Taxes: meaning, canons and classification

Detail

1. What a tax is

• Tax is a compulsory payment to the government.
• It is unrequited. The taxpayer gets no specific service in return for paying it.

• The state uses tax money to pay for services everyone uses, such as defence, police, roads and schools.

• Tax vs fee vs charge

• A fee is paid for a specific service, for example a passport fee or a court fee.
• A charge (such as a user charge) is also a price paid for a service you receive.
• Fees and charges are non-tax revenue, not tax revenue.
• Class 12, Government Budget and the Economy lists the items of non-tax revenue: interest, dividends, profits, fees and foreign grants.

• Test to tell them apart: if a direct service comes back to the payer, it is a fee. If nothing specific comes back, it is a tax.

• Article 265: "No tax shall be levied or collected except by authority of law." [2]

• Every tax needs a law passed by Parliament or a State Legislature.
• An executive order alone cannot impose a tax.
• Article 265 appears under the heading "Taxes not to be imposed save by authority of law." [2]

2. Canons of taxation

• A canon of taxation is a rule that a good tax should follow.
• Adam Smith's four canons (Wealth of Nations, 1776):

Canon	Meaning in simple words	Indian illustration
Equity	People pay according to their ability to pay	Income-tax slabs: higher income, higher rate
Certainty	The amount, the time and the manner of payment are clear	Rates and due dates are fixed in the Finance Act
Convenience	Tax is collected at a time and in a way that suits the payer	TDS is cut from salary at source. GST is paid with the purchase price
Economy	Collecting the tax costs little	Online filing keeps collection costs low

• Canons added by later writers
• Productivity: the tax should raise enough revenue to be worth levying.
• Elasticity: revenue should rise on its own as income rises, without new laws.
  • Worked example: GDP grows 10% and tax revenue grows 12%. Revenue is rising faster than income, so the tax system is elastic.
  • A progressive income tax is naturally elastic. As incomes rise, people move into higher slabs and pay a larger share.

3. Direct vs indirect taxes

• Impact is on the person the law makes pay the tax.
• Incidence is on the person who finally bears the money burden.
• Shifting means passing the burden to someone else, usually through higher prices.

Basis	Direct tax	Indirect tax
Who bears it	Impact and incidence fall on the same person	Burden can be shifted to others through prices
Levied on	Incomes of individuals and profits of firms	Goods and services
Examples	Personal income tax, corporation tax, capital gains tax, MAT, STT	GST, customs duty, excise duty, Social Welfare Surcharge
Nature	Can be made progressive	Generally regressive

• NCERT definitions (Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal)
• Direct taxes are "taxes on incomes of individuals, as well as, profits of business enterprises".

• Indirect taxes are "taxes levied on goods and services".

• Terms in the table

• Corporation tax: tax on the profits of companies.
• Capital gains tax: tax on the profit from selling an asset such as shares or land.
• MAT (Minimum Alternate Tax): a minimum tax on a company's book profit. It stops companies that use many exemptions from paying almost nothing.
• STT (Securities Transaction Tax): a small tax on each purchase or sale of shares on a stock exchange. It is counted with direct taxes.

• Surcharge: an extra tax calculated on the tax itself, e.g. the Social Welfare Surcharge on customs duty.

• How impact and incidence differ in indirect taxes

• A shop pays GST to the government, so the impact is on the shop.
• The shop adds GST to the bill, so the buyer pays more.

• The incidence therefore falls on the final consumer.

• Recent data

• Net direct tax collections, FY 2024-25, up to 17 June 2024 (provisional): ₹5,15,986 crore. [3]
  • Corporation tax: ₹2,26,280 crore. [3]
  • Personal income tax including STT: ₹2,88,993 crore. [3]
• Gross direct tax collections, same period: ₹4,62,664 crore, against ₹3,82,414 crore a year earlier (+20.99%). [3]
• Union Budget 2025-26 (Budget Estimates)
  • Gross tax revenue is budgeted to grow 10.8%. [4]
  • Taxes on income: +14.4%. Corporation tax: +10.4%. [4]
  • GST: ₹11,78,000 crore, of which CGST is ₹10,10,890 crore (86%) and GST compensation cess is ₹1,67,110 crore (14%). [4]
  • Total indirect taxes: ₹17,35,100 crore. [4]
  • Receipts excluding borrowings: ₹34,96,409 crore (+11.1% over 2024-25 RE). [4]

4. Ad valorem vs specific taxes

• Ad valorem tax: a percentage of the value (price) of a good. Most GST rates work this way.
• Example: 18% GST on a ₹100 item is ₹18. If the price rises to ₹200, the tax becomes ₹36.

• Revenue rises automatically with prices, so the tax is inflation-proof.

• Specific tax: a fixed amount per unit of quantity, whatever the price.

• Examples: per-litre excise on petrol, the old ₹400/tonne coal cess, and the per-machine levy on pan-masala units.
• Example: ₹10 per litre stays ₹10 whether petrol costs ₹90 or ₹110.
• Revenue does not rise with prices. It is easy to calculate and hard to evade by under-stating value.

5. Rate structures

• Progressive tax: the tax rate rises as income rises.
• India's income-tax slabs are the main example.

• Class 12, Government Budget and the Economy calls progressive taxation the government's main tool for redistribution (moving income from rich to poor).

• Proportional tax: one flat rate at every level of income.

• Example: corporation tax taken as a fixed proportion of profits.

• Regressive tax: takes a larger share of income from the poor than from the rich.

• Examples: uniform consumption taxes, and a poll tax (the same amount per head).

Proportional tax and the multiplier

• The tax is written as T = tY, where t is the tax rate and Y is income.
• Disposable income (income left after tax) = (1 − t)Y.
• The MPC out of total income falls from c to c(1 − t). MPC is the marginal propensity to consume: the share of each extra rupee that people spend.
• Multiplier = 1 / [1 − c(1 − t)]
• NCERT worked example
• c = 0.8 and t = 0.25.
• c(1 − t) = 0.8 × 0.75 = 0.6.
• Multiplier = 1 / (1 − 0.6) = 2.5.
• With a lump-sum tax (a fixed amount, not linked to income), the multiplier is 1 / (1 − 0.8) = 5.

• If government spending rises by ₹100 crore, output rises by ₹250 crore with the proportional tax and by ₹500 crore with the lump-sum tax.

• Why this makes it an automatic stabiliser

• In a boom, incomes rise, so tax paid rises on its own.
• People are left with less extra money to spend.
• Swings in demand and output become smaller, with no new government decision needed.
• The full derivation is in the Government Budget and Fiscal Policy note.

Why indirect taxes are regressive (NCERT error)

• Class 12, Government Budget and the Economy says indirect taxes are regressive because "they impact all income groups equally".
• The correct reason: an equal rate on consumption takes a larger share of a poor household's income.

• Poor households spend almost all their income. Rich households save part of it.

• Worked example with 10% GST

Household	Income (₹)	Consumption (₹)	GST paid (₹)	GST as % of income
Poor	10,000	10,000	1,000	10%
Rich	1,00,000	60,000	6,000	6%

• The rich household pays more rupees but a smaller share of its income. That is what makes the tax regressive.

6. Product vs production taxes (national accounts link)

• Product taxes are paid per unit of output. Examples: GST, excise, service tax, and import and export duties.
• Production taxes are paid whatever the volume of output. Examples: land revenue, and stamp and registration fees (Class 12, National Income Accounting).
• Net taxes = taxes − subsidies. The same split applies to subsidies.
• The bridge from factor cost to market prices
• GVA at factor cost + net production taxes = GVA at basic prices
• GVA at basic prices + net product taxes = GDP at market prices

• GVA (gross value added) is the value of output minus the value of inputs used up.

• NCERT data for 2024-25 (constant prices)

• GVA at basic prices ₹1,71,87,446 crore + net taxes ₹16,09,509 crore = GDP ₹1,87,96,955 crore.

• Check: 1,71,87,446 + 16,09,509 = 1,87,96,955. ✔

• Labelling issue

• The NCERT table calls the ₹16,09,509 crore row "net production taxes".
• Under the formula above, the step from basic prices to GDP adds net product taxes.
• Details are in the National Income Accounting note.

7. International comparison: tax-to-GDP

• Tax-to-GDP ratio: total tax revenue as a percentage of GDP. It shows how much of national income the state collects as tax.
• OECD average: rose from 33.7% (2023) to 34.1% (2024). This was the first rise since 2021 and the highest level on record. [5]
• OECD range in 2024: from 18.3% (Mexico) to 45.2% (Denmark). France was 43.5% and Austria 43.4%. [5]

Prelims Hooks

• Article 265: no tax can be levied or collected except by authority of law. An executive order alone cannot impose a tax. [2]
• Fees, interest, dividends, profits and foreign grants are non-tax revenue. A passport fee is not a tax.
• Adam Smith's four canons (1776) are equity, certainty, convenience and economy. Productivity and elasticity were added by later writers. They are not Smith's.
• Direct tax: impact and incidence fall on the same person. Indirect tax: the burden can be shifted through prices.
• STT and MAT are direct taxes. Customs duty and the Social Welfare Surcharge are indirect.
• Specific vs ad valorem: ₹400/tonne coal cess = specific; 18% GST = ad valorem.
• With a proportional tax, the multiplier is 1 / [1 − c(1 − t)]. For c = 0.8 and t = 0.25 it is 2.5, against 5 under a lump-sum tax.
• Stamp and registration fees and land revenue are production taxes. GST and excise are product taxes.

• GVA at basic prices + net product taxes = GDP at market prices.

• Poll tax (the same amount per head) is the textbook example of a regressive tax.

• OECD average tax-to-GDP: 34.1% (2024). Denmark is highest at 45.2%, Mexico lowest at 18.3%. [5]

Mains Points

• Equity vs efficiency in India's tax mix
• Indirect taxes are easy to collect: GST raises ₹11,78,000 crore (BE 2025-26). [4]
• But they take a larger share of poor households' incomes.
• Moving the mix towards progressive direct taxes serves the canons of equity and elasticity.

• Taxing consumption serves convenience and economy.

• Tax design as an automatic stabiliser

• A proportional or progressive tax cuts the multiplier (2.5 against 5 in NCERT's example).

• This dampens booms and slumps without new policy decisions, which supports counter-cyclical fiscal policy (policy that works against the business cycle).

• Rule of law in taxation

• Article 265 requires every levy to have a law behind it. [2]
• This links the canon of certainty to parliamentary control over money, the "no taxation without representation" principle.

• Changing tax rules backwards in time (retrospective amendments) weakens this certainty and hurts investor confidence.

• Low tax base vs OECD peers

• OECD countries average 34.1% tax-to-GDP (2024). [5]
• Raising India's ratio needs a wider base (more people and firms paying tax), not only higher rates.
• Tools for this include TDS, GST invoice-matching and simpler slabs. Together they improve productivity without breaking the canon of economy.