NEXUS BETWEEN TAXATION SYSTEM IN INDIA AND ECONOMIC GROWTH

NEXUS BETWEEN TAXATION SYSTEM IN INDIA AND ECONOMIC GROWTH

WRITTEN BY: Twinkle Purohit

ABSTRACT

Taxation is critical to a country’s economic prosperity. It provides the government with revenue that can be utilized for social welfare programs, infrastructure development, and other public services. Excessive taxation, on the other hand, can stifle economic growth by reducing people’ discretionary income and raising the cost of doing business for businesses.

India has enacted a number of tax reforms in recent years in order to promote economic growth and development. Some of the significant efforts taken by the Indian government in this regard have been the implementation of the Goods and Services Tax (GST) in 2017, corporate tax reforms in 2019, and several other measures targeted at strengthening tax administration.

The purpose of this research article is to investigate the relationship between India’s taxation structure and economic growth. The research will use both qualitative and quantitative methodologies, such as a review of current literature, analysis of macroeconomic data, and so on. The research findings will provide insights into the effectiveness of India’s tax system and will assist policymakers on the formulation and implementation of future tax policies targeted at fostering economic growth and development.

RESEARCH METHODOLOGY

The research undertaken is descriptive and somewhat analytical, as it seeks to put forth the pattern of tax and its impact on economic growth. For the purpose of the research, secondary data, in the form of articles, journals, case studies and various blogs have been utilised to enlist the major shortcomings to be able to suggest the required changes in the Act. Thus, the research conducted hereunder is Secondary research. 

Lastly, the research undertaken here is qualitative as well as quantitative for the budget has been analysed and Statics of the same has been represented respectively and also the information is very factual in nature.

LITERATURE REVIEW

1. “The Impact of Indian Taxation system on its Economic Growth”[1]

The Indian taxation system is currently undergoing dramatic reform. One of the most significant sources of income for the government is tax. Government, while also being one of the criterion for determining economic growth while direct tax has an influence on the directly indirect tax effects on disposable income what the cost of goods and services are in the market. The article’s primary goal is to in order to assess the effects of both direct and indirect fees on India’s economic development.

• “Impact of Goods and Services Tax on Indian Economy”[2]

The implementation of the GST in India has fundamentally altered the indirect tax system’s outlook by unifying the vast majority of taxes imposed on the sale and consumption of goods and services as well as on manufacturers, merchants, and consumers. One of the biggest changes to Indian tax law was the implementation of the GST system as it has incorporated nearly all of the previous indirect taxes, including VAT, Central Sales Tax, and Excise & Service Tax, among others, which formerly had an impact on how much goods and services cost. The findings of the article shows that GST will affect various Indian economic sectors has revealed both positive and negative effects, depending on the industry and previous indirect taxes as well as the type of the industry. comparable to GST rates, at least. Moreover, it was shown that GST is having a favourable effect on a variety of industries like those involved in manufacturing, FMCG, IT, and so forth. 

Also Read: TAXING REGIME FOR VIRTUAL ASSETS: TAX LAWS CLUB

• “Advance pricing agreements in India: revolution in Taxation law”[3].

The article is based on analysing the conflict that arises between the revenue authorities of various nations about how transfer pricing is determined. Utilizing a “Advance Pricing Agreement” is one strategy to combat this issue (APA). An APA is a contract made between a revenue authority (or authorities) and a taxpayer to determine the transfer price in advance. Compared to the traditional techniques of determining transfer price, it has a wide range of benefits and procedural advantages. APA, which has long been used in many nations, was just recently adopted in India.

4. “Tax structure and economic growth in India: insights from ARDL model”[4]

The article analysed that income tax share, corporate tax share, and excise tax share all have a negative long-term impact on growth. As the custom share increases growing performance. And the slowing growth in the short term is the corporation tax share. The article discovered that the researched variables have a long-term association by using the ARDL bound testing method developed by Pesaran et al. (2001). The threshold impact in the tax-growth relationship for India, however, is not found in this analysis.

INTRODUCTION

India’s tax system is undergoing significant changes aimed at improving business growth and expanding revenue for the government. The government is implementing a more liberal tax system and plugging loopholes to prevent tax evasion. Direct taxes directly affect disposable income, while indirect taxes impact the prices of goods and services in the market.

The Indian tax structure is well-designed, with the constitution enabling the three tiers of government to levy taxes and duties. The Union government levies taxes such as custom duties, income tax (excluding agriculture salary), sales tax, central excise, and service tax. The State government levies taxes such as stamp duty, land revenue (for both agricultural and non-agricultural purposes), state excise (on alcohol production), tax on calling and profession, and entertainment tax. Local bodies are also authorized to levy taxes, including octroi on local goods, property taxes, and utility taxes like water supply, drainage, and market taxes.

The taxing system is classic into three categories:

1. Progressive Taxing System

2. Regressive Taxing System

3. Proportional Taxing System

 The tax liability can be imposed on natural person (individuals), HUF, companies, firms, society etc. Tax can be Direct or Indirect. Direct Tax is a tax paid directly to the government example Income Tax. Indirect Tax is a which is paid to seller, producer, service provider etc who is liable to pay to the government Example GST. Also, apart from raising revenue, the government should accomplish some social and economic goals.

THE TAX SYSTEM IN INDIA

The tax system is a bundle of taxes in action in a country at a given point in time. The taxes can be categorised as direct taxes and indirect taxes. Direct taxes are those which are paid by a person directly to the taxing authority, whereas Indirect taxes mean on the goods and services, which are paid by a consumer to the producer/ seller. The seller or producer collects these taxes from the consumer and pays the taxing authority on behalf of the consumers.

Further, the taxing system around the globe can be categorised into three categories-

1. Progressive Taxation system
2. Regressive Taxation system
3. Proportional Taxation system

A country may follow either any of the above-mentioned taxing systems or a combination of the above systems that best suits its economic conditions.

A progressive Taxation System is a tax system that raises rates in accordance with the rise in taxable income. Typically, it is divided into tax brackets with increasing tax rates. Under this system burden of tax increases with the increase in the amount of taxable income.[5] However, a regressive taxation system is a system in which the tax rate decreases as the taxable amount rises. In other words, the tax rate and taxable income have a negative relationship. As taxpayers’ income rises, the rate of taxation falls. The higher income groups in society who must pay less tax as a result of this system of taxation often benefit. Individuals with lower salaries, on the other hand, are subject to higher tax rates.[6] Further, a Proportional taxation system is a system where the taxing authority levies the same amount of tax on every taxpayer, regardless of income. This implies that all income groups—lower, middle, and upper—pay the same amount in taxes. The tax is sometimes known as a flat tax because it is levied at the same rate for all individuals, regardless of income level. [7]

In India, at present, progressive as well as proportional taxation systems are used.[8]

According to tax laws followed in India, the tax on income (Direct Tax) is levied under the progressive taxing system, as the tax rate increases with the increase in the taxable income, that is, income is divided into tax brackets where the tax rate increases with the rise in the tax bracket.

Taxes that are charged besides income tax, such as excise duty, customs duty, GST etc (Indirect taxes)., are subject to proportional taxation, as the tax rate is the same for all. There is no increase or decrease in the tax rates with the increase or decrease in the amount of income. Further, lottery income, long-term capital gain, and in some cases short-term capital gain, though part of the tax on income but are charged as per the proportional taxing system, because a common rate is charged in all circumstances. For instance, the income from the lottery is taxed at a flat rate of 30%.

The Indian taxing system comprises of various taxes that are divided into Direct and Indirect Taxes.

• Direct Taxes consists of the following-
• Income tax
• Wealth Tax

• Major Indirect Taxes consists of the following-
• Excise duty
• Customs duty
• GST

TAX COLLECTION MECHANISM IN INDIA

In order to understand the Tax collection mechanism in India, it needs to be addressed in two phases, namely Tax Structure and Tax collection pattern.

Tax Structure

According to Article 256 of the constitution, “No tax shall be levied or collected except by the authority of law.” This essentially means that each tax levied or collected must be backed by a law passed by either the Parliament or the State Legislature.

India has a three-tiered federal tax structure. This structure is made up of the central government, state governments, and local municipal bodies. The majority of taxes are levied by the Central Government and the State Governments under powers granted to them by the Constitution. However, some minor taxes are also levied by local government and authorities, such as the Municipal government.

Tax Collection Pattern

In India, the tax collection pattern is based upon the ideology of maximizing taxpayers’ convenience. The tax collection mechanism pattern is well-structured and three-fold in nature, namely:

1. TDS (Tax Deducted at Source)

TDS is the tax deduction that occurs at the point of origin. TDS is calculated based on your tax bracket. TDS is deducted from a taxpayer’s salary as well as interest payments, rent, professional fees, commission, etc. Form 16 and Form 16 A is required while filing income tax returns. This form entails all the necessary and detailed information about the deducted tax.

• TCS (Tax Collected at Source)

TCS is collected by sellers from buyers. Section 206C of the IT Act lists down all of the goods for which TCS is applicable and is to be collected. TCS rates differ depending upon the commodity sold. It is essential to note that the seller do not pay any taxes. The sellers merely  collect the tax-money from the buyers and remit it to the government. OTHER PATTERNS

While TDS is automatically deducted at source, taxpayers may be required to pay additional taxes such as Self-Assessment Tax, Regular Assessment Tax, and Advance Tax to the government. Challan 280 can be used to pay such income taxes either online or in person. The TIN NSDL website can also be used as a channel for online payment of such taxes. Another option is to pay the fee offline at one of the IT department’s designated bank branches.

IMPACT OF TAXATION ON ECONOMIC GROWTH

Impact of indirect tax

Since the burden of indirect taxes falls directly on consumers, it creates a direct impact on the cost of products and services. Thus, indirect tax promotes producer efficiency because, in order to maintain demand, manufacturers must devote all of their efforts to cost-cutting strategies. Furthermore, this producer effort results in proper resource utilisation in the economy. As consumers have the opportunity to choose the things they want, healthy competition grows in the economy. Thus, the following are some of the benefits of indirect taxes on economic growth:

• Improved resource utilisation
• Increased producer efficiency
• Rise of healthy competition in market.
• More Choices to Consumers.
• Increased demand for high-end items
• Improved standard of living

Impact of Direct Tax

The direct tax is a major source of government revenue and has a direct impact on people’s spending power. If the government raises the direct tax rate, people begin to save for investment purposes. Individuals’ income generation process is impeded as a result of which economy is hampered.  This is especially true for high-end goods. This reduces the economy’s production of luxury commodities, which has a negative impact on GDP and living standards. But on the positive side, proper deductions based on investments help to capital formation in the country. Thus, the following are some of the benefits of direct taxation on economic growth:

• Increased capital formation
• Encouragement of saving and investing
• Government revenue growth assurance
• Increase in government spending plans
• Inflation rate falls as a result of people having less discretionary income.
• Revenue is made available to the government on time.

TAX  REFORMS AIMED TOWARDS ECONOMIC DEVELOPMENT

Over the years, India has introduced a number of tax reforms to boost economic growth and development. Some of the prominent tax reforms have been discussed as follows:

• GST: The implementation of GST in 2017 marked a significant tax reform in India. It has simplified the tax code and lessened the burden of compliance on businesses by replacing several indirect taxes with a single, unified tax. GST has also enhanced the ease of doing business in India and raised tax revenue collection.
• Corporate Tax Reforms: To encourage greater foreign investment and economic growth, the Indian government proposed a major drop in the corporation tax rate from 30% to 22% and to 15% for new manufacturing enterprises in September 2019. India’s corporate tax rates are now more competitive with those of other nations in the area as a result of the change.
• Taxation of Dividend: The dividend distribution tax (DDT) was eliminated by the Indian government in the Union Budget 2020, and the recipient shareholders now bear the tax burden. This action was taken to make Indian equities more appealing to foreign investors.

PROBLEM AREAS

Following are some of the loopholes in the tax regime which needs an immediate resolve in order to make it less burdensome for the taxpayer’s-

1. There is no provision for minimum taxes for individuals other than Companies. 
2. Little is being done to reduce inflation through the government’s taxation policy. More options for tax reduction through investments must be made available.
3. The regime of indirect taxes is being expanded by the government unduly. Nearly everyone is now subject to indirect taxes, whereas only 10% to 15% of the population as a whole is subject to direct taxes[9].
4. The income inequality gap in India is widening as our national revenue rises without a corresponding rise in taxes.
5. The taxation system is complicated because it includes several taxes and rates.
6. The fact that urban populations in India pay higher taxes than rural populations is extremely unfortunate.
7. People who practise tax evasion and avoidance are encouraged to do so by the high levels of corruption in the tax department.

The current tax structure in India has significant limitation. India simultaneously has a tax base that is too large for indirect taxes and one that is too small for direct taxes. As a result, too little tax income is generated, and the poor bear an excessive share of the tax burden. Due to this, the state is less able to provide the resources necessary for effective governance. There is still more to be done in this regard, notwithstanding the government of India’s initiatives to streamline the tax laws.

SUGGESTIONS TO IMPROVE THE EXISTING TAX REGIME IN INDIA

• Efficiency: A competent taxation system is essential for any government, especially a developing country like India, to obtain appropriate funds to finance its expanding welfare and development programmes. To accomplish this, both direct and indirect taxes must be included in the tax system, which should be intended to be productive and progressive in order to generate revenue in tandem with people’s income.
• Diversity: To minimise negative effects on incentives to work, save, and invest, governments should not rely on a single or a few taxes to collect a huge quantity of money. Instead, a multiple tax system with a wide range of taxes is required to encourage everyone who can contribute to public revenue to do so.
• Economic Growth: In a developing economy like India, taxation should be used to spur economic progress. How swiftly an economy grows is largely determined by the rate of capital formation. If the public sector is given a major role in the development strategy, capital formation in that sector must increase proportionally. A successful tax system for a developing country should thus allow the government to raise sufficient revenue for capital formation or economic expansion.
• Enhanced Economic Distribution: Taxation should be a tool for economic growth in a developing country, and the tax system should allow the government to mobilise adequate cash for capital production or economic expansion. A strong tax framework should also attempt to reduce economic inequality by requiring the wealthiest citizens to pay a higher percentage of taxes. This necessitates having sufficiently high progressive direct tax rates on income, wealth, consumption, capital gains, and so on. Allocating a considerable part of tax money to anti-poverty programmes can help to reduce income inequality. 
• Healthy Economic Fluctuation: Flexible taxation policies can help reduce economic swings in industrialised countries. In this approach, the tax system must be designed to be responsive to changes in national income while being flexible and progressive. This means that the government will receive a higher share of any growth in national income. At the same time, during a recession or depression, the money earned from taxes decreases faster.

CONCLUSION

The goal of this study is to determine the long- and short-term relationships between various tax structures and economic growth in Indian states. According to empirical data from linear regression, property taxes increase growth whereas commodity and service taxes inhibit it. These results for property taxes, where high property taxes are beneficial to growth, are validated using non-linear regression. Commodity and service taxes produce consequences that are the contrary after a certain point, negatively hurting growth. Intriguingly, both linear and non-linear regressions show little evidence of a long-term effect of income taxes on growth.

Both the linear and non-linear coefficients are important with distinct signs in the case of the commodities and service taxes. However, because both linear and quadratic factors are incorporated into the same equation, the coefficient magnitudes are unnaturally large. Small commodity and service taxes have a negative impact on the state’s economy, but big amounts have a beneficial effect. The refreshed return can be recorded in something like a long time from the finish of the pertinent evaluation year. Although this tax is now included in the Goods and Services Taxes, prior to the introduction of the GST, commodity and service taxes were slowing the growth of the national savings per person.  This study showed that lowering the overall tax burden and switching from income and commodity taxes to property taxes as a source of revenue for Indian states is the most promising course for long-term growth performance. The finding may be contested for a number of reasons, including the exclusion of factors such as institutional quality, administrative effectiveness in tax collection, fiscal balance and state-level conditions, and the existence of informal sectors from the variables under study. 

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[1] “Chadha, A. (2019). The Indian Taxation System and Its Impact on the Economy. Supremo Amicus, 11, 1-9.”

[2] “Jain, E. (2020). Impact of Goods and Services Tax on Indian Economy. Our Heritage. 68(7). 0474-9030.”

[3] “Verma, A., & Singh, S. (2014). Advance pricing agreements in India: revolution in Taxation law. Christ University Law Journal, 3(2), 39-68.”

[4] “Neog, Y. & Gaur, A.K. (2020), Tax structure and economic growth in India: insights from ARDL model, Indian Growth and Development Review, 13(3), 589-605.”

[5]“Progressive Tax. (2022, March 4). Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/accounting/progressive-tax-system/”

[6] “What is Regressive Tax? Definition of Regressive Tax, Regressive Tax Meaning. (n.d.). The Economic Times. https://economictimes.indiatimes.com/definition/regressive-tax”

[7] “What is Proportional Tax? Definition of Proportional Tax, Proportional Tax Meaning. (n.d.). The Economic Times. https://economictimes.indiatimes.com/definition/proportional-tax”

[8] “Pandey, C. A. (Dr. ) P. K. (2017). The Impact of Indian Taxation system on  its Economic Growth. Scientific Society of Advanced Research and Social Change SSARSC International Journal of Management, 3(1), ISSN 2349-6975.”

[9] “Shruti R, (2017, Dec. 26). Rethinking India’s Tax System. Mint. https://www.livemint.com/Opinion/z2DURCdrbtLjCPnutKs3gJ/Rethinking-Indias-tax-system.html”