corporate tax rate of a company to an extent that may cause a compet-
itive disadvantage as compared to competitors headquartered in jurisdictions with lower effective
corporate taxes. A higher group-wide tax burden may therefore cause companies to reconsider
their overall international investment positions including their country of headquarter. Con-
fronted with such situations, governments may have to reconsider their effective corporate tax
rates if they want to keep successful international businesses in their country. Governments
would have to change tax policies at home, e.g. through lower statutory tax rates or measures
intended to lower their effective tax rates.
15
The methodology underlying this analysis follows the considerations of a 2017 Working Paper
published by the OECD’s Economics Department (OECD 2017), which analyses the impact
of corporate tax rate differentials on OECD countries’ FDI positions (stocks) and tax revenues.6
The authors estimate the redistribution effect of corporate tax rate differentials on FDI and
changes countries’ corporate tax revenues that result from companies’ responses to international
differences in corporate tax rates.
The authors acknowledge that different “policy- and non-policy” factors impact on multina-
tional companies’ investment decisions. Non-policy factors include gravity forces, such as market
size and distance between home and host countries, but also factor endowment characteristics.
Policy factors include regulatory (trade and investment) openness, product-market regulation,
labour-market arrangements and infrastructure. It is highlighted that policy factors can generally
raise or lower the overall cost of investment and other commercial transactions. In line with a
vast body of economic literature, the authors stress that “[t]axation is another important policy
factor affecting [multinational enterprises] real investments decisions. Ceteris paribus, lower-tax
countries are expected to have larger inflows (and smaller outflows) of capital than higher-tax
countries.” (p. 6)
The authors estimate changes in OECD countries’ bilateral FDI positions (inward and outward
FDI) in response to a full elimination of corporate tax rate differentials. They find that “in the
absence of bilateral tax rate differences, the inward FDI position of high tax countries would
increase and their outward FDI position would decrease. In a symmetrical way, the inward FDI
position of low tax countries would decrease and their outward FDI position would increase. [...]
For most OECD countries, the calculated effects of tax rate differentials on FDI positions range
between -15% and 15% of current FDI positions, assuming a semi-elasticity of -1.5”.7 (p- 12) It
is also found that “[t]he share of OECD countries aggregate outward FDI positions into partner
countries that can be explained by the tax rate differential is decreasing with partner countries
statutory tax rate. This reflects that in most cases, taxes are not the major driver of FDI position.”
(p. 13) Similarly, their “analysis suggests that higher-tax OECD countries lose revenue due to
the effect of tax differentials on FDI positions, while lower-tax countries gain revenue.” (p.14)
It should be noted that OECD (2017) does not report results on a country-by country level.
Results are only plotted for ranges of countries’ “current statutory corporate tax rates”. The
highest relative changes in inward FDI, outward FDI and tax revenues are generally estimated
for low-tax countries (statutory corporate tax rate of less than 15%) and high-tax countries (stat-
utory corporate tax rate of more than 35%).
6
It should be noted that this publication does not represent “the official views of the OECD or of its member countries. The
opinions expressed and arguments employed are those of the author(s).” (p.1)
7
The semi-elasticity indicates the percentage change in FDI associated with a one percentage-point change in taxes. A
change in the semi-elasticity would change the size of the estimated effects proportionally, but the relative revenue effects
will be unchanged.
16
For the three scenarios outlined above, this analysis replicates the methodology of OECD
(2017). We compute changes in OECD countries’ inward and outward FDI positions and cor-
responding changes in tax revenues that may result from the imposition of a global minimum
effective tax rate of 12.5%. The calculations are based in the following formulas:
whereby ∆FDIOUT,r is the change in total FDI from the home country r to the host country p,
FDIr,p is the total current FDI from the home country to the host country, tr is the effective cor-
porate tax rate in the home country, tp is the effective corporate tax rate in the host country and
ε is the semi-elasticity of investment (in response to changes in the effective corporate tax rate).
Changes in inward FDI positions of country r can be obtained by a similar approach. In line
with OECD (2017), we provide estimates for two semi-elasticities ε: -1.5 and -3, representing
the percentage change in FDI positions (stock) associated with a one percentage-point change in
the effective corporate tax rate. 8
In line with OECD (2017), FDI is treated as an investment in equity. For outward FDI, for
example, it is assumed that any extra outflow of equity caused by tax rate differences would
have been invested at home in the absence of tax rate differences. It is also assumed that this
investment at home would generate a taxable profit equal to a “normal” rate of return, which
is set at 10%. Multiplying the normal return with the effective corporate tax rate in the home
country results in an estimate of the FDI-induced tax revenue effect caused by the differences
in tax rates between the home country and the partner (host) countries and the elimination of
these differences respectively.
It should be noted that, in line with OECD (2017), we compute hypothetical changes in bilat-
eral FDI positions, i.e. changes in FDI positions that may evolve in the absence of tax rate
differences, everything else being equal. The numbers should not be taken by face value but con-
sidered indicative with respect to direction and relative magnitude of the effects from continued
tax competition on a country’s FDI positions and corporate tax revenues.
4.2. Data
FDI data: FDI data are taken from the OECD’s foreign direct investment statistics database.
Bilateral data is only available for the period 2003 to 2013, while for most countries the latest
year for which data is published is 2012. The data available is generally patchy. Many govern-
ments did not consistently report FDI data in the past. Some governments refer to classified
(confidential) information, while other do not further specify why data is not made publicly
8
The tax sensitivity of FDI generally varies for countries as well as sectors and business models. Ballpark numbers or “consen-
sus estimates” such as the ones applied by OECD (2017) and used in this study are indicative and should not be taken by
face value. “Studies examining cross-border flows suggest that on average, FDI decreases by 3.7% following a 1 percentage
point increase in the tax rate on FDI. But there is a wide range of estimates, with most studies finding decreases in the range
of 0% to 5%. This variation partly reflects differences between the industries and countries being examined, or the time
periods concerned.” (OECD 2008, p.2) It should be noted that the tax rate equalisation effect of scenario 3 does not require
the effective tax rate to be 12.5%. Tax rate equalisation would also take place at any tax rate including very low or very high
tax rates. However, the level of effective tax rates also impacts on the level of semi-elasticities. The higher the corporate tax
rate the higher the decrease in investments and vice versa.
17
available. To address this problem, average values were calculated for the period 2003-2013. If
the 2003-2013 average value is greater than the value reported in the latest year available (2012
or 2013), the higher value is used for the calculations.9
Corporate income tax rates: due to complete coverage of OECD countries, composite effective
average tax rates were taken from the OECD, representing the year 2017.10 To account for the
2017 corporate tax reform in the US, an updated effective average corporate tax rate has been
taken from ZEW (2019).11 For scenario 1, we applied the 12.5% effective corporate tax rate to
the home countries and 2017 effective corporate tax rates to partner counties. For scenario 2,
we applied 2017 effective corporate tax rate for the home country and the 12.5% minimum
effective rate for partner countries. In scenario 3, the 12.5% minimum effective rate was applied
for all OECD countries.
4.3. Results
In the main body of this paper, results are only plotted for scenario 3. For scenarios 1 and 2,
results are provided in Appendix III – Estimation results. As concerns scenario 1, with the excep-
tion of Hungary and Ireland, which currently show effective corporate tax rates lower than the
OECD-proposed minimum effective corporate tax rate of 12.5%, domestic investment would
increase in all countries if their governments would unilaterally lower the domestic effective cor-
porate tax rate to 12.5% while all other countries would maintain effective corporate tax rates at
2017 levels (2019 level for the US). Countries’ increases in investment are driven by higher levels
of inward investment from abroad and “returning” outward investment. In contrast, countries
would lose domestic investment if their governments would maintain effective corporate tax
rates at current (2017) levels while all other governments would lower their effective corporate
tax rates to 12.5%.
Scenario 3 assumes a full elimination of effective corporate tax rate differentials among OECD
countries. For scenario 3, inward investment would increase in Greece, Germany, Portugal,
Chile, the US, Australia and France, while inward investment would decrease in all other coun-
tries. At the same time, Austria, Belgium, the Slovak Republic, Germany, Greece, Portugal, the
US, Australia, Chile and France would experience returning outward investment (see Figure 5
and Figure 6).
9
The authors of OECD (2017) encountered the same problem, stating that “[t]he coverage of FDI data increases over time
and some observations are missing. This is especially true for FDI positions and flows between OECD countries and non-
OECD countries. Thus, changes in FDI over time should be interpreted with care, because some of the observed variations
might reflect changes in data coverage and not real changes in FDI. The effects of taxes reported in this paper might
underestimate the actual effects due to missing observations. However, for the countries included in this study the coverage
of bilateral FDI data is fairly good after 2006, so this bias is likely to be small.” (p. 11).
10
In OECD (2017), the authors used statutory corporate tax rates due to data coverage.
11
We apply the OECD’s 2017 estimates for effective corporate tax rates, which are based on a harmonised methodology.
ZEW (2019) does not provide data for the full sample of OECD countries.
18
FIGURE 5: CHANGES IN INWARD INVESTMENT IN % OF TOTAL INWARD INVESTMENT FROM

OECD COUNTRIES RESULTING FROM THE FULL ELIMINATION OF EFFECTIVE CORPORATE TAX
RATE DIFFERENTIALS, SCENARIO 3
Hungary -48%
Ireland -40%
United Kingdom -31%
Poland -23%
Canada -20%
Switzerland -19%
Slovenia -18%
Israel -18%
Iceland -17%
Korea -16%
Turkey -14%
Denmark -14%
Mexico -13%
Estonia -13%
Sweden -12%
Czech Republic -12%
New Zealand -12%
Luxembourg -11%
Netherlands -10%
Italy -10%
Finland -9%
Austria -8%
Japan -6%
Slovak Republic -4%
Norway -3%
Spain -2%
Belgium 0%
Greece 6%
Germany 7%
Portugal 11%
Chile 11%
United States 11%
Australia 20%
France 25%
Source: ECIPE calculations based on methodology of OECD (2017). Note: the estimates depicted are for sce-
nario 3 and based on a semi-elasticity of -3.
19
FIGURE 6: CHANGES IN OUTWARD INVESTMENT IN % OF TOTAL OUTWARD INVESTMENT IN

OECD COUNTRIES RESULTING FROM THE FULL ELIMINATION OF EFFECTIVE CORPORATE TAX
RATE DIFFERENTIALS, SCENARIO 3
Hungary 44%
Ireland 32%
United Kingdom 26%
Korea 24%
Switzerland 22%
Iceland 22%
Estonia 19%
Poland 18%
Canada 18%
Slovenia 17%
Sweden 16%
New Zealand 14%
Denmark 13%
Finland 12%
Turkey 11%
Mexico 11%
Japan 10%
Israel 9%
Italy 9%
Netherlands 6%
Norway 6%
Luxembourg 4%
Czech Republic 4%
Spain 0%
Austria -1%
Belgium -2%
Slovak Republic -2%
Germany -5%
Greece -10%
Portugal -14%
United States -14%
Australia -15%
Chile -19%
France -22%
Source: ECIPE calculations based on methodology of OECD (2017). Note: the estimates depicted are for sce-
nario 3 and based on a semi-elasticity of -3. Positive values imply divestment in the home country. Negative
values reflect returning investment to the home country.
As outlined by Table 8 in Appendix III – Estimation results, for scenario 3 the highest positive
net impacts on aggregate domestic investment are estimated for the US (+715bn USD), France
(+542bn USD), Germany (+124bn USD), and Australia (123bn USD). The highest negative
net impacts in terms of domestic investment are estimated for the UK (-747bn USD), Canada
(-209bn USD), Switzerland (-324bn USD), Ireland (-207bn USD), the Netherlands (-110bn
USD), Sweden (-99bn USD), Japan (-77bn USD), Italy (-73bn USD), Poland (-59bn USD)
and Mexico (-53bn USD).
The estimated changes in domestic investment are generally mirrored in the changes in gov-
ernment revenues from corporate income taxes (Table 9 and Table 10). For the high elastic-
ity scenario 3, the aggregate FDI change-induced corporate tax revenues would rise in the US
(+8.9bn USD annually; +5% of 2018 CIT revenues), France (+6.8bn USD; +10%), Germany
(1.5bn USD; +2%), and Australia (+1.5bn USD; +3%). The highest decreases in FDI-induced
corporate tax revenues changes are estimated for Estonia (-36% of 2018 CIT revenues), Ireland
(-23%), Switzerland (-19%), the UK (-13%), Iceland (-11%), and Sweden (-9%). It should be
20
noted that these estimates are based on a comparison of tax revenues generated by countries’
current FDI stock and tax revenues generated by countries’ FDI stock in the new equilibrium,
everything else remaining equal. The numbers do not reflect the revenue impact resulting from
tax revenues generated by other businesses that are subject to corporate income taxes.
Rising and falling levels of domestic investment would also impact governments’ tax revenues
on personal income and revenues from social security contributions. As outlined by Table 11,
for most OECD countries, taxes on personal income as well as social security contributions are
a much more important source of tax revenue than revenues generated from corporate income.
The OECD median multiplier is 1.45, i.e. the sum of revenues from taxes on personal income
and social security contributions exceeds corporate income tax revenues by about 45%. Taking
into account changes taxes on personal income and social security contributions, the increases
in FDI change-induced revenue gains would amount to 20bn USD for the French government,
4bn USD for the German government, and 14bn USD for the US government.12 Again, it
should be noted that these estimates are based on a comparison of tax revenues generated by
countries’ current FDI stock and tax revenues generated by countries’ FDI stock in the new equi-
librium, everything else remaining equal. The numbers do not reflect the revenue impact result-
ing from tax revenues generated by other businesses that are subject to corporate income taxes.
A much more significant change in tax revenues may result from the reduction of current effec-
tive corporate tax rates to the minimum effective rate proposed by the OECD. If individual gov-
ernments would lower their effective tax rates to 12.5%, these rates would more or less (depend-
ing on specific tax privileges granted for certain sectors or activities) apply for all businesses,
including SMEs and micro businesses. It is an often-stated policy objective of the OECD, the
European Commission and individual governments to level the tax playing field for businesses
of all sizes by eliminating tax loopholes for large multinationals. Assuming a linear relationship
between the current levels of countries’ effective corporate tax rates and governments’ tax reve-
nues, we can derive hypothetical annual tax revenues for the 12.5% threshold rate proposed by
the OECD. Accordingly, annual corporate tax revenues would decrease significantly for most
countries. As outlined by Figure 10, the largest losses in corporate tax revenues would arise in
the countries with the highest effective corporate tax rates, i.e. France (-62%), Australia (-60%)
and Greece, Portugal (-55%), and the US (-55%). The losses would be lower in relative terms,
but still significant in low tax jurisdictions (except for Ireland). For OECD countries, compared
to 2018 corporate tax revenues the median percentage loss estimate is -44%.
Everything else being equal, the losses in overall corporate tax revenues would decrease govern-
ment budgets unless compensated by lower public spending or higher taxes on other sources of
tax income, e.g. higher sales taxes or higher labour income taxes. At the same time, it should be
noted that historical data suggest that reductions in corporate income tax rates have a positive
effect on investment and overall economic activity, which would increase overall tax revenues
over time. As outlined by Figure 11 to Figure 16, the reductions of statutory corporate tax rates
by OECD countries since 1995 had a generally positive impact on corporate tax revenues, sales
tax revenues, social security contributions (which are positively correlated with labour income
tax revenues, for which OECD data is patchy), overall GDP growth as well as inward and out-
ward FDI positions.
12
Businesses generate economic activity, which generates revenues from labor income taxes and social security contribu-
tions. Taxes on payroll and workforce covers taxes paid by employers or the self-employed either as a proportion of payroll
or as a fixed amount per person, and which (unlike social security contributions) do not confer entitlement to social benefits.
Social security contributions cover compulsory payments to general government by individuals or businesses that confer an
entitlement to receive a contingent future social benefit. In most countries, social security contributions are applied to both
an employer’s payroll and an individual’s wages (see, Milanez (2017).
21
Overall positive economic and tax revenue implications from lower corporate taxes are also
suggested by recent data provided by the OECD’s recent 2020 Corporate Tax Statistics report
(OECD 2020c). However, these relationships are not consistent over time. Their magnitude
is sensitive to country-specific characteristics, e.g. market size (economic gravity) and regula-
tory policies for domestic commerce as well as international trade and investment. At the same
time, the mechanisms at work are largely the same for all countries, irrespective of geographical
and institutional characteristics: a meaningful reduction of corporate income tax rates would
increase the disposable income of companies. Lower taxes on corporate income would thus
stimulate overall investment and commercial, i.e. income-generating activities, which have a
positive impact on tax revenues from labour-income taxes, sales taxes and other taxes. Also, lower
corporate taxes would decrease social policy distortions that arise from tax incidence effects. A
lower corporate tax burden would increase the disposable income of workers over time, which
would improve the degree of tax progressivity in the overall tax system (see, e.g. Fuest et al.
2018; Fuest 2015).13 Figure 17 in Appendix V – Tax incidence effects) outlines the transmission
channels for the incidence of taxes on corporate income. Similar considerations apply for sales
taxes, tariffs and taxes on digital services, for which the economic costs and tax incidence effects
are outlined by Table 13.
4.4. Interpretation of Results in Light of the OECD Proposals
Accounting for the tax sensitivity of FDI and governments’ continued incentives for tax com-
petition, the above analysis reveals hypothetical bilateral FDI positions in the absence of tax
rate differentials. The net effects for domestic investment are calculated for a hypothetical equi-
librium in which all OECD countries have lowered their effective corporate tax rate to the
OECD-proposed minimum rate of 12.5% (scenario 3).
In line with the findings of OECD (2017), it becomes obvious that the OECD’s corporate tax
proposals would primarily benefit large OECD countries that currently apply relatively high
statutory and effective corporate tax rates. The analysis suggests that large OECD countries with
high effective corporate tax rates would gain most in FDI and tax revenues respectively. Large
countries’ outward investment would decrease, while inward investment would increase if tax
rate differentials narrow. The analysis does not include large non-OED countries such as China
and India and large high-tax countries participating in the OECD’s Inclusive Framework (see
Table 3). Small OECD countries, of which most apply relatively low effective corporate tax rates,
would lose domestic investment and FDI-related tax revenues to the OECD’s largest economies.
The estimated revenue gains and losses increase substantially if taxes FDI-induced revenues from
taxes on personal income and social security contributions are taken into consideration. Similar
considerations apply for non-OECD countries.
The 12.5% target rate may appear extreme given that most OECD countries, with the exception
of Ireland and Hungary, currently apply much higher effective corporate tax rates. While it is
very likely that governments across the globe will continue to lower their effective corporate tax
rates, it is questionable whether governments will enter a corporate tax “race to the bottom”,
which would be marked by the OECD’s 12.5% target rate. However, the results for scenario 3
would not change if a different target rate would be applied, e.g. 15% or 50%, as the net effect
(from scenario 1 and scenario 2) depends on current and future tax rate differentials (see equa-
tion III above).
13
s argued by Fuest et al. (2018, p. 1) “[a]ccording to surveys, most people think that capital owners bear the burden of
A
corporate taxation”. By contrast, the authors find that workers bear about half of the total economic burden resulting from a
tax change, whereby low-skilled, young and female employees bear a larger share of the tax burden. The authors highlight
that, overall, the findings indicate that taxes on corporate income reduce the progressivity of the overall tax system. Accord-
ingly, and different to the notions of most policymakers and tax justice activists, corporate tax avoidance can increase the
progressivity of the overall tax system.
22
The estimations illustrate that lower-tax OECD countries’ future scope for tax competition
would be limited by any lower bound threshold for the effective corporate tax rate. If high-tax
countries gradually lower their effective corporate tax rates, lower-tax countries’ tax advantage
would be squeezed, i.e. existing tax differentials would decline and, depending on the intensity
of tax competition, may eventually disappear. At any rate, a narrowing of international effective
corporate tax rate differentials works exclusively to benefit of large and very large countries with
high effective corporate tax rates and at the expense of small open economies, particularly small
open economies with low effective corporate tax rates.
Everything else being equal, for large countries with high effective corporate tax rates the posi-
tive impact of “economic gravity” on inward and outward investment would increase in relative
terms over time, i.e. the marginal increase in domestic investment in a large country increases
with the narrowing of the corporate tax differentials between the large country and small coun-
tries and vice versa. Importantly, this relative increase in attractiveness to foreign investors would
not require the governments of large countries to improve the domestic business and investment
climate in their countries, while at the same time governments’ marginal return from improving
the business and investment climate in small countries would also decrease.
Would a narrowing of effective corporate tax rates contribute to a more efficient allocation of
capital, as is suggested by the OECD? This answer to this question is clearly no.
First, governments will continue to compete on tax code characteristics to lower effective corpo-
rate tax rates, which is why tax-induced distortions will continue to prevail in the future, even
more so if governments increasingly rely on obscure tax privileges which reduce effective tax
rates in the domestic economy. This is highlighted by Devereux et al. (2020), who argue that “it
appears likely that the GloBE proposal will not achieve its two primary objectives unless […]
countries agree to a detailed set of harmonised rules; and (iii) the harmonised rules incorporate a
strong form of minimum tax. Even then, it is not clear that some technical issues, such as those
involved in the calculation of effective tax rates, can be solved.” (p. 2)
Second, a more efficient allocation of global investment would require more harmonised policies
for trade and investment or, at least, much less discriminatory (protectionist) rules for interna-
tional trade and investment. However, countries’ legal and institutional characteristics, which
are presented in Section 3 ab, indicate that a narrowing of tax rate differentials would effectively
shift taxing powers to the world’s largest countries, of which most perform poorly with respect to
economic freedoms, openness to trade and investment and the state of the rule of law. In addi-
tion to tax policies, these are important policy factors that impact on multinational companies’
investment decisions (OECD 2017).
As outlined by OECD (2011), “[l]arge jurisdictions with agglomeration economies are less
affected by tax base mobility and tend to set higher tax rates.” (p. 5) The same rationale is valid
for regulations on trade and investment, which are much more restrictive in large countries than
in small open economies (see above discussion and Table 4, Table 5 and Table 6). Accordingly,
the shift of taxing powers away from and well-performing small economies to the governments
of large countries with poor legal, political and governmental institutions may result in a much
more inefficient allocation of capital over time as governments of large countries have much
lower incentives than small country governments to compete for investment on the basis of good
legal and governmental institutions. For business and citizens in the world’s largest and most
protectionist countries, the OECD-proposed minimum corporate tax may therefore become a
tax on longer-term social and economic development.
23
Third, higher corporate tax rates generally reduce companies’ “disposable income”, which
decreases companies’ capacity to invest in R&D, new business models and (international) busi-
ness expansion. The OECD’s own impact assessment comes to the conclusion that multinational
companies’ total tax burden would increase as a result of the implementation of Pillar I and
II proposals. Following the reasoning of the OECD, which does not account for continued
tax competition among governments globally, the reform proposals would reduce the finan-
cial resources of companies, implying lower levels of domestic and international investment. As
financial resources would be allocated away from businesses to governmental institutions, which
spend tax funds according to political will, the reallocation of financial resources would likely
generally result in a less efficient allocation of financial resources, particularly in countries that
show high levels of corruption and cronyism.
Moreover, many R&D activities currently take place in countries that allow for special tax deduc-
tions or special tax treatment of losses carried forward. These and other measures are designed
to encourage private sector investment and innovation. In economic lingo, tax incentives were
explicitly designed to achieve a more efficient allocation of capital investments. Many large and
small open economies actually allow companies to carry forward losses from R&D expenditures,
which lower companies’ taxable income in subsequent years (and significantly impact on com-
panies’ actual effective tax rates). Due to their economic and political clout, the governments of
large countries could use their political leverage to challenge such behaviour under the OECD’s
new rules for Pillar I and II. The OECD’s reforms would thus undermine tax practices that are
intended to stimulate investment and innovation, particularly in small open economies.
The implementation of the OECD’s reform proposals is likely to result in a rising number of dis-
putes between governments over the calculation of multinational enterprises’ annual profits and
the number of years to net losses against future profits, which can have significant implications
on how much and where companies invest in R&D in the future. Accordingly, for small open
economies that are home to research- and knowledge-intensive multinational combines, the
OECD’s proposed tax reform could undermine investments in R&D, innovation and business
model development, with adverse implications on existing research clusters, education systems
and high value-added jobs.
5. CONCLUSIONS
The reforms proposed by the OECD would impact where large multinational companies pro-
duce and invest in the future. The above analysis has shown that continued tax competition
would contribute to a narrowing of international corporate tax rate differentials up to the 12.5%
minimum tax threshold level proposed by the OCED. The narrowing of tax rate differentials
between today’s high-tax jurisdictions, of which most are very large countries, and today’s low-
tax jurisdictions, which are exclusively small open economies, would direct international and
domestic investments and investment-induced tax revenues away from small countries. Overall,
the shift in effective taxing powers would undermine small countries’ attractiveness to interna-
tional businesses and, in addition, induce domestic businesses to relocate to larger countries with
the economic gravity of larger markets.
Contrary to claims made by the OECD, the implementation of Pillar I and II proposals would
not improve the global allocation of capital. Global trade and investment flows would still be
subject to tax competition and widespread trade and investment barriers. The OECD’s current
proposals would likely incentivise the governments of large countries to maintain long-standing
barriers to trade and investment or to erect additional barriers that would restrict market access
for companies from small open economies. For small open economies that are home to research-
and knowledge-intensive multinational companies, the OECD’s proposed tax reforms would
undermine future investments in R&D, innovation and business model development, with
adverse implications for existing research clusters, education systems and high value-added jobs.
24
The investment relocation mechanisms at work under Pillar II are similar for those that can be
expected for Pillar I. Additional or higher corporate taxes in market jurisdictions would increase
the effective corporate tax rate of a company to an extent that may cause a competitive disadvan-
tage as compared to competitors headquartered in jurisdictions with lower effective corporate
tax rates. A higher group-wide tax burden may therefore cause companies to reconsider their
overall international investment positions including their country of headquarter. Confronted
with such situations, governments may need to reconsider their effective corporate tax rates if
they want to keep successful international businesses in their country. They may adopt lower
statutory tax rates or new measures intended to lower their effective tax rates.
The high level of variation in countries’ corporate tax codes demonstrates that governments
actively encourage internationally operating companies to lawfully reduce their (global) corpo-
rate tax bills. The measures proposed by the OECD would not stop future governments from
lowering their countries’ effective corporate tax rates. The measures proposed by the OECD
would also fail to address a systemic problem of corporate tax law: enormous legal complexity
and tax law obfuscation:14 corporate income taxes are at the heart of numerous inefficiencies.
They are at the root of double taxation for multiple sources of individual incomes. As a result of
the economic incidence, taxes on corporate income depress the real income of workers, consum-
ers and entrepreneurs. More corporate tax avoidance would have a positive impact on house-
holds’ disposable incomes and, due to the sensitivity of low-skilled workers, tax progressivity
respectively (see Fuest et al. 2018).
The OECD’s recent proposals for international corporate tax reform would add another complex
layer of tax law to non-transparent corporate tax regimes whose actual distributional effects on
workers, consumers and company owners are currently almost impossible to assess. The adop-
tion of the OECD’s reform proposals would cement corporate tax-induced wage depression and
shield complex national corporate tax regimes that are incomprehensible for most citizens and
politicians. Policymakers in small and large countries should be wary of the path dependency
in corporate taxation, i.e. the historical pattern that tax complexity bred further tax complexity,
effectively taking corporate tax rules out of the control of taxpayers and elected lawmakers.
Given the path dependency of national tax systems and the political economy barriers to reform,
tax competition is the most promising way to achieve simpler and more transparent tax sys-
tems globally. Any multilateral limitations on tax competition would impede the evolution of
modern, i.e. simpler and more transparent, tax systems that stand a chance of being considered
fairer by countries’ local populations. Policymakers should reconsider whether taxes on corporate
income actually contribute to governments’ overall social and economic policy objectives, such
as economic development, redistribution and fairness in taxation.
As outlined by Figure 7, taxes on corporate income account for only 9.5% of OECD countries
total tax revenues. Similarly, as shown by Figure 8, new taxes on digital services would also
account for very low – de facto negligible – shares on governments’ total annual tax revenues.
As shown by Figure 9, this order of magnitude is generally mirrored by countries tax revenues
per capita values. Against this background, policymakers should consider replacing corporate
income taxes by taxes on consumption to generate tax revenues from economic activities and
user participation, including user participation in certain locations. As argued by ZEW (2020)
and others, value added taxes (VAT) and sales taxes are a suitable (and already available) tool
to tax consumption in market countries. Sales taxes already account for relatively high shares of
14
In software development, obfuscation is the deliberate act of creating source or machine code that is difficult for humans to
understand.
25
overall tax revenue (see also Table 14). Enforcing VAT/sales taxes on both digital services and less
digital sectors of the economy would allow governments to generate and sustain tax revenue in
market jurisdictions.
Replacing tax systems that include taxes on corporate income by systems that rely more or
exclusively on direct taxes on labour income, capital income and consumption (VAT/sales taxes)
would not only increase transparency about the distributional effects of taxation; it would also
significantly improve governments’ tax manoeuvrability in response to citizens’ preferences for
fairer taxation. A regime change towards greater use of VAT/sales taxes would also have a pos-
itive impact on global capital allocation: companies would no longer have to pay attention to
corporate income tax rate differentials, while governments would have additional invectives to
embrace foreign trade and investment, materialising in lower barriers to trade and investment
and a more efficient allocation of global capital respectively.
FIGURE 7: TAX REVENUE IN TOTAL TAX REVENUES, OECD COUNTRIES, 2018
32,1%
26,2%
23,9%
9,5%
5,6%
2,6%
Sales taxes and Social insurance Individual taxes Corporate taxes Property taxes Other taxes
VAT taxes
Source: OECD, Tax Foundation. Note: individual taxes include taxes on labour income and taxes on capital
income. For Greece, only the aggregate of taxes on income, profits and capital gains was available for the year
2018. To split this aggregate into the three categories Individual Income Taxes, Corporate Income Taxes and
Other Income Taxes, the average of the distribution of these categories in the three years prior (2015-2017)
was used.15
FIGURE 8: GOVERNMENT-ESTIMATED TAX REVENUES FROM SPECIAL TAXES ON DIGITAL SER-

VICES AS SHARE OF TOTAL ANNUAL TAX REVENUES FROM 2018
0,29%
0,15%
0,10%
0,05% 0,03%
Austria France UK Italy Spain
Source: revenues projections of national finance ministries. OECD tax revenue data for 2018. Note: for Spain,
the technical experts’ union at the Finance Ministry stated that this forecast “could be an overestimate.”
4.202
3.379 3.359 3.312

3.179
15 2.575 2.581
The data is available at: OECD Global Revenue Statistics Database, https://stats.oecd.org/Index.aspx?DataSetCode=RS_GBL.
1.703 1.708
1.208
948 1.025
26
542
7,46 11,72 3,64 2,83 - - 25,68
France Italy United Kingdom Austria Spain
0,29%
0,15%
0,10%
0,05% 0,03%
Austria France UK Italy Spain
FIGURE 9: ANNUAL TAX REVENUE PER NATIONAL CITIZEN: LABOUR INCOME TAXES, SALES
TAXES, CORPORATE INCOME TAXES, DIGITAL SERVICES TAXES (DST), IN EUR
4.202
3.379 3.359 3.312

3.179
2.575 2.581
1.703 1.708
1.208
948 1.025
542
7,46 11,72 3,64 2,83 - - 25,68
France Italy United Kingdom Austria Spain
Tax revenue per capita, labour income tax Tax revenue per capita, sales taxes
Tax revenue per capita, corporate income tax Tax revenue per capita, digital services tax
Source: ECIPE calculations based on Eurostat tax and World Bank population statistics from 2018. DST esti-
mates based on national governments’ own fiscal forecasts. Note: the government of Spain does not report
revenues for corporate income tax and labour income tax. For the Spanish government’s DST proposal, the
technical experts’ union at the Finance Ministry stated that this revenue forecast “could be an overestimate.”
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29
APPENDIX I – OVERVIEW OF ECONOMIC IMPACT ASSESSMENTS
Appendix I.1: IMF Working Paper (2019): The Impact of Profit Shifting on Economic
Activity and Tax Competition
In an IMF Working Paper from 2019 (No. 19/287), Klemm and Liu (2019) investigate the
impact of internationally operating companies’ profit shifting behaviour on investment activities
and the implications of restraints on profits shifting on future tax competition. The authors
generally criticise that “existing empirical literature has paid relatively little attention to the inter-
action between profit shifting and the allocation of real activities by MNCs.” (p.12). The authors
question the merits of the OECD’s corporate tax reform initiative, particularly the focus on
profit-shifting activities. Their critique is based on the positive economic effects of profit-shifting
activities for the creation of productive investment globally.
Klemm and Liu discuss the impacts of profit-shifting on companies’ cost of capital, investment,
tax revenues and government behaviour. The authors present a literature review outlining empir-
ical evidence on the impact of profit-shifting on the cost of capital and investment effects, with
a focus on tax rate differentials, changes in transfer pricing regulation, and Controlled Foreign
Corporation (CFC) rules. They highlight that “[o]ne particularly interesting aspect is that profit
shifting opportunities reduce the cost of capital both in countries whose tax rates exceed and
undercut the weighted average.” (p. 7). It is shown that both low-tax and high-tax countries
benefit from higher investment as a result of profit-shifting opportunities, whereby the impact
on government revenues is found to be generally be positive for low-tax countries.
Following the empirics as well as their own analysis, they conclude that “profit shifting opportu-
nities unambiguously reduce the cost of capital in all countries [analysed].” (p.14) It is stressed
that profit-shifting opportunities raise the global stocks of capital. Regarding the impact on the
welfare state and governments’ “optimal” behaviour, the results of the authors are rather incon-
clusive. It is stated that “[w]hile jurisdictions with relatively low taxes are likely to gain revenues
and capital, high-tax countries are likely to gain capital but lose revenue.” (p. 14)
As concerns the quality of impact assessments of tax reform proposals, the findings of Klemm
and Liu indicate that it is very difficult to estimate the precise economic impacts from the status
quo as well as the potential impacts that may result from corporate tax reforms. Referring to their
calculations, the authors stress that “[t]he illustrative use of the simple model also revealed the
difficulty in assessing separately the impact of changes to tax rates or the ease of profit shifting on
investment and revenues. If this is complicated already in a very simple model, it must be much
more so in practice, where many further channels and interactions exist.” Accordingly, they con-
clude with the critique that “[g]iven the ambiguity of many of the findings, the recent strength
of international [OECD BEPS] efforts at curbing profit shifting may appear surprising.” (p. 15)
Klemm and Liu argue that a “permissible attitude” towards profit shifting is a component of tax
competition. Governments can reduce effective tax levels by tolerating “profit-shifting behav-
iour”. If profit shifting is limited through international coordination, governments may face
stronger pressure to reduce tax levels directly, e.g. by cut-ting statutory tax rates. The authors
highlight that governments are unlikely to give up on tax competition in the future. The OECD’s
proposed rules would likely induce governments to further cut statutory corporate tax rates to
compensate new limitations on profit shifting opportunities. A summary of the findings is pro-
vided by Table 1.
30
TABLE 1: THE IMPACT OF PROFIT-SHIFTING OPPORTUNITIES ON INVESTMENT AND TAX COM-

PETITION
Impact of profit-shifting opportunities

Impact on government-induced tax competition
on productive investment
• Investment in high-tax countries may be higher if inves- • Tax competition is the process of lowering taxes to at-
tors know that they are able to avoid some of the tax tract capital investment
through profit shifting
• “ Permissible attitude” towards profit shifting is a compo-
• More subtly, investors may also invest more in low-tax nent of tax competition
jurisdictions because having capital there may facilitate
shifting profits into those jurisdictions • Governments can reduce effective tax levels by tolera-
ting such “profit-shifting behaviour”
• If profit shifting is limited through international coordina-

tion, governments may face stronger pressure to reduce
tax levels directly, e.g. by cutting statutory tax rates
Source: IMF Working Paper 19/287, Klemm and Liu (2019).
Appendix I.2: Devereux et al. (2020): The OECD Global Anti-Base Erosion Proposal
(Pillar II)
In a study published by the Oxford University Centre for Business Taxation, Devereux et al.
(2020) provide a comprehensive analysis of the OECD’s Pillar II proposals. The authors argue
that the OECD’s Pillar II proposal appears to be guided by two main objectives: to combat profit
shifting and to reduce international tax competition.
The authors demonstrate that the proposed rules under Pillar II are in many ways inconsistent
with the policies suggested for Pillar I. Pillar I explicitly aims at allocating taxing rights to the
market country, while Pillar II would allocate taxing rights to the country of a group’s parent
(the country of headquarters). They also highlight that with the joint implementation of Pillar I
and Pillar II, governments would continue to tax corporate income in all the locations in which
companies are already taxed, with additional taxes in the jurisdictions where sales take place. The
authors criticise that “this approach may yield higher revenues; but is likely to be at a considera-
ble cost in terms of complexity and uncertainty.” (p. 5)
Devereux et al. emphasise that the OECD’s reform proposals suffer from the “lack of obvious
principles”. (p. 6) The authors do not elaborate further on principles that should guide tax poli-
cymaking. They nevertheless critically assess the OECD’s vague proposals against the stated pol-
icy objectives, i.e. to address profit shifting, to address tax competition, to stop uncoordinated
anti-avoidance measures, and to improve the allocation of capital and economic growth. The
authors assess whether the objectives are justified, whether the proposed reforms would actually
achieve these objectives, and whether alternative reforms would be more appropriate.
Devereux et al. outline that the OECD’s current proposals are inconsistent with the objective to
tax corporate income where value is created. The authors point to flaws in the notion of “taxation
according to the place of value creation”, which, despite of its “shaky foundation” (p. 3) has also
been adopted by the European Commission and some individual governments.
It is noted that the taxation of corporate income on the basis of a minimum tax or income
inclusion rules is not justified on the basis of the “taxation according to value creation” princi-
ple. Referring to the initial OECD opinion that “no or low taxation is not a cause of concern”,
the authors make clear that “no or low taxation” is now the OECD’s main motivation for work
under Pillar II.
31
With respect to profit shifting opportunities, Devereux et at. argue that “the issue now appears to be
no or low taxation per se, rather than no or low taxation in jurisdictions where there is little substance.”
(p. 6) They also criticise that “the approach of the BEPS project, and now the GloBE proposal, is to
introduce ad hoc measures to limit the extent to which profits are declared in low tax countries, but
without changing the basic structure of the system.” (p. 7) Accordingly, the authors attest that “[t]
his illustrates a common, and classic, approach in tax policy. Instead of directly aiming to correct a
problem in the tax system, policy makers instead introduce some offsetting provision.” (p. 8)
With respect to tax competition, Devereux et al. refer to the OECD’s claim that “global action is
needed to stop a harmful race to the bottom, which otherwise risks shifting taxes to fund public
goods onto less mobile bases including labour and consumption, effectively undermining the tax
sovereignty of nations and their elected legislators” (OECD 2019c, p.24). They argue, however,
that the global decline in statutory corporate tax rates globally is to some extent the result of tax
competition and governments’ interest to attract real economic activity and “mobile profit” (p.
8). It is also highlighted that “many countries […] implemented many forms of anti-avoidance
rules at the same time as competing on other aspects of their tax systems,” while corporate tax
revenues have not fallen considerably (p. 8)
With respect to the efficiency of taxes on corporate income, Devereux et al. stress that evidence
shows that source-based taxes on profits are particularly harmful in terms of the market dis-
tortions they create, i.e. so-called economic inefficiencies (see also OECD 2010). Against this
background, the authors “find it puzzling that the OECD warns against a scenario which is
characterised by a greater use of taxes on less mobile factors, e.g. workers or consumers. Moreo-
ver, referring to the incidence of taxes, i.e. the person who is actually worse off as a result of the
tax being levied, it is argued that mobile factors (including citizens in their capacity as capital
owners or shareholders or owners of IPR) are unlikely to pay the tax as they can move elsewhere
to escape taxation. With regard to the tax incidence, Devereux et al. also highlight that “[o]ne
key lesson of economic theory is that immobile factors tend to bear the incidence of taxes, irre-
spective of how the tax is levied.” (p. 9)
Pointing to the OECD’s claim that a reduction of profit shifting and/or base erosion would
improve the allocation of capital and encourage economic growth, Devereux et al. are doubtful,
highlighting that a rise in the effective corporate tax rate (internationally) has a depressing effect
on overall investment. The argument, as e.g. put forward by Englisch and Becker (2019), that
Pillar II proposals would lead to a global narrowing of effective corporate tax rates (a smaller
distribution of effective tax rates “available” to internationally operating companies) is rejected.
Devereux et al. argue that Pillar II policies would increase the cost of capital, with adverse impli-
cations on overall investment activity. In their simulations, Devereux et al. demonstrate that “[t]
here is a clear trade-off between the aims of reducing profit shifting and supporting investment.”
(p. 46) It is further demonstrated that effective tax rates only converge if “the threshold [effective
tax] rate exceeds the tax rates in lower taxed jurisdictions in which multinationals would consider
undertaking real investment projects.”16 The equalisation effect of the income inclusion rule,
which could in theory improve capital export or investment location neutrality, would be offset
by higher costs of capital and lower investment respectively. It should be noted that the simula-
tions conducted by Devereux et al. (2020) – like other empirical or model-based assessments of
international corporate tax policymaking – suffers from a lack of publicly available data.17
16
Following an income inclusion rule, a tax would be imposed on the income of a foreign branch or a controlled entity if that
income was subject to tax at an effective rate which is below a minimum threshold rate.
17
Devereux et al. (2020) state “We should note one important caveat of this study. In considering the blended approach in
particular, we have modelled a business without any existing foreign operations. The income inclusion rule is then applied to
a new investment without any consideration of existing profit and the rate at which it is taxed. To analyse the impact of exist-
ing activities and profit would require good data on the entire worldwide activities of the business, and the taxes that it pays
in the absence of the GloBE proposal. Such data is generally not available, though country-by- country reports introduced by
the BEPS project may provide information for such a study. (p. 46)
32
Appendix I.3: PWC (2020): Analysis of the Revised Regime for Taxing Rights and
Income Allocation (Pillar I)
Focussing on Pillar I, Singh et al. (2020) provide an analysis of the impact of the proposed nexus
and income allocation rules on internationally operating companies’ taxable income. Based
on aggregated and anonymised data from country-by-country (CbC) reports filed by (mainly)
US-headquartered multinational enterprises (MNEs), the authors estimate the extent of change
the OECD’s unified approach will bring about.18 The authors estimate the share of income in a
given industry that will be reallocated, relative to the status quo, which is governed by the per-
manent establishment (PE) concept and the arm’s-length principle (ALP).
The authors decompose “taxable income under the status quo into the three constituent ele-
ments, i.e. the total routine source-country return, the total routine market-country return, and
source-country residual profit for each industry grouping (manufacturing; wholesale, retail and
related services; information services, professional services, other services). On the basis of this
decomposition, estimates are provided for Amount A, Amount B and Amount C.
For each sector, the authors provide estimates for the “unified approach scope income” (UAP)
expressed as the percentage of a company’s global pre-tax income. The UAP is intended to meas-
ure the share of an MNE’s global pre-tax income whose international allocation will be governed
by the new formulaic conventions of the unified approach. Based on the authors’ assumptions,
the estimates for the UAP range from 15% to 33% depending on the industry and the measure
of pre-tax income used (pre-tax profit or earnings before interest and tax, EBIT). The estimates
suggest a maximum potential of 67% to 85% in terms of the share of pre-tax income that will
continue to be allocated under the arm’s-length principle.
Following these calculations, the authors provide estimates for the “reallocated percentage” (RAP)
as the reallocated income divided by the companies’ total pre-tax income (which is assumes to
remain constant). The RAP is intended to measure the share of an MNE’s global pre-tax income
that will actually be reallocated under the unified approach. The estimates for the RAP range
from just under 2% to 8% depending on the industry and the measure of pre-tax income used
(pre-tax profit or EBIT). The findings are displayed in Table 2 below.
The numbers estimated by Singh et al. indicate that the new formulaic elements of the OECD’s
unified approach may directly govern the allocation of a large portion of an MNE’s pre-tax
income. However, their impact in terms of changing the allocation of pre-tax profits, and tax
revenues respectively, different from the status quo is more modest. The authors highlight that
existing nexus and income allocation rules grounded in the permanent establishment concept
and the arm’s-length principle will continue to be relevant in the future. It is stated that “[r]
umors of the arm’s- length principle’s demise may have been somewhat exaggerated”. (p. 562)
18
The data used in the analysis is from the US IRS SOI program, which annually publishes statistics on the operations of the
internal revenue laws. The information published by the SOI is frequently used in the analysis of tax policy.
33
TABLE 2: MNE’S GLOBAL PRE-TAX INCOME WHOSE INTERNATIONAL ALLOCATION WILL BE GOV-
ERNED (UAP) AND REALLOCATED (RAP) BY THE OECD’S NEW FORMULAIC CONVENTIONS OF
THE UNIFIED APPROACH
Wholesale,
UAP by Indus- Information Professional
Manufacturing Retail and Re- Other Services
try Grouping Services Services
lated Services
UAP - UA
Scope Income/ 24.10% 32.50% 24.10% 25.40% 19.80%
Pre-tax Profit
UAP - UA
Scope Income/ 19.00% 23.90% 16.90% 18.60% 14.50%
EBIT
Wholesale, Re-
RAP by Indus- Information Professional
Manufacturing tail and Related Other Services
try Grouping Services Services
Services
RAP - UA
Scope Income/ 5.00% 8.00% 6.20% 7.20% 2.20%
Pre-tax Profit
RAP - UA
Scope Income/ 3.90% 5.90% 4.40% 5.30% 1.60%
EBIT
Source: Singh et al. (2020). Numbers bases on authors’ calculations on the basis of data from country-by-coun-
try reports filed by (mainly) US-headquartered MNEs.
Appendix I.4: OECD (2020): Update on the Economic Analysis and Impact Assessment
In its January 2020 announcement, the institutional framework called “for continued efforts to
strengthen the analysis with caution due to data limitations and for more detailed analysis on
the investment and growth impacts of the proposals before the end of March 2020. (OECD
2020a, p. 5) On February 15, 2020, the OECD’s secretariat presented its first own preliminary
impact assessment of its proposed Pillar I and II proposals (OECD 2020b). The focus of the
assessment is on the impacts on governments’ tax revenues. The actual impact on investments
is treated in a rudimentary manner. The impact assessment remains silent about the effects on
economic activities and the impact on international trade facilitated by the affected companies.
The OECD’s secretariat neither analysed the distributional implications of its reform proposals
on individual companies, nor did it address the incidence effects on workers, consumers and
company owners/investors.
The modelling of the OECD is based information gathered from country-by-country reporting,
which is only available for 2016. In the assessment it is highlighted that “due to gaps in coverage
and time lags and the methodology inevitably involves simplifying assumptions.” (p. 9). It is
further stated that both companies and governments will “react strategically”. While for Pillar
2, “some of these reactions have been modelled in the assessment, these reactions are difficult to
anticipate with certainty.” (p. 9)
For Pillar I estimations (Amount A only), the OECD calculated residual profits on the basis of
a 10% and 20% threshold on profit-before-tax to turnover. It assumed a 20% reallocation of
these profits to market jurisdictions.19 The assessment considers MNE groups as a whole rather
than entity-by-entity. Pillar II estimates are based on an illustrative scenario with “jurisdiction
blending” and a 12.5% minimum tax rate. The OECD argues that the proposed reforms are
expected to lead to a significant reduction in profit shifting.
19
Extractive industries and financial services sectors were not covered by the analysis.
34
The major outcomes promoted by the OECD are as follows:
Combined effects of Pillar I and II:
• global net tax revenue would increase by up to 4% of global corporate income

tax revenues, which corresponds to about 100 billion USD annually
• the highest impacts are expected if low tax governments increase their statutory/
effective CIT rates, which is said to be “highly uncertain” (scenario 4 in the
assessment)
• the estimates are sensitive to the final reform design
• it is nevertheless stated that the revenue gains are broadly similar across the gov-
ernments of high, middle and low-income economies, as a share of corporate
tax revenues, which correspond to 4% of governments corporate income tax
revenues
For Pillar I, the OECD states that
• global tax revenues would slightly increase as some taxing rights shift from low-
tax jurisdictions to higher-tax jurisdictions
• most economies would experience a small tax revenue gain
• on average, low and middle-income economies would gain relatively more rev-
enue than advanced economies
• global corporate income tax revenues would only slightly change in the OECD’s
model: less than 0.75% for the 20% threshold assumption and less than 0.25%
for the 20% threshold % threshold assumption; some high-income coun-
tries (other than investment hubs) could lose tax revenues for both threshold
assumptions
For Pillar II, the OECD states that
• a significant amount of additional tax revenues would be generated

• profit shifting would be reduced because of the reduction tax rate differentials
between jurisdictions
• developing economies would benefit more as they tend to be more adversely
affected by profit shifting than high-income economies20
It should be noted that the results are presented for country groups only. The impacts on indi-
vidual countries have not been published by the OECD. The aggregation of countries on the
basis of level of income or economic development disregards important determinants for social,
economic and political development, such as openness to trade and investment and the quality
of governmental institutions (rule of law, corruption, etc.). Moreover, countries within groups
are characterised by distinct differences in statutory and effective corporate tax rates. The gov-
ernments of many low-income and middle-income countries, for example, apply relatively high
statutory corporate tax rates, which impact on the level of domestic and foreign investment. For
Pillar I, the OECD states that more than half of the profits reallocated comes from 100 MNE
groups. The OECD does not provide any further information, e.g. who these companies are,
where they are invested and their value-adding activities take place.
20
High, middle and low income jurisdictions are defined based on the World Bank classification. Investment hubs are jurisdic-
tions with inward FDI above 150% of GDP.
35
As concerns the impacts on global investment, the OECD’s assessment provides estimates on
the basis of effective tax rates (ETRs). It is generally acknowledged that the impacts of effective
tax rates will vary across MNEs. The model results point to small direct effects on the cost of
investment in most countries. Detailed information is not provided by the authors. It is high-
lighted that the proposed measures mainly target MNEs with high levels of profitability and low
effective (corporate) tax rates. At the same time, the authors recognise that investment “could
be driven more by other factors (e.g. infrastructure, education levels or labour costs).” (p. 24)
Despite the recognition of these factors and the “small effects” on investment costs estimated by
the OECD’s model, a rather bold claim is made by the authors regarding the global allocation of
investment. It is argued that the reforms “could channel more investment to jurisdictions where
it would be more productive, which would support global growth.” (p. 24). The assessment of
investment effects (and economic growth) did not factor in economic gravity of large countries
(market size), trade and investment barriers and other aspects that impact on private-sector
investment decisions, e.g. tax competition beyond tax rates (tax credits, tax exemptions), tax and
regulatory compliance cost, double taxation risks, etc.
Appendix I.5: ZEW (2020): Global Corporate Tax Reform to the Worse
ZEW (2020) does not provide a fully-fledged analysis, but discusses potential implications of the
OECD’s proposals that stand in opposition to the OECD’s stated policy objectives. The authors
highlight that the OECD is currently pursuing a “fundamental and potentially overshooting
corporate tax reform”. (p. 1) For the Pillar I proposals, it is outlined that a new taxable “nexus
based on sales, with no need for a physical presence, would extend the taxing right to all types
of businesses, even to exports.” (p.2) The authors argue that this would increase arbitrariness in
determining the amount of profit subject to taxation and increase the risk of double taxation.
Regarding Pillar II the authors highlight that the “proposed coexistence and reinforcement of the
residence and source based taxation principle” […] “could also increase tax competition between
OECD member states with the coordinated minimum tax level being the lower bound.” It is
also highlighted that “the risk of double taxation increases if all jurisdictions try to expand their
access to the tax base of multinational enterprises.” (p. 3)
It is concluded that the OECD should focus on “indirect taxes to generate tax revenues at the
location of user participation. The value added tax (VAT), as an already existing suitable tool to
tax consumption in market countries. Enforcing VAT on digital services thoroughly is a crucial
step to generate and protect tax revenue in market jurisdictions.” (p. 3-4)
36
APPENDIX II – INSTITUTIONAL CHARACTERISTICS OF TOP 30 “INCLUSIVE FRAME-

WORK” COUNTRIES WITH THE HIGHEST AND LOWEST EXPORT INTENSITIES
TABLE 3: TOP-30 “INCLUSIVE FRAMEWORK” COUNTRIES WITH THE HIGHEST AND LOWEST
EXPORT INTENSITIES, DEVELOPMENT OF STATUTORY CORPORATE TAX RATES
Change in stat- Change in stat-

Statutory cor- Statutory cor-
Highest export utory corporate Lowest export utory corporate
porate tax rate, porate tax rate,
intensities (5Y) tax rates, 1990 intensities (5Y) tax rates, 1990
2019 2019
- 2019, in pp - 2019, in pp
Hong Kong 16.5 NA Turkey NA -33.0
Luxembourg 24.9 NA New Zealand 28.0 -5.0
Singapore 17.0 NA Italy 27.8 -18.6
Malta 35.0 NA Burkina Faso 28.0 NA
Ireland 12.5 -30.5 Uruguay 25.0 -5.0
Slovak
21.0 NA Benin 30.0 NA
Republic
Russian
Seychelles 33.0 NA 20.0 -15.0
Federation
Aruba 25.0 NA Bermuda - NA
Bahrain - NA Sierra Leone 30.0 NA
Dominican
Slovenia 19.0 NA 25.0 NA
Republic
Netherlands 25.0 -10.0 Sri Lanka 28.0 NA
Hungary 9.0 -31.0 Peru 29.5 -5.5
Belgium 29.6 -11.4 Djibouti 25.0 NA
Macao 12.0 -3.0 Cameroon 33.0 -5.5
Maldives 15.0 NA China 25.0 -15.0
Czech
19.0 NA India 30.0 -20.0
Republic
Thailand 20.0 -10.0 Senegal 30.0 -5.0
Estonia 20.0 NA Australia 30.0 -9.0
Cayman
NA NA Indonesia 25.0 -10.0
Islands
Malaysia 24.0 -11.0 Haiti 30.0 -5.0
Switzerland 21.1 -9.4 Japan 29.7 -20.2
Vietnam 20.0 NA Colombia 33.0 3.0
Antigua and
25.0 -15.0 Kenya 30.0 -12.5
Barbuda
Lithuania 15.0 NA Liberia 25.0 -25.0
Bulgaria 10.0 NA United States 25.9 -12.8
Trinidad and
25.0 -15.0 Nigeria 30.0 -10.0
Tobago
Belize NA NA Argentina 30.0 10.0
Curacao 22.0 NA Egypt 22.5 -17.5
Oman 15.0 -35.0 Brazil 34.0 4.0
St. Lucia 30.0 -3.3 Pakistan 30.0 -15.0
Average 19.3 -11.9 Average 27.2 -9.1
Median 20.0 -15.0 Median 29.5 -7.3
Source: World Bank and Tax Foundation.
37
TABLE 4: ECONOMIC FREEDOM IN THE TOP-30 “INCLUSIVE FRAMEWORK” COUNTRIES WITH

THE HIGHEST AND LOWEST EXPORT INTENSITIES
Highest Lowest
Economic Economic
export Quartile export Quartile
Freedom Rank 2017 Freedom Rank 2017
intensities 2017 intensities 2017
2017 2017
(5Y) (5Y)
Hong Kong 8.91 1 1 Turkey 6.67 95 3
New
Luxembourg 7.86 17 1 8.5 3 1
Zealand
Singapore 8.71 2 1 Italy 7.41 46 2
Burkina
Malta 7.97 11 1 6.07 130 4
Faso
Ireland 8.13 6 1 Uruguay 7.05 70 2
Slovak
7.51 40 1 Benin 6.08 129 4
Republic
Russian
Seychelles 7.16 63 2 6.78 85 3
Federation
Aruba Bermuda
Sierra
Bahrain 7.35 50 2 5.63 147 4
Leone
Dominican
Slovenia 7.15 62 7 6.92 77 2
Republic
Netherlands 7.72 25 1 Sri Lanka 6.57 104 3
Hungary 7.27 54 2 Peru 7.49 42 2
Belgium 7.51 40 1 Djibouti
Macao Cameroon 5.84 140 4
Maldives China 6.42 113 3

Czech
7.75 22 1 India 6.91 79 2
Republic
Thailand 6.86 81 2 Senegal 6.17 124 4
Estonia 7.89 13 1 Australia 8.07 9 1

Cayman
Indonesia 7.27 54 2
Islands
Malaysia 7.34 52 2 Haiti 6.49 110 3
Switzerland 8.40 4 1 Japan 7.86 17 1
Vietnam 6.27 119 3 Colombia 6.68 94 1

Antigua and
Kenya 7.05 70 2
Barbuda
Lithuania 7.88 16 1 Liberia 6.56 105 3
United
Bulgaria 7.54 37 1 8.19 5 1
States
Trinidad and
6.70 91 3 Nigeria 6.86 142 4
Tobago
Belize 6.78 85 3 Argentina 5.67 146 4
Curacao Egypt 5.05 155 4
Oman 6.76 89 3 Brazil 6.23 120 3
St. Lucia Pakistan 5.91 136 4
Average 7.54 43 2 Average 6.73 91 3
Median 7.51 40 1 Median 6.68 100 3
Source: World Bank and Fraser Institute.
38
TABLE 5: REGULATORY TRADE BARRIERS IN THE TOP-30 “INCLUSIVE FRAMEWORK” COUN-

TRIES WITH THE HIGHEST AND LOWEST EXPORT INTENSITIES
Highest export Regulatory trade Change in Lowest export Regulatory Change in

intensities (5Y) barriers, 2017 regulatory trade intensities (5Y) trade barriers, regulatory trade
barriers, 2010- 2017 barriers, 2010-
2017, in index 2017, in index
points points
Hong Kong 8.88 0.04 Turkey 7.61 0.76
Luxembourg 8.38 -0.45 New Zealand 8.13 -0.73
Singapore 8.69 -0.31 Italy 8.17 1.29
Malta 8.20 0.75 Burkina Faso 4.43 -0.37
Ireland 7.85 -0.50 Uruguay 5.96 -1.00
Slovak Republic 7.96 0.62 Benin 4.94 -0.41

Russian
Seychelles 5.68 6.00 1.49
Federation
Aruba Bermuda
Bahrain 6.56 -1.73 Sierra Leone 3.94 -2.52

Dominican
Slovenia 8.09 0.80 7.03 0.20
Republic
Netherlands 8.52 0.22 Sri Lanka 5.24 -0.91
Hungary 7.70 0.04 Peru 5.77 -1.68
Belgium 7.93 -0.41 Djibouti NA 0.00
Macao Cameroon 2.53 -4.04
Maldives China 6.99 0.60
Czech Republic 8.40 1.01 India 6.12 -0.34
Thailand 6.87 0.05 Senegal 5.67 -1.11
Estonia 8.46 -0.04 Australia 7.55 -0.73
Cayman Islands Indonesia 4.70 -1.59
Malaysia 7.55 0.47 Haiti 6.11 1.30
Switzerland 8.06 0.90 Japan 7.49 0.59
Vietnam 5.28 -0.49 Colombia 4.27 -2.29

Antigua and
Kenya 5.52 -0.48
Barbuda
Lithuania 7.73 0.38 Liberia 2.33
Bulgaria 7.60 1.32 United States 8.40 0.75

Trinidad and
6.31 -0.62 Nigeria 3.06 -2.12
Tobago
Belize 5.05 -0.45 Argentina 4.89 -0.43
Curacao Egypt 3.70 -3.05
Oman 6.84 -0.79 Brazil 5.94 -0.54
St. Lucia Pakistan 4.09 -1.99
Average 7.50 0.03 Average 5.59 -0.69
Median 7.85 0.02 Median 5.72 -0.51
39
TABLE 6: INVESTMENT BARRIERS IN THE TOP-30 “INCLUSIVE FRAMEWORK” COUNTRIES WITH

Highest export Foreign owner- Change in Lowest export Foreign owner- Change in
intensities (5Y) ship/investment foreign owner- intensities (5Y) ship/investment foreign owner-
restrictions, ship/investment restrictions, ship/investment
2017 restrictions, 2017 restrictions,
2010-2017, in 2010-2017, in
index points index points
Hong Kong 8.46 0.27 Turkey 5.84 0.03
Luxembourg 8.27 -0.49 New Zealand 6.91 -0.45
Singapore 8.53 -0.29 Italy 5.05 0.08
Malta 7.09 0.19 Burkina Faso 5.57 -0.49
Ireland 8.01 -0.36 Uruguay 6.97 -1.04
Slovak Republic 7.88 0.02 Benin 5.22 -0.72
Seychelles Russian
5.97 4.18 -0.05
Federation
Aruba Bermuda
Bahrain 7.46 -0.69 Sierra Leone 5.24
Slovenia Dominican
4.98 0.71 6.54 -0.27
Republic
Netherlands 7.43 0.17 Sri Lanka 5.40 -1.14
Hungary 6.27 -0.89 Peru 6.57 -0.73
Belgium 7.85 0.60 Djibouti
Macao Cameroon 5.69 -0.50
Maldives China 5.89 -0.46
Czech Republic 7.95 1.15 India 5.84 -0.29
Thailand 6.45 0.02 Senegal 5.83 -0.43
Estonia 7.82 0.78 Australia 6.85 -0.41
Cayman Islands 0.00 Indonesia 5.75 -0.23
Malaysia 6.68 -0.45 Haiti 4.20 0.88
Switzerland 7.75 0.24 Japan 7.23 1.45
Vietnam 5.18 -0.17 Colombia 5.54 -0.48
Antigua and
Kenya 6.09 -0.09
Barbuda
Lithuania 5.85 0.61 Liberia 5.78
Bulgaria 5.30 0.42 United States 7.17 0.71
Trinidad and
6.04 -0.23 Nigeria 6.52 0.47
Tobago
Belize 7.82 2.66 Argentina 5.36 -0.01
Curacao 0.00 Egypt 4.30 -0.99
Oman 5.25 -1.07 Brazil 5.20 -0.79
St. Lucia Pakistan 4.94 -0.46
Average 6.97 0.15 Average 5.77 -0.25
Median 7.43 0.10 Median 5.76 -0.42
40
TABLE 7: STATE OF RULE OF LAW IN THE TOP-30 “INCLUSIVE FRAMEWORK” COUNTRIES WITH
Change Change Change Change

Highest Lowest
2010- 2010- 2010- 2010-
export LSPI, export LSPI,
LEC, 2017 2017, in 2017, in LEC, 2017 2017, in 2017, in
intensities 2017 intensities 2017
index index index index
(5Y) (5Y)
points points points points
Hong
6.13 -0.94 7.93 -0.25 Turkey 4.36 -1.24 4.62 -0.44
Kong
Luxem- New
7.46 8.34 0.05 7.18 -0.29 8.61 -0.08
bourg Zealand
Singapore 7.66 -0.11 8.22 -0.01 Italy 3.60 0.41 5.78 -0.17
Burkina
Malta 5.35 6.45 -1.07 2.14 4.26 0.01
Faso
Ireland 3.93 7.51 -0.28 Uruguay 3.59 -0.29 5.23 -0.66
Slovak
3.75 -0.63 5.68 -0.10 Benin 1.07 4.18 -0.03
Republic
Russian
Seychelles 4.06 5.76 Federa- 6.88 -0.66 4.83 -0.34
tion
Aruba Bermuda
Sierra
Bahrain 4.79 5.22 -0.16 4.18 2.60 3.88 0.24
Leone
Dominican
Slovenia 4.23 6.22 0.25 3.53 -0.98 4.11 -0.11
Republic
Nether-
5.14 8.11 0.01 Sri Lanka 3.61 4.91 -0.34
lands
Hungary 4.99 -1.58 5.96 -0.26 Peru 5.08 0.02 4.73 -0.37
Belgium 5.57 -0.02 7.07 0.12 Djibouti
Macao Cameroon 2.17 3.20 -0.32
Maldives China 5.72 -1.01 5.58 -0.55
Czech
3.30 -0.55 6.40 0.35 India 3.12 0.52 5.17 -0.27
Republic
Thailand 6.27 0.17 4.67 -0.48 Senegal 2.79 -0.60 4.28 0.42
Estonia 5.70 -0.20 7.40 0.10 Australia 6.03 -0.14 7.92 -0.16
Cayman
Indonesia 3.32 2.15 4.94 0.69
Islands
Malaysia 4.96 -0.63 5.57 -0.15 Haiti 3.88 2.50 0.49
Switzer-
4.50 -1.57 8.40 -0.14 Japan 6.33 0.53 7.62 0.23
land
Vietnam 5.69 -0.82 5.00 -0.78 Colombia 2.22 0.13 3.94 -0.34
Antigua
and Kenya 4.42 0.33 5.20 1.15
Barbuda
Lithuania 6.24 -0.72 6.56 0.11 Liberia 2.87 4.22
United
Bulgaria 5.08 0.32 5.28 0.39 5.23 -2.10 7.44 0.29
States
Trinidad
and 2.96 4.56 0.05 Nigeria 4.85 -0.23 3.32 -0.48
Tobago
Belize 3.33 5.21 1.21 Argentina 3.63 -1.38 3.98 -0.26
Egypt,
Curacao 3.41 4.04 -0.52
Arab Rep.
Oman 5.04 -0.10 6.18 0.17 Brazil 3.64 -0.36 4.53 -0.53
St. Lucia Pakistan 3.69 0.14 3.63 -0.08
Average 5.05 -0.53 6.42 -0.04 Average 4.02 -0.12 4.88 -0.09
Median 5.04 -0.59 6.22 0.00 Median 3.64 -0.23 4.57 -0.17
Source: Fraser Institute. Note: LEC = state of legal enforcement of contracts, LSPI = state of legal system and
property rights.
41
APPENDIX III – ESTIMATION RESULTS
TABLE 8: CHANGES IN DOMESTIC INVESTMENT, IN BILLION USD
Scenario 1: 12.5% in Scenario 2: 12.5% in Scenario 3: Full elimination

“Home Country” “Host Country” of tax rate differentials
In billion USD Elasticity, low Elasticity, high Elasticity, low Elasticity, high Elasticity, low Elasticity, high
Australia 178.7 357.5 -117.0 -234.0 61.7 123.4
Austria 51.0 101.9 -56.4 -112.9 -5.5 -10.9
Belgium 379.4 758.8 -373.9 -747.9 5.5 10.9
Canada 201.8 403.6 -306.2 -612.4 -104.4 -208.8
Chile 29.3 58.6 -23.7 -47.4 5.6 11.2
Czech
17.2 34.4 -25.1 -50.2 -7.9 -15.8
Republic
Denmark 36.7 73.4 -59.4 -118.9 -22.7 -45.4
Estonia 1.2 2.3 -2.3 -4.6 -1.1 -2.2
Finland 23.4 46.8 -35.6 -71.2 -12.2 -24.3
France 716.8 1,433.6 -445.7 -891.5 271.1 542.1
Germany 455.5 911.0 -393.7 -787.3 61.8 123.7
Greece 11.6 23.2 -9.8 -19.6 1.8 3.6
Hungary -4.0 -8.1 -19.7 -39.4 -23.8 -47.5
Iceland 2.3 4.6 -4.4 -8.8 -2.1 -4.2
Ireland -5.6 -11.2 -98.1 -196.1 -103.6 -207.3
Israel 15.0 29.9 -21.1 -42.2 -6.2 -12.3
Italy 115.4 230.8 -151.7 -303.5 -36.4 -72.7
Japan 184.1 368.3 -222.5 -444.9 -38.3 -76.7
Korea 30.9 61.9 -51.5 -103.0 -20.5 -41.1
Luxembourg 25.7 51.5 -33.4 -66.7 -7.6 -15.2
Mexico 97.7 195.5 -124.2 -248.5 -26.5 -53.0
Netherlands 221.9 443.8 -276.6 -553.2 -54.7 -109.5
New Zealand 18.7 37.4 -24.1 -48.2 -5.4 -10.8
Norway 51.8 103.6 -59.0 -118.0 -7.2 -14.4
Poland 20.3 40.6 -49.7 -99.3 -29.3 -58.7
Portugal 44.1 88.2 -33.5 -67.0 10.6 21.2
Slovak Re-
7.9 15.8 -8.9 -17.8 -1.0 -2.0
public
Slovenia 1.3 2.6 -2.7 -5.4 -1.4 -2.8
Spain 207.7 415.4 -212.0 -424.1 -4.4 -8.7
Sweden 78.2 156.4 -127.5 -255.0 -49.3 -98.7
Switzerland 159.7 319.3 -321.8 -643.5 -162.1 -324.2
Turkey 17.1 34.1 -27.1 -54.2 -10.1 -20.1
United
263.4 526.8 -636.7 -1,273.5 -373.3 -746.7
Kingdom
United States 1,293.2 2,586.5 -935.8 -1,871.6 357.4 714.8
Source: ECIPE calculations based on methodology of OECD (2017).
42
TABLE 9: CHANGES ANNUAL FDI-INDUCED CORPORATE TAX REVENUES, IN BILLION USD

In billion USD Elasticity, low Elasticity, high Elasticity, low Elasticity, high Elasticity, low Elasticity, high
Australia 2.2 4.5 -3.7 -7.3 0.8 1.5
Austria 0.6 1.3 -1.3 -2.7 -0.1 -0.1
Belgium 4.7 9.5 -9.7 -19.4 0.1 0.1
Canada 2.5 5.0 -7.6 -15.1 -1.3 -2.6
Chile 0.4 0.7 -0.8 -1.5 0.1 0.1
Czech
0.2 0.4 -0.5 -1.0 -0.1 -0.2
Republic
Denmark 0.5 0.9 -1.2 -2.3 -0.3 -0.6
Estonia 0.0 0.0 0.0 -0.1 0.0 0.0
Finland 0.3 0.6 -0.7 -1.4 -0.2 -0.3
France 9.0 17.9 -14.7 -29.4 3.4 6.8
Germany 5.7 11.4 -10.7 -21.5 0.8 1.5
Greece 0.1 0.3 -0.3 -0.5 0.0 0.0
Hungary -0.1 -0.1 -0.2 -0.4 -0.3 -0.6
Iceland 0.0 0.1 -0.1 -0.2 0.0 -0.1
Ireland -0.1 -0.1 -1.2 -2.3 -1.3 -2.6
Israel 0.2 0.4 -0.5 -1.0 -0.1 -0.2
Italy 1.4 2.9 -3.3 -6.7 -0.5 -0.9
Japan 2.3 4.6 -6.1 -12.2 -0.5 -1.0
Korea 0.4 0.8 -1.1 -2.3 -0.3 -0.5
Luxembourg 0.3 0.6 -0.8 -1.6 -0.1 -0.2
Mexico 1.2 2.4 -3.4 -6.8 -0.3 -0.7
Netherlands 2.8 5.5 -6.4 -12.7 -0.7 -1.4
New Zealand 0.2 0.5 -0.6 -1.3 -0.1 -0.1
Norway 0.6 1.3 -1.4 -2.7 -0.1 -0.2
Poland 0.3 0.5 -0.9 -1.7 -0.4 -0.7
Portugal 0.6 1.1 -0.9 -1.8 0.1 0.3
Slovak Re-
0.1 0.2 -0.2 -0.4 0.0 0.0
public
Slovenia 0.0 0.0 0.0 -0.1 0.0 0.0
Spain 2.6 5.2 -5.3 -10.5 -0.1 -0.1
Sweden 1.0 2.0 -2.5 -5.0 -0.6 -1.2
Switzerland 2.0 4.0 -6.3 -12.6 -2.0 -4.1
Turkey 0.2 0.4 -0.5 -1.1 -0.1 -0.3
United
3.3 6.6 -12.1 -24.2 -4.7 -9.3
Kingdom
United States 16.2 32.3 -25.7 -51.5 4.5 8.9
Source: ECIPE calculations based on methodology of OECD (2017).
43
TABLE 10: CHANGES IN ANNUAL FDI-INDUCED CORPORATE TAX REVENUES, IN % OF ANNUAL

2018 CIT REVENUES

in % of total
Elasticity, low Elasticity, high Elasticity, low Elasticity, high Elasticity, low Elasticity, high
CIT revenue
Australia 4% 7% -6% -12% 1% 3%
Austria 5% 11% -11% -23% -1% -1%
Belgium 22% 44% -45% -90% 0% 1%
Canada 4% 9% -13% -26% -2% -5%
Chile
Czech Re-
3% 5% -7% -13% -1% -3%
public
Denmark 5% 10% -12% -24% -3% -6%
Estonia 19% 38% -50% -100% -18% -36%
Finland 5% 9% -10% -21% -2% -5%
France 13% 26% -21% -43% 5% 10%
Germany 7% 14% -14% -27% 1% 2%
Greece 3% 7% -6% -12% 1% 1%
Hungary
Iceland 6% 12% -17% -33% -5% -11%
Ireland -1% -1% -10% -21% -11% -23%
Israel 2% 3% -4% -8% -1% -1%
Italy 4% 8% -9% -19% -1% -3%
Japan 1% 2% -3% -6% 0% 0%
Korea 1% 1% -2% -3% 0% -1%
Luxembourg 8% 17% -21% -43% -3% -5%
Mexico
Netherlands 9% 19% -22% -43% -2% -5%
New Zealand 3% 5% -7% -14% -1% -1%
Norway 3% 6% -7% -14% 0% -1%
Poland 2% 5% -8% -16% -3% -7%
Portugal 7% 15% -12% -25% 2% 4%

Slovak Re-
3% 6% -6% -12% 0% -1%
public
Slovenia 2% 3% -5% -10% -2% -4%
Spain
Sweden 7% 14% -18% -35% -4% -9%
Switzerland 9% 19% -29% -59% -9% -19%
Turkey 2% 4% -5% -10% -1% -2%

United King-
4% 9% -16% -33% -6% -13%
dom
United States 9% 18% -14% -29% 2% 5%
Source: ECIPE calculations based on methodology of OECD (2017). Scenario 3: full elimination of tax rate
differentials.
44
TABLE 11: CHANGES IN REVENUES FROM TAXES ON PERSONAL INCOME AND SOCIAL SECU-
RITY CONTRIBUTIONS UNDER 12.5% EFFECTIVE CORPORATE TAX
Change in
Change in so-
personal
cial security
Taxes on FDI-induced income tax
Personal Social secu- contributions
corporate changes in revenues
income taxes rity contribu- attributed
income in % corporate tax attributed
in % of total tions in % of to changes
of total tax- revenues in to changes
taxation total taxation in domestic
ation bn USD in domestic
investment, in
investment, in
bn USD
bn USD
Australia 1.5
Austria 22% 6% 35% -0.1 0.0 -0.2
Belgium 27% 10% 30% 0.1 0.0 0.2
Canada 36% 11% 14% -2.6 -0.8 -1.0
Chile 7% 22% 40% 0.1 0.5 0.8

Czech Re-
12% 10% 44% -0.2 -0.2 -0.7
public
Denmark 54% 6% 0% -0.6 -0.1 0.0
Estonia 17% 6% 25% 0.0 0.0 0.0
Finland 29% 6% 28% -0.3 -0.1 -0.3
France 21% 5% 35% 6.8 1.5 11.5
Germany 27% 6% 38% 1.5 0.3 2.1
Greece 0% 0% 0% 0.0
Hungary 14% 3% 30% -0.6 -0.1 -1.3
Iceland 40% 7% 33% -0.1 0.0 0.0
Ireland 31% 14% 10% -2.6 -1.2 -0.8
Israel 21% 10% 7% -0.2 -0.1 -0.1
Italy 26% 4% 17% -0.9 -0.2 -0.6
Japan 0% 0% 0% -1.0
Korea 18% 16% 31% -0.5 -0.4 -0.9
Luxembourg 24% 15% 25% -0.2 -0.1 -0.2
Mexico 0% 0% 0% -0.7
Netherlands 21% 9% 27% -1.4 -0.6 -1.8
New Zealand 37% 16% 36% -0.1 -0.1 -0.1
Norway 25% 15% 0% -0.2 -0.1 0.0
Poland 15% 6% 26% -0.7 -0.3 -1.3
Portugal 19% 10% 37% 0.3 0.1 0.5

Slovak
11% 10% 27% 0.0 0.0 -0.1
Republic
Slovenia 15% 5% 35% 0.0 0.0 -0.1
Spain 22% 7% 44% -0.1 0.0 -0.2
Sweden 29% 7% 34% -1.2 -0.3 -1.4
Switzerland 30% 11% 22% -4.1 -1.4 -2.9
Turkey 15% 9% 24% -0.3 -0.1 -0.4

United
27% 9% 30% -9.3 -2.9 -10.3
Kingdom
United States 41% 4% 19% 8.9 1.0 4.2
Source: ECIPE calculations and OECD tax revenue data. Note: the estimates outlined in column 5 are for sce-
nario 3 and based on a semi-elasticity of -3.
45
FIGURE 10: DECREASES IN ANNUAL CORPORATE TAX REVENUES IN % OF 2018 CORPORATE

TAX REVENUES
-62% France
-60% Australia
-55% Greece
-55% Portugal
-55% United States
-55% Japan
-54% Germany
-53% New Zealand
-52% Belgium
-49% Canada
-49% Luxembourg
-47% Austria
-46% Norway
-46% Netherlands
-45% Israel
-43% Italy
-43% Korea
-43% Slovak Republic
-39% Czech Republic
-38% Turkey
-37% Sweden
-36% Switzerland
-36% Denmark
-34% United Kingdom
-34% Finland
-34% Iceland
-30% Slovenia
-29% Poland
-26% Estonia
6% Ireland
Source: ECIPE calculations based on OECD data.
46
TABLE 12: CHANGES IN CORPORATE TAX REVENUES UNDER 12.5% EFFECTIVE CORPORATE TAX
Corpo- Change in
Difference FDI-in-
rate tax tax reve- FDI-in- Aggregate
corpo- duced
revenues, nues [cur- duced change in
rate tax changes in
Corporate based rent regime, changes tax reve-
revenues tax reve-
tax reve- on 12.5% 12.5% in tax nues, in
[current nues in %
nues, in bn minimum regime], in revenues % of tax
regime, of tax reve-
USD, 2018 effective % of reve- from 12.5% revenues
12.5% nues under
corporate nues from regime, in of current
regime], in 12.5%
tax regime, current bn USD regime
bn USD regime
in bn USD regime
Australia 61.4 24.5 -37.0 -60% 1.5 6% -58%
Austria 11.6 6.1 -5.5 -47% -0.1 -2% -48%
Belgium 21.5 10.3 -11.2 -52% 0.1 1% -51%
Canada 57.4 29.0 -28.4 -49% -2.6 -9% -54%
Chile 0.1
Czech
7.9 4.8 -3.1 -39% -0.2 -4% -42%
Republic
Denmark 9.5 6.1 -3.4 -36% -0.6 -9% -42%
Estonia 0.1 0.1 0.0 -26% 0.0 -49% -62%
Finland 6.5 4.3 -2.2 -34% -0.3 -7% -39%
France 69.1 26.2 -42.9 -62% 6.8 26% -52%
Germany 78.8 36.1 -42.7 -54% 1.5 4% -52%
Greece 4.3 2.0 -2.4 -55% 0.0 2% -54%
Hungary - - 0.0 - -0.6 - -
Iceland 0.5 0.3 -0.2 -34% -0.1 -16% -44%
Ireland 11.3 11.9 0.6 6% -2.6 -22% -17%
Israel 11.4 6.2 -5.2 -45% -0.2 -2% -47%
Italy 35.7 20.2 -15.5 -43% -0.9 -4% -46%
Japan 210.8 95.9 -114.9 -55% -1.0 -1% -55%
Korea 65.0 36.9 -28.0 -43% -0.5 -1% -44%
Luxembourg 3.8 1.9 -1.9 -49% -0.2 -10% -54%
Mexico - - - - -0.7 - -
Netherlands 29.4 16.0 -13.4 -46% -1.4 -9% -50%

New
9.1 4.3 -4.9 -53% -0.1 -3% -55%
Zealand
Norway 20.1 10.9 -9.3 -46% -0.2 -2% -47%
Poland 10.7 7.6 -3.1 -29% -0.7 -10% -36%
Portugal 7.4 3.4 -4.0 -55% 0.3 8% -51%

Slovak
3.2 1.8 -1.4 -43% 0.0 -1% -43%
Republic
Slovenia 1.0 0.7 -0.3 -30% 0.0 -5% -34%
Spain - - - - -0.1 - -
Sweden 14.3 9.0 -5.3 -37% -1.2 -14% -45%
Switzerland 21.4 13.7 -7.7 -36% -4.1 -30% -55%
Turkey 11.3 7.0 -4.3 -38% -0.3 -4% -40%

United
74.1 48.7 -25.5 -34% -9.3 -19% -47%
Kingdom
United
179.8 81.7 -98.1 -55% 8.9 11% -50%
States
Source: ECIPE calculations based on OECD tax revenue data. Note: the estimates outlined in column 6 are for
scenario 3 and based on a semi-elasticity of -3.
47
APPENDIX IV – CORPORATE TAXATION, REVENUES AND ECONOMIC ACTIVITY
FIGURE 11: CORRELATION BETWEEN REDUCTIONS IN THE STATUTORY CORPORATE TAX RATE
AND REVENUES FROM TAXES ON CORPORATE INCOME
100%
90%
100%
1995 level
80%
90%
% oflevel
70%
80%
% ofin1995
60%
70%
in rate
50%
60%
CIT rateCIT
40%
50%
2018 statutory
30%
40%
2018 statutory
20%
30%
10%
20%
0%
10%
-2% 0% 2% 4% 6% 8% 10% 12% 14%
0% CAGR corporate tax revenue
-2% 0% 2% 4% 6% 8% 10% 12% 14%
CAGR corporate tax revenue
AND100%
REVENUES FROM SALES TAXES
90%
1995 level
100%
80%
90%
% oflevel
70%
80%
% ofin1995
60%
70%
in rate
50%
60%
CIT rateCIT
40%
50%
2018 statutory
30%
40%
2018 statutory
20%
30%
10%
20%
0%
10%
0% 2% 4% 6% 8% 10% 12%
0% CAGR sales tax revenues, 1995 to 2018
0% 2% 4% 6% 8% 10% 12%
CAGR sales tax revenues, 1995 to 2018
48
AND REVENUES FROM SOCIAL SECURITY CONTRIBUTIONS
100%
90%
of 1995 level
80%
100%
70%
90%
in %level
60%
80%
1995
rate
50%
70%
% of
rate inCIT
40%
60%
statutory
30%
50%
2018 CIT
20%
40%
2018 statutory
10%
30%
0%
20%
0% 2% 4% 6% 8% 10% 12% 14%
10%
CAGR social security contributions, 1995 to 2018
0%
0% 2% 4% 6% 8% 10% 12% 14%
Source: ECIPE calculations based on OECD
CAGR data.
social security contributions, 1995 to 2018
100%
AND GDP GROWTH
90%
of 1995 level
100%
80%
90%
70%
in %level
60%
80%
1995
rate
50%
70%
% of
rate inCIT
40%
60%
statutory
30%
50%
2018 CIT
40%
20%
2018 statutory
30%
10%
0%
20%
0% 1% 2% 3% 4% 5% 6% 7% 8% 9%
10%
CAGR GDP (Current prices, current PPPs), 1995-2018
0%
0% 1% 2% 3% 4% 5% 6% 7% 8% 9%
CAGR GDP (Current prices, current PPPs), 1995-2018
49
AND GROWTH IN INWARD FDI POSITIONS
100%
90%
1995 level
100%
80%
90%
% oflevel
70%
80%
1995
60%
% of in
70%
in rate
50%
60%
CIT rateCIT
40%
50%
2018 statutory
30%
40%
2018 statutory
20%
30%
10%
20%
0%
10%
6% 8% 0% 10% 2% 12% 4% 14% 16%
0%
CAGR inward FDI positions, 2005-2018
0% 2% 4% 6% 8% 10% 12% 14% 16%
AND GROWTH IN OUTWARD FDI POSITIONS
100%
90%
1995 level
100%
80%
90%
% oflevel
70%
80%
1995
60%
% of in
70%
in rate
50%
60%
CIT rateCIT
40%
50%
2018 statutory
30%
40%
2018 statutory
20%
30%
10%
20%
0%
10%
-10% -5% 0% 5% 10% 15% 20% 25%
0% CAGR inward FDI positions, 2005-2018
-10% -5% 0% 5% 10% 15% 20% 25%
50
APPENDIX V – TAX INCIDENCE EFFECTS
FIGURE 17: TRANSMISSION CHANNELS UNDERLYING THE INCIDENCE OF TAXES ON CORPO-

RATE INCOME
Company subject to corporate income tax

Upstream pass on: Downstream pass on: Internal pass on: Internal/external pass on:
Company decides to increase Company decides to pay less Company decides to pay less Company decides to pay less to
prices to suppliers to workers owners and investors
• Higher cost for purchasing • Higher cost for other • Lower wages and salaries • Lower personal income for
companies (B2B), resulting in companies (B2B) other • Job cuts company owners
lower profitability, lower suppliers, resulting in lower • Lower rises in wages and • Lower capital income for
solvency, less investment profitability, lower salaries company owners
• Higher prices for final solvency, less investment • Less purchasing power (shareholders)
consumers (B2C), less • Lower dividend payments
purchasing power (shareholders)
• Lower returns on investment
Burden directly and indirectly borne by individual consumers, Burden directly borne by Burden directly borne by
individual workers and individual company owners/investors individual workers (labour) individual investors (capital)
2nd –round, 3rd –round … effects due to value chain pass on effects
Source: Own illustration.
51
TABLE 13: ECONOMIC COSTS (TAX INCIDENCE EFFECTS) OF CORPORATE TAXES, SALES TAXES,
TARIFFS AND TAXES ON DIGITAL SERVICES
Sales taxes and taxes on Taxes on Digital Services

Corporate taxes Tariffs
value added (VAT) (DST)
Taxes on corporate The tax incidence of Tariffs are sales taxes As DSTs are hybrids,
income are directly and in- sales taxes is borne by levied on imported goods. combining the features
directly passed on workers buyers and sellers. The The tax incidence of of corporate taxes, sales
(lower wages), consumers lower the price elasticity tariffs is similar to the inci- taxes and tariffs, their tax
(higher prices), entre- of demand, the higher the dence of sales taxes. The burden will directly and
preneurs and investors share of the burden that difference is that the tax indirectly passed on to
(lower income). Depending is borne by consumers. burden is shared between workers (lower wages),
on bargaining power com- Although sales tax code foreign sellers and domes- consumers (higher prices),
panies can also pass on is generally comparatively tics buyers, depending on entrepreneurs and in-
costs to suppliers or cor- transparent with respect the elasticity of demand. vestors (lower income).
porate customers, which to tax base and tax rates, Although tariff schedules The precise size and dis-
pass on the tax burden the share that is borne by are comparatively trans- tribution of these effects
to others (second-round companies is directly and parent with respect to is close to impossible to
effects). The transmission indirectly passed on to commodities and rates, assess. For advertisement
channels are complex. others, i.e. workers (lower the share that is borne by and online intermediation
Due to corporate tax code wages) and entrepreneurs companies is directly and services, impacts assess-
complexity, it is close to and investors. indirectly passed on to ment and recent develop-
impossible to assess the others, i.e. workers (lower ment show that the burden
distributional impacts of wages) and entrepreneurs from DSTs will, to varying
corporate taxes. and investors. extents, be passed on to
the consumers of these
services.
Source: ECIPE.
TABLE 14: CONTRIBUTION TO TOTAL ANNUAL TAX REVENUES
Sales taxes and taxes on Taxes on Digital Services

Corporate taxes Tariffs
value added (VAT) (DST)
Taxes on corporate Sales taxes account for Customs and other import Taxes on digital services
income account for low relatively high shares of duties account for very are hybrids of corporate
shares of overall tax overall tax revenue. The low shares of overall tax taxes, sales taxes and
revenue. The OECD OECD average is 26.2%. revenue in OECD count- tariffs. They are formally
average is 9.5%. In 2018, In 2018, sales taxes ries, e.g. for only 1.6% of paid by firms, calculated on
taxes on corporate income accounted for only 27.5% the total tax revenues in the basis of revenues and
accounted for only 6.4% of the total tax revenue in Japan and 2.7% in the by design equivalent to an
of the total tax revenue in Austria, 25.0% in France, United States. The shares import tariff on services.
Austria, 4.6% in France, 26.2% in Germany, and are relatively high for Fiscal forecasts indicate
5.6% in Germany, and 17.6% in the United some developing count- that revenues from DSTs
4.4% in the United States. States. ries and island states. are very small, accounting
for only 0.15% of the total
tax revenues in Austria,
0.05% in France, 0.1% in
Italy, 0.29% in Spain, and
0.03% in the UK.
Source: Summary based on ECIPE calculations.
52
Tax Policy
Concept Statement 3
Guiding Principles for Tax Law Transparency
Issued September 2003
AICPA______________________________________________________
Issued by the Tax Division of the
American Institute of Certified Public Accountants
1
NOTICE TO READERS
Tax Policy Concept Statements of the AICPA Tax Division are issued for the general
information of those interested in the subject. They present the conclusions of the
Division, as approved by the Tax Executive Committee. The Tax Executive Committee is
a senior technical body of the AICPA authorized to speak for the AICPA in the area of
taxation.
Tax Policy Concept Statements are intended to aid in the development of tax legislation
in directions that the AICPA believes are in the public interest.
Tax Policy Concept Statements do not establish standards enforceable under the
AICPA’s Code of Professional Ethics and are not intended for that purpose.
2
Copyright © 2003 by
American Institute of Certified Public Accountants, Inc.
New York, NY 10036-8775
All rights reserved. For information about the procedure for requesting permission to
make copies of any part of this work, please call the AICPA Copyright Permissions
Hotline at (201) 938-3245. A Permissions Request Form for e-mailing requests is
available at www.aicpa.org by clicking on the copyright notice of any page. Otherwise,
requests should be written and mailed to Permissions Department, AICPA, Harborside
Financial Center, 201 Plaza Three, Jersey City, NJ 07311-3881
1 2 3 4 5 6 7 8 9 0 TD 0 9 8 7 6 5 4 3
3
TABLE OF CONTENTS
Foreword
The Transparency Principle
Why Tax Law Transparency Is Important
AICPA Tax Policy Statement
A Roadmap for Tax Law Transparency
Explanation of the Roadmap

Make the Promulgation of a Good Tax System a Priority
Implement Transparent Approaches
Eliminate and Avoid Phaseouts
Eliminate and Avoid Interactive Provisions
Adopt Uniform Definitions of Terms for All Statutory Purposes
Avoid Multiple Effective Dates and Sunset Dates
Challenges
Bibliography
4
FOREWORD
This is the third in a series of tax policy concept statements issued by the AICPA Tax
Division on tax policy matters. It is intended to aid in the development of tax legislation
in directions that the AICPA believes are in the public interest.
Tax policy concept statements are approved by the Tax Executive Committee of the
AICPA Tax Division after they are developed and approved by the division’s Tax
Legislation and Policy Committee. Other division committees and technical resource
panels may develop tax policy concept statements if requested to do so.
This statement was developed by the 2001-02 and 2002-03 Tax Legislation and Policy
Committee. It was approved by the 2002-03Tax Legislation and Policy Committee and
the 2002-03 Tax Executive Committee. Members of the bodies that approved this
statement tax policy concept statement are listed below.
AICPA Tax Executive Committee

(2002-03)
Robert A. Zarzar, Chair Annette Nellen
Pamela J. Pecarich, Past Chair Thomas P. Ochsenschlager
Steven K. Bentley Robert A. Petersen
Barbara A. Bond Thomas J. Purcell, III
Mark H. Ely James W. Sansone
Lisa C. Germano C. Clinton Stretch
Ronald B. Hegt Judyth A. Swingen
Kenneth H. Heller William A. Tate
Jeffrey R. Hoops James P. Whitson
Nancy K. Hyde
AICPA Tax Legislation and Policy Committee

(2002-03)
Rachelle B. Bernstein, Chair Christopher W. Hesse

Donald R. Longano, Past Chair Betty R. Jackson
Donald A. Barnes Cherie J. O’Neil
Allen M. Beck Mary Lou Pier
Daniel J. Breuning Abram J.Serotta
Robert G. Byelich Neil A.J. Sullivan
Nicholas P. Giordano C. Elizabeth Wagner
5
Additional Members
AICPA 2001-02 Tax Legislation and Policy Committee Members
Mark Garay J.F. Kubik

James Hale Lorin D. Luchs
Joseph L. Keller Phillip D. Moseley
Stuart Kessler Judyth A. Swingen
AICPA Tax Division Staff
Gerald W. Padwe, Vice President William R. Stromsem, Director

Edward S. Karl, Director Carol B. Ferguson, Technical Manager
The AICPA Tax Division gratefully acknowledges the significant contributions of Betty
R. Jackson in the development of the direction and the drafting of the statement.
6
GUIDING PRINCIPLES FOR TAX LAW TRANSPARENCY
THE TRANSPARENCY PRINCIPLE

A good tax system – one that facilitates and encourages compliance – needs to be
understandable to those who are expected to pay the tax and by those who administer the
tax. In Tax Policy Concept Statement No. 1, Guiding Principles for Good Tax Policy: A
Framework for Evaluating Tax Proposals, the AICPA sets forth ten guiding principles.
One of the principles, transparency, is the basic notion that taxpayers should know,
namely, (1) that a tax exists; and, 2) how and when the tax is imposed on them and
others.
In Tax Policy Concept Statement No. 2, Guiding Principles for Tax Simplification, the
AICPA explores the importance of reducing complexity in the law. Transparency is an
important partner with tax simplification. The more complex a tax system is, the less
transparent it tends to be. Complexity obscures how, when, and on whom a tax is
imposed, which increases confusion, frustration, and the perception that the tax is
unfairly imposed and thereby decreases compliance. Transparency is critical for
understanding the impact of any given tax.
WHY TAX LAW TRANSPARENCY IS IMPORTANT
If taxpayers and their advisers cannot understand the tax system, they cannot evaluate the
impact of that system. Beyond the fundamental aspect of actual and perceived fairness,
7
proposing understandable changes to an understandable tax system would result in
broader consensus on whether a change is necessary, wise, or effective. A tax that is not
understandable can be easily retained or raised with little awareness among taxpayers
about how the tax affects them. Without transparency, “gimmicks” such as deduction,
exemption and credit phaseouts for raising revenue flourish and more appropriate,
fundamental approaches such as increases in statutory tax rates are avoided.
The tax system is a primary link between citizens and their government, with a
significant influence on citizen attitudes toward government. In 1972, Americans rated
the income tax as the fairest tax; but by 1979, most people rated it as the most unfair tax.1
This downward trend continues. If taxpayers cannot clearly “see” their tax burdens, they
view the entire system as unfair. Some taxpayers have come to believe that they are
entitled to a lower tax bill and resist in the only way they can – by exerting more effort to
find ways of reducing their tax bills, legitimately or otherwise. These efforts put
additional pressure on our self-assessment system that depends heavily on taxpayers’
willingness to comply.
Recently, transparency in financial reporting has become a top priority, recognized even
in the mainstream media. Transparency in financial reporting by public companies is
measured by “the extent to which financial information about a company is available and
1
The Decline [and Fall?] of the Income Tax, by Michael J. Graetz, New York, NY: W.W. Norton &
Company, Inc., 1997.
8
understandable to investors and other market participants.”2 Transparency in tax law
should be measured by how easily taxpayers can determine whether and how any
particular tax provision – and the tax statute as a whole – affects their tax burden.
As an example of the problems faced by the tax system, Department of the Treasury
Assistant Secretary for Tax Policy, Pam Olson described the international tax rules as
“hard to understand, messy, inconsistent, and display[ing] little regard for the real
world.”3 This same statement could be made with respect to many federal and state tax
rules today because they are obscured.
Obscurity in the tax law may cause harm by:
• Creating significant inequities, both real and perceived.
• Impairing government’s ability to administer the tax system.
• Allowing opportunities for tax evasion and aggressive tax avoidance techniques.
• Frustrating taxpayers and tax advisers when they attempt to plan transactions and
comply with the law.
• Resulting in unintentional misstatements of income and deductions.
• Creating inefficiencies that impede taxpayer decision-making and undermine
economic development.
2
Statement by John M. Morrissey, Deputy Chief Accountant, U.S. Securities and Exchange
Commission, in testimony before the Subcommittee on Oversight and Investigations, Committee on
Financial Services, March 21, 2002.
9
• Imposing significant costs on taxpayers, tax advisers, and the government.
Increasing the transparency of the tax law should:
• Result in a system that is and is perceived by taxpayers as being fairer.
• Enhance the efficiency of administering the tax system.
• Decrease tax evasion.
• Diminish the incentive to use overly aggressive tax avoidance techniques.
• Increase taxpayer and tax practitioner certainty in tax planning and compliance.
• Reduce tax return error rates.
• Provide a stimulus for growth by making economic decision-making more
efficient.
• Reduce the direct and indirect costs of complying with and administering a
complex and nontransparent tax system, freeing up resources for productive
activities.
Too little transparency affects everyone dealing with the tax system:
• Taxpayers. Taxpayers at all education and economic levels have the right to be
able to comprehend both the tax base (the amount upon which a tax will be
3
Remarks of Pam Olson, Assistant Secretary for Tax Policy, before the IRS/George Washington
University 15th Annual Institute on Current Issues in International Taxation, December 12, 2002.
10
levied) and the tax rate that will be imposed. Currently, taxpayers face a
bewildering array of ambiguities about the tax base which result from multiple
definitions of identical terms, interactive provisions, phaseouts, disallowance of
certain tax benefits as income rises, and the increasing possibility of falling into
an alternative tax system, e.g., the alternative minimum tax (AMT). Taxpayers are
also challenged in determining their tax rate under the combination of an
expanding menu of applicable “regular” income tax rates, phaseouts which
change effective rates as income rises, and potential alternative tax rates under the
AMT system.
• Tax Practitioners. Efficient decision-making requires that tax advisers be able to
integrate reasonable approximations of relevant tax consequences as they
encounter or plan economic transactions. This is very difficult today, even in
some of the most routine aspects of our economic lives. The difficulty of
estimating tax effects is increasingly burdensome and a drag on economic activity
and development.
• Tax Administrators. The tax system’s administrators must be able to understand
the system sufficiently to (1) provide timely, comprehensible guidance to
taxpayers and their advisers and, (2) be able to enforce the law and make the
appropriate collections. The growing burden placed on tax administrators
significantly reduces efficiency and impedes effective interactions with taxpayers
and advisers.
• Lawmakers and Policy Analysts. In order to evaluate how fairly the tax burden is
distributed, lawmakers and policy analysts must be able to see clearly how and to
11
whom various taxes apply, how laws are complied with, and the revenue
generated by various provisions in the law.
The AICPA and other concerned observers believe that we have reached a critical
juncture. Improving the tax system’s transparency will be the more difficult choice in the
short run; but by making transparency a priority in the legislative process and by
developing procedures in legislative and regulatory processes to avoid obscuring the true
tax burden, we can reverse the detrimental effects and provide long-term benefits for
taxpayers and the economy.
AICPA TAX POLICY STATEMENT
In this document, Tax Policy Concept Statement No. 3, Guiding Principles for Tax Law
Transparency, the AICPA affirms its support of efforts to improve the transparency and
visibility of our federal and state tax laws. This entails bringing an end to the unnecessary
mechanical complexity and backdoor revenue provisions which obscure taxpayers’
ability to identify the true cost of transactions, what their total tax liability is, and which
level of government is being paid the tax. Increased transparency will reduce the
complexity and improve the perceived fairness of our tax system, benefiting all
constituents of the tax system.
12
A ROADMAP FOR TAX LAW TRANSPARENCY
The AICPA recommends that the following guiding principles be used in the
development of more transparent tax legislation:
• Make the promulgation of a good tax system a priority. Transparency is a key
principle of good tax law. Unfortunately, it has not been a high priority in tax
legislation in recent years. For the law to become more transparent, lawmakers
must recognize transparency’s significance in achieving: a fair tax law, improved
compliance, and a healthy economic environment.
• Implement transparent approaches. Lawmakers should thoroughly review tax
statutes to identify and eliminate features that systematically obscure the tax base
and tax rate. To the extent feasible, existing provisions should be revised. In
addition, all prospective provisions should be evaluated against the transparency
principle. For example, any proposed change to the tax law should address
whether taxpayers will be able to understand their true tax rate and have
confidence in calculating their tax base. If the answer is no, additional work is
needed to make the proposal follow the transparency principle.
Actions that must be taken in order to follow the guiding principles set forth above
include (more detailed discussion and examples are provided in the next section):
• Eliminate and avoid phaseouts. Phaseouts create difficulties in estimating a
taxpayer’s marginal tax rate and in determining the ultimate tax cost or tax
savings of any economic choice.
13
• Eliminate and avoid interactive provisions. Interactive provisions, which apply if
a taxpayer engages in specific transactions, benefits from certain deductions, or
exceeds a range of income limitations, complicate taxpayers’ determinations of
their tax bases or their tax rates; thereby, obscuring the impact of any given
provision.
• Adopt uniform definitions of terms for all statutory purposes. Inconsistent
concepts and definitions are unnecessarily confusing and obscure the law’s
purpose and impact.
• Avoid multiple effective dates and sunset dates. Multiple effective dates and
sunset dates create confusion and obscure the law’s effect.
EXPLANATION OF THE ROADMAP
Make the Promulgation of a Good Tax System a Priority
Political expediency has driven the implementation of many provisions that harm
constituents of the tax system by concealing the tax base and tax rates. Transparency, a
key principle of good tax law, has devolved from an accepted ideology into a nearly zero-
priority concern.
Transparency is tightly intertwined with the broad principle of simplification. Multiple
calculations using different sets of rules, definitions, and reference points have become
14
exceedingly complex. The resulting lack of transparency leads to higher levels of
confusion and errors on the part of taxpayers and greater administrative costs for the
Internal Revenue Service (IRS).
The tax law has become virtually impenetrable, not only to most taxpayers but also to
many tax experts. Money magazine’s annual comparative study of standard returns
prepared by professionals regularly results in a wide variety of final tax calculations. It
also demonstrates that the relative correctness of the returns does not reflect either the
time spent or fees charged. Furthermore, the study shows that IRS personnel, who are
responsible for administering the tax system, also have difficulties in calculating tax
liabilities.
Implement Transparent Approaches
Revenue needs, as well as economic and social objectives, will always drive tax law
changes, but necessary rate changes should be straightforward and visible. Although it
may seem obvious, a taxpayer’s effective marginal tax rate should be the same as the
statutory rate, thus enabling taxpayers to reasonably anticipate their ultimate tax rate.
Many taxpayers still experience marginal rates substantially higher than the statutory rate.
Taxpayers commonly have no confidence in their ability to calculate their own tax rate or
their taxable income, even after consulting with their tax advisers.
Although the following examples focus on federal individual income tax law, the
concepts apply equally to state tax law, other types of taxes, and other types of taxpayers.
15
Example 1: John and Mary Taylor are both age 65 and file a joint tax return for
2003. They have $38,600 of retirement plan and other ordinary income, and
$18,000 of social security benefits. They claim the standard deduction. Their
taxable income is $30,160 ($38,600 of retirement plan and other ordinary income,
$9,060 of taxable social security, less $11,400 standard deduction and $6,100
personal exemption). Their income tax is $3,824 (15-percent bracket).
Next, assume that all the facts are the same as above, but the taxpayers receive an
additional $1,000 of retirement plan income. The Taylors’ taxable income
increases by $1,850 ($1,000 additional retirement income and an $850 increase in
the taxable portion of their social security) to $32,010. Their income tax increases
by $278 (27.8 percent of their incremental income, even though they remain in
the 15-percent tax rate bracket) to $4,102.
Starting with the same original example, next assume that the Taylors instead
realize $1,000 of capital gain from the sale of stock that they have held for more
than one year (rather than have $1,000 of retirement plan income). Their taxable
income increases by $1,850 ($1,000 additional capital gain with an $850 increase
in the taxable portion of their social security) to $32,010. Their income tax
increases by $178 (17.8 percent of their incremental income, even though they
remain in the 15-percent tax rate bracket and their long-term capital gain rate is 5
percent) to $4002.
16
In each situation, $1,000 of additional ordinary or long-term capital gain income
does not result in $150 or $50 of additional tax for someone in the 15- or 5-
percent tax bracket respectively, but instead has differing results. Very often, the
taxpayer will not understand the tax impact of a change in financial circumstances
until they ultimately prepare their tax return or seek professional advice.
Unnecessary mechanical and complex calculations, ambiguous definitions, and
complicated interactions with other provisions should be identified and eliminated.
Backdoor provisions that affect the tax base and tax rate under certain circumstances
should be eliminated in favor of straightforward tax-base or tax-rate adjustments. Formal
procedures restricting the use of these types of “problem provisions” can be developed to
promote future transparency.
Eliminate and Avoid Phaseouts
Until the Tax Reform Act of 1986, deductions and credits were generally not subject to
phaseouts. Since then, the standard de facto method of increasing revenue (and changing
tax rates) has been to phase out exemptions and deductions at specific income levels.
These phaseouts have dramatically complicated the law and proliferated without
common, coherent guidelines for determining threshold amounts, phaseout ranges, or
17
applicable percentages. Practitioners are burdened daily by the lack of transparency
resulting from phaseouts, which complicates their workloads and confuses their clients.
Example 2: Robert and Ann Smith file a joint tax return in 2003 listing ordinary
income of $140,000 and $15,000 of itemized deductions from taxes and charitable
giving. Their taxable income is $118,915 ($140,000 less $6,100 in personal
exemptions and $14,985 in itemized deductions [$15,000 net of an itemized
deduction phaseout of $15]). Their tax is $23,477, and they are in the 28-percent
bracket.
If the Smiths have an additional $10,000 of ordinary income, their taxable income
increases by $10,300 ($10,000 additional ordinary income, plus $300 more in
disallowed itemized deductions) to $129,215. Their income tax increases by
$2,884 (28.8 percent of their incremental income) to $26,361 even though they
remain in the 28-percent bracket.
Example 3: Sam and Sarah Jones file a joint return for 2003 listing ordinary
income of $209,200 and $20,000 of itemized deductions from taxes and charitable
giving. Their taxable income is $185,191 ($209,200 less $6,100 in personal
exemptions and $17,909 in itemized deductions [$20,000 net of an itemized
deduction phaseout of $2,091]. Their tax is $42,559, and they are in the 33-
percent bracket.
18
If the Joneses have only an additional $100 of ordinary income, their taxable
income increases by $225 ($100 additional ordinary income, plus $3 more in
disallowed itemized deductions and a $122 decrease in personal exemptions) to
$185,416. Their income tax increases by $74 (74 percent of their incremental
income) to $42,633, even though they remain in the 33-percent bracket.
As a result of the hidden tax imposed by the phaseouts of itemized deductions and
personal exemptions, neither the Smiths nor the Joneses can accurately predict the
impact of a change in their financial circumstances based on their tax bracket.
As noted in a September 13, 2002, submission to the Department of Treasury by the
AICPA:4
Under current law, phaseouts complicate tax returns immensely and
impose marriage penalties. Phaseout instructions are difficult to
understand and the average taxpayer cannot manage the complex
calculations. In addition, the differences in phaseout methods and
definitions of income cause a compliance burden on many individuals and
make it difficult for taxpayers to recognize when they are eligible for a
benefit and when and how any phaseout applies. Tremendous income-
level differences exist across the various programs using phaseouts. As it
stands, some phaseouts are so complicated that neither the targeted
4
Identical submissions were also made by the American Bar Association Section of Taxation and the Tax
Executives Institute.
19
taxpayers nor those charged with explaining and administering the rules
are able to accurately understand and interpret them.
Eliminate and Avoid Interactive Provisions
Interactive provisions such as investment interest limitations or passive activity losses
complicate determinations of the tax base and tax rates by segregating certain income and
deductions into “baskets” and applying separate, and often complex, rules to each of
those baskets. Then taxpayers are required to maintain records to carryover currently
disallowed deductions to future years.
The most egregious example of the problems created by interactive provisions is the
AMT. The AMT obscures both the tax base and the tax rate by exposing taxpayers to a
second tax system with many different rules and a different tax rate. Originally designed
as a “class tax,” the AMT is now a looming “mass tax,”5 because it is not indexed for
inflation nor does it take into account the scheduled reduction in the regular statutory
rates.
Example 4: Fred and Beth Miller have four dependent children and file a joint tax
return in 2003. They have ordinary income of $114,500, $1,000 of charitable
giving, $12,200 of state taxes, and $6,000 of mortgage interest. Their taxable
5
Burman, L.E., W. G. Gale, J. Rohaly, and B.H. Harris, “The AMT: Out of Control,” Tax Policy Issues
and Options, Urban-Brookings Tax Policy Center, No. 5, September 2002, page 1.
20
income is $77,000 ($114,500 less personal exemptions of $18,300 and itemized
deductions of $19,200.). Their tax is $9,120 (net of child tax credit of $3,750),
and they are in the 25-percent tax rate bracket.
If the Millers incur $5,000 of additional state taxes, their taxable income
decreases by $5,000 to $72,000, and their regular tax decreases by $1,250 ($5,000
times their marginal tax rate of 25 percent). However, they now incur $1,250 of
AMT, resulting in no federal tax savings from their additional itemized tax
deduction of $5,000.
Historically, the AMT applied to a relatively small set of very wealthy taxpayers (155
taxpayers in 1969 under the predecessor add-on minimum tax system). However, the
AMT grew to affect one million taxpayers in 1999. Based on current projections, the
AMT will apply to 36 million taxpayers in 2010.6 Unfortunately, the growing realization
that the AMT must be reformed has met with the cold reality of the burgeoning, projected
revenue losses that accompany its repeal or reform. By 2010, “repealing the AMT could
cost more than repealing the regular income tax.”7
Adopt Uniform Definitions of Terms for All Statutory Purposes
Multiple and inconsistent definitions create significant, unnecessary confusion. For
example, dependent and related party are defined in different ways for different sections
6
Id.
7
Id.
21
of the Internal Revenue Code (IRC). Considerable taxpayer and administrative resources
are spent in trying to reduce planning and compliance uncertainty and errors in light of
these inconsistent definitions. A tax term used in multiple sections of the statute should
have only one definition for all statutory purposes. This in turn helps taxpayers
understand whether a provision does or could apply to them.
Avoid Multiple Effective Dates and Sunset Dates
Multiple effective dates and sunset dates create confusion as to when a provision applies.
The problem is compounded by expiring provisions that are regularly extended and
frequently applied retroactively.
CHALLENGES
Creating a transparent tax system has its challenges. However these challenges must not
discourage us from steadily improving the transparency of our tax laws. Significant
improvements are possible if legislators recognize the benefits that will accrue to all
participants and vigorously tackle the challenge. By recognizing the ways in which our
tax system has obscured tax bases and tax rates, we can reverse the trend of proliferating
22
phaseouts and interactive provisions, and guide future tax law design toward greater
transparency.
Revenue demands will always be an intrinsic barrier to a transparent tax system. Crafting
tax law is admittedly difficult. There are usually no politically easy methods to adjust
revenue and lawmakers frequently choose methods that will result in the least public
outcry. Taxpayers need to be educated about the actual impact on effective tax rates of
backdoor approaches. They need to understand that direct rate increases, to raise the same
amount of revenue, are preferable from a “good tax policy” standpoint.
Structural components of our economy that also complicate the law-making process
include:
1. The financial lives of businesses and individuals are inherently complex. The tax
laws crafted to address this complexity frequently lack transparency.
2. Businesses face two competing regimes for their different financial reporting
purposes, namely, (a) the need for accurate and useful financial reporting for
investors and other users of financial information, and (b) compliance with and
reporting for tax systems that are increasingly used to implement social and
economic policies. The resulting differences between calculating reported
financial income and taxable income increase the burdens imposed on business
and impairs the comparability of the two measures.
23
3. Legislators have difficulty balancing the often conflicting objectives of meeting
revenue targets, achieving social change, providing economic stimulus, and
maintaining broad fairness and equity in the system.
4. The existing tangle of tax provisions makes anticipating the complexities that
might flow from new provisions extremely difficult.8
Lawmakers must become convinced that improving transparency is an important goal for
the legislative process. Methodical review and analysis should be undertaken to identify
aspects of the law that obscure the tax base and tax rate. Existing provisions should be
modified and prospective provisions should be tested for clarity. A significant amount of
transparency can be restored by some of the same means which will simplify the statute,
such as (1) eliminating phaseouts; (2) eliminating interactive provisions; (3) adopting
uniform definitions of terms; and, (4) avoiding multiple effective dates and sunset dates.
8
The problems resulting from these inherently complex issues have been previously addressed in Tax
Policy Concept Statement No. 2: Guiding Principles for Tax Simplification. Simplifying the tax law
will directly improve its transparency.
24
BIBLIOGRAPHY
AICPA. Blueprint for Tax Simplification. AICPA, New York: 1992.
AICPA. Tax Policy Concept Statement No. 1, Guiding Principles of Good Tax Policy: A
Framework for Evaluating Tax Proposals. AICPA, New York: 2001.
https://www.cpa2biz.com/NR/rdonlyres/enmqmb6irwsrel236azlxnjrnmollvc6xjrd
srcx3adtcc5novjvr627fgggnvupasxct3os7if7db/Resource1.pdf
AICPA. Tax Policy Concept Statement No. 2, Guiding Principles for Tax Simplification,
AICPA, New York: 2001.
https://www.cpa2biz.com/NR/rdonlyres/eofk2a6ncdtvj3w23iwlg3sdhbfmhaytoox
7kv6b3xkj5tbwlok4w53yyksq5cjdofl5islmele36a/302.pdf
AICPA. Tax Simplification Index. AICPA, New York: Approved December 1993;
Revised February 1997.
Andreoni, J., B. Erard, and J. Feinstein, “Tax Compliance,” 36 Journal of Economic
Literature, No. 2, June 1998, 818-860.
Burman, L.E., W. G. Gale, J. Rohaly, and B.H. Harris, “The AMT: Out of Control,” Tax
Policy Issues and Options, Urban-Brookings Tax Policy Center, No. 5,
September 2002.
Burman, L.E., W. G. Gale, and J. Rohaly, “The AMT: Projections and Problems,” Tax
Notes, July 7, 2003, 105-117.
Gale, W.G., “Why Are Taxes So Complicated? And What Can We Do About It?” 17
Brookings Review, No. 1, Winter 1999, 36-39.
25
Graetz, M.J. The Decline [and Fall?] of the Income Tax. New York: W.W. Norton &
Company, 1997.
Goode, Richard, "Overview of the U.S. Tax System," in The Promise of Tax Reform.
Joseph Pechman, ed. Englewood Cliffs, N.J.: Prentice-Hall, 1985.
Gustafson, C.H., ed. Federal Income Tax Simplification. Proceedings of the ALI-ABA
Conference on Tax Simplification, 1979.
Internal Revenue Service. FY 1999 National Taxpayer Advocate’s Annual Report to
Congress. March 1, 2000. Available at www.irs.gov/prod/ind_info/rpt99-1.html.
Krause, K., “Tax Complexity: Problem or Opportunity?” 28 Public Finance Review
No.5, 395-414, September 2000.
Lewis, A. The Psychology of Taxation. New York: St. Martin’s Press, 1982.
Madeo, S.A., ed. Proceedings of the Invitational Conference on Reduction of Income Tax
Complexity. A Joint Project of the AICPA, Tax Section and the ABA, Tax
Section, 1990.
National Commission on Restructuring the Internal Revenue Service (Bob Kerrey and
Rob Portman, co-chairs). A Vision for a New IRS. June 25, 1997. See July 24,
1997, hearings on this report at: http://frwebgate.access.gpo.gov/cgi-
bin/getdoc.cgi?dbname=105_house_hearings&docid=f:49307.pdf
New York State Bar Association. Tax Section. “A Report on Complexity and the Income
Tax.” 27 Tax Law Review, 325, 336-73, 1972.
Rook, L.W. “Laying Down the Law: Canons for Drafting Complex Tax Legislation.” Tax
Notes, January 31, 1994, 621-634.
26
Slemrod, J., ed. Why People Pay Taxes: Tax Compliance and Enforcement, Ann Arbor:
The University of Michigan Press, 1992.
U.S. Congress. Joint Committee on Taxation. Study of the Overall State of the Federal
Tax System and Recommendations for Simplification, Pursuant to Section
8022(3)(B) of the Internal Revenue Code of 1986. Vols I – III. April 2001.
Available at http://www.house.gov/jct/pubs01.html.
U.S. Congress. Joint Committee on Taxation. Testimony at a Hearing of the
Subcommittees on Oversight and Select Revenue Measures of the House
Committee on Ways and Means Concerning Complexity of the Internal Revenue
Code. July 17, 2001. Available at http://www.house.gov/jct/x-60-01.pdf.
U.S. House of Representatives. Committee on Ways and Means. Written Proposals on
Tax Simplification, 1990.
U.S. House of Representatives. Committee on Ways and Means. Subcommittee on
Oversight. Complexity in Administration of Federal Tax Laws. June 29, 2000.
U.S. House of Representatives. Committee on Ways and Means. Subcommittee
on Oversight. Impact of Complexity in the Tax Code on Individual Taxpayers and
Small Businesses. May 25, 1999.
U.S. Senate. Committee on Finance. Hearings on the Complexity of the Individual
Income Tax. April 15, 1999. .
U.S. Senate. Committee on Finance. Tax Code Complexity: New Hope for Fresh
Solutions. April 26, 2001.
27
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Law of Taxation - Teaching Plan With Reading Material

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Teaching Plan

Prepared & Compiled By:

Ms. Ruchira Chaturvedi

2. Objectives of the Course 04

2.0 Objectives of the Course

1.1. Indian Constitutional Scheme of Taxation

1.2. Kinds of Taxes

1.3. Tax policy of India: evolution and challenges

1.4. Canons of Taxation

2. Direct Tax Regime

2.1. Income Tax Act, 1961: Important Definitions

2.3. Income from other sources, Capital Gains

2.4. Principles of Tax computation & filing

Professional Self-Development Activity

• Registration for PAN

3.3. Remedies beyond Income Tax Act, 1961: Constitutional Remedies.

3.4. Emerging Issues: Faceless Appeals and Assessment.

Professional Self-Development Activity

• Drafting of appeal application and reply to be filed before appellate authorities.

4.1. Fundamental Concepts in International Taxation.

4.2. Model Tax Conventions.

4.3. International Tax Agreements of India.

4.4. International Tax Issues: Permanent Establishment, Information Exchange.

Professional Self-development Activity:

• ‘Can liberal tax regime play aa crucial role in expansion of economy?’

S. No. Topic Number of Lectures

5.0 Reference Material

c. W. Neilson Hancock, ‘On the general Principles of Taxation as illustrating the

d. Guiding Principles of Good Tax Policy: A framework for evaluating tax

e. Jon R. Neil- ‘The Benefit and Sacrifice Principle of Taxation: A synthesis’,

5.3 Module III

6.0 List of Assignment/Project Topics

DHARMASHASTRA NATIONAL LAW UNIVERSITY, JABALPUR (M.P.)

B.A.LL.B. (Hons) BATCH 2018-19

7.0 Instructions to Students

Stable URL: https://www.jstor.org/stable/1015334

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Public Finance in Ancient India

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