Taxation System

Introduction

• A tax is a mandatory financial contribution imposed by the government on a taxpayer (an individual or legal entity) in order to support certain government expenses. Most governments’ principal source of revenue taxes, which also serve as a tool for income distribution.
• For Example: Suppose a Government imposes a rate of income tax i.e., 20%. If a person earns more in comparison to another person. 
• Then the difference between their income before tax is much higher. But after tax is imposed at 20% income difference between them is reduced. Hence, the imposition of income tax reduces income disparity between both A and B. 

Classification of Taxes

• • Progressive Tax: It is a system of taxation where less income earners pay less tax and vice versa. It has more fiscal impact on high income individuals and businesses and less fiscal impact on low income earners. In India, personal income tax is progressive.

• Proportional Tax: It is also known as flat tax. It is a tax where the rate of taxation is fixed irrespective of the income of an individual. In India, GST is a proportional tax.

• Regressive Tax: It is a tax where the rate of taxation decreases as the income increases. It has a greater impact on low income individuals or entities than high income earners. This system of taxation is not followed as it adversely affects the poor people of a country.

Characteristics of Good Taxation System

Equity (horizontal & vertical):  

• Equity means that each and everybody should get equally distributed or each and everybody will pay equally. Now we will see it in the tax system. It means that everyone should contribute a fair amount to taxes. 
• Taxpayers in identical financial situations should pay the same amount of taxes, according to horizontal equity. 
• Vertical equity means that higher income taxpayers should pay at least the same proportion of their income in taxes as lower-income taxpayers. It involves categorizing taxes as regressive, proportional, or progressive. 

Adequacy: 

• It means being enough or satisfactory for a purpose. Adequacy is now being employed in the taxation system, as taxes must generate enough money to support a society’s basic necessities. 

Simplicity: 

• It means that the tax system must be simple so that it can avoid a maze of taxes, forms and filing requirements. A simplified tax system makes it easier for taxpayers to grasp the system and lowers the cost of compliance. 

Transparency: 

• It implies that taxpayers and leaders can quickly learn about the tax system, including how money is spent and where tax revenue is received. With a transparent system, we can quickly determine who pays taxes, how much they pay, and whether or not the tax they pay is correct. We can easily find those who are exempted from tax paying and who are not exempted. 

Administrative ease: 

• It indicates that the tax system should be simpler and less expensive for taxpayers. Rules for tax paying are clearly simple and fair. 
• The government must know that when they are auditing the tax received and if they find that if a person or businessman did not pay right taxes then what are the sections implemented on him for not paying right taxes. These sections should be very simple and clear. So we can say that administration must be good and simple for taxpayers and the government.