Understanding Taxes - financemistry

The government receives most of its funding from taxes, which it uses to benefit disadvantaged groups and pay for public services.

Why Taxes?

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Promote equity

Reduce disparities

Taxes ensure that everyone has access to basic essentials by facilitating the transfer of wealth from the wealthy to the less fortunate.

Basically, it is a kind of distributing the money from rich to the poor.

Direct vs Indirect Taxes

Taxes are categorized into direct taxes and indirect taxes.

Direct Taxes

Direct taxes are paid directly by individuals or entities to the government without any intermediaries.

Characteristics of Direct Taxes

Progressive in nature: Higher income earners are subject to higher tax rates.

Elasticity: Tax revenue increases with a rise in income

When an individual’s income grows, the tax revenue for the government also increases.

Anti-inflationary tool: Direct taxes help control inflation by reducing the purchasing power of the public

Inflation: the rise of prices for the goods and services
During inflationary periods, the government can increase direct tax rates to reduce the amount of money in the hands of the public.
Less money means lower demand, which can lead to a decrease in prices
Excessive purchasing power of the public can be decreased by increasing the direct taxes.

Direct Tax Example

The most common example of a direct tax is income tax.

Direct Tax Definition

Direct tax is the tax levied and tax incidence is on the same person.

Tax incidence: the burden of paying the tax.

Indirect Taxes

Indirect taxes are levied on one entity such as manu facturer but the tax incidence burden of payment falls on the consumer.

These taxes are applied to the manufacture or sale of goods and services.

Tax is levied on one person but tax incidence is on other person.

Indirect Tax Example

The best example of an indirect tax is the Goods and Services Tax GST.

GST: Goods and Services Tax

GST is an indirect tax levied on the supply of goods and services, designed to create a unified tax system across the country.

GST replaced many indirect taxes that had previously existed in India

The goal of GST is to have a single tax for the entire country

Key Features of GST

Multi-stage taxation system: Tax is levied at every point of value addition.

For example, a tax is applied when wheat is processed into wheat flour, and then again when the flour is made into bread.

Destination-based tax: The tax revenue goes to the state where the goods or services are consumed, not where they are produced.

For example, if cars are made in Tamil Nadu but sold in Gujarat, the tax revenue goes to the Gujarat government.

GST Goods and Services Tax

GST is a destination-based, multi-stage taxation system.

Taxes for products are categorized based on slabs e. g., 0-5. Luxury goods and tobacco products are usually in the highest slab rate.

GST is divided into three types:

Central GST CGST: Tax levied by the central government.
State GST SGST: Tax levied by the state government.
Interstate GST IGST: Tax levied on the sale or service between two different states e. g., Tamil Nadu and Kerala.

Taxes Subsumed Under GST

Service tax

Sales tax

Luxury tax

Entertainment tax

Purchase tax

To identify taxes subsumed under GST, determine if the tax incidence and the tax levied are on different people.

Goods Exempted Under GST

Petroleum

Crude oil

Natural gas

Aviation fuel

Alcohol

Advantages of GST

Avoids the cascading effect double taxation, which reduces the price of products for the end consumer.

Improves the collection of taxes.

Removes indirect tax barriers between states, helping investors view the entire country in the same perspective.

Amendments After GST

GST was brought by the 101st amendment.

Article 246A: Both the union and the states have concurrent powers to make legislation regarding goods and services. Intrastate trade is under the jurisdiction of both the center and the state, while interstate trade is exclusively under union jurisdiction.

Article 249: Parliament can make laws on GST in the national interest if Rajya Sabha passes a resolution with a two-thirds majority.

Article 250: Parliament can make laws on GST during an emergency period.

Article 269: Empowers the parliament to make GST-related laws for interstate trade and commerce.

Article 269A: In the case of interstate trade, the tax will be levied and collected by the union, and the revenues will be shared between the union and the states based on the recommendation of the GST council.

GST Council

GST council is the key decision-making body for GST-related decisions.

Its main function is to ensure a uniform tax rate for goods and services across the nation.

Members include:

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The union finance minister chairperson.
The union minister of state in charge of revenue or finance.
The minister in charge of finance or taxation, or any other minister nominated by each state government.

Decision Making

Decisions require a three-fourths majority.

The central government holds one-third of the majority.

State governments hold two-thirds of the majority.

The GST council is the final authority to resolve any disputes arising out of GST-related issues between the center and the states, or between the states.

Taxation

Laffer Curve

When discussing taxes, it’s important to remember the Laffer Curve.

The Laffer Curve illustrates the relationship between tax rates and tax revenue. It suggests that tax revenue can be maximized when the tax rate is at an optimum level.

The x-axis is the tax rate, and the y-axis is the tax revenue.

The Laffer Curve posits that if tax rates are too high, people may avoid paying taxes, which decreases tax revenue. If tax rates are optimum, tax revenue is maximized. If tax rates are further increased past this point, tax revenue will decrease.

In summary: to maximize tax revenue, tax rates should be at an optimum level.

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