Fiscal System

Consider a tale of two economies. China has an economic boom which has been going
on for a while. But as a result, China struggles with high inflation. Uganda, on the other hand,
has been in a recession for quite some time, with high unemployment causing widespread
suffering. But the self-correction mechanism isn't kicking in for either country. Is there
anything that can be done?
Yes! Both governments can use fiscal policy as a tool to bring their countries back to
“normal.” For example, they can use fiscal policy
(changes in government spending or taxes), which will Fiscal policy is the use of taxes,
government spending, and government
impact output, unemployment, and inflation. Uganda transfers to stabilize an economy. The
word “fisc” means “state treasury” and
needs to increase output to end its recession. China’s
fiscal policy refers to the policy
inflation is caused by producing more than is concerning the use of “state treasury.

sustainable, so reducing output would fix its problem.

Now question is, how to control output, unemployment, and inflation? In rest of the chapter
we shall discuss the fiscal policy mechanisms that help to maintain the stability in an
economy.
Fiscal policy is based on the theories of British economist John Maynard Keynes,
which state that increasing or decreasing revenue (taxes) and expenditures (spending) levels
influences inflation, employment and the flow of money through the economic system. Fiscal
policy is often used in combination with monetary policy, which in India, is set by the
Reserve Bank of India, to influence the direction of the economy and meet economic goals.

1: The prime objectives of the fiscal policy under the economy are:
1. To achieve full employment in the economy;
2. To maintain price stability;
3. To control inflation;
4. To enhance income inequality;
5. To enhance economic growth;
6. To induce savings and investment in the economy.
In this way, the whole responsibility to maintain viable fiscal stability in the economy goes to
the government. Govt. always tries to increase its income through different sources and to
reduce the income by suitable means. But it is not an easy task for a country like India, where
the challenges of development are multi-dimensional.

2: Types of fiscal policy

2.1: Expansionary Fiscal Policy
Expansionary fiscal policy, designed to stimulate the economy, is most often used during a
recession, times of high unemployment or other low periods of the business cycle. It entails
the government spending more money, lowering taxes, or both. The goal is to put more
money in the hands of consumers so they spend more and stimulate the economy.

2.2: Contractionary Fiscal Policy

Contractionary fiscal policy is used to slow down economic growth, such as when inflation is
growing too rapidly. The opposite of expansionary fiscal policy, contractionary fiscal policy
raises taxes and cuts spending.

Figure-1: Fiscal Structure

Direct taxes Internal borrowing

Individual income tax Budget Treasury bills

Corporate tax Government bond
Wealth tax Borrowing from Central bank

Fiscal Public debt

Taxation
Structure

Indirect taxes External borrowing

Central excise tax Public Foreign investment

VAT tax expenditure International organisations like IMF
Service tax Market borrowing
Custom Duty

3: Tool of fiscal policy

3.1: Automatic stabilizers
Automatic stabilizers have emerged as key elements of fiscal policy. Increases in income tax
rates and unemployment benefits have enhanced their importance as automatic stabilizers.
The introduction in the 1960s and 1970s of means-
tested federal transfer payments, in which individuals Automatic stabilizers are economic
policies and programs designed to offset
qualify depending on their income, added to the nation’s fluctuations in a nation's economic
activity without intervention by the
arsenal of automatic stabilizers. The advantage of
government or policymakers on an
automatic stabilizers is suggested by their name. As individual basis.

soon as income starts to change, they go to work.

Because they affect disposable personal income directly, and because changes in disposable
personal income are closely linked to changes in consumption, automatic stabilizers act
swiftly to reduce the degree of changes in real GDP. It is important to note that changes in
expenditures and taxes that occur through automatic stabilizers do not shift the aggregate
demand curve. Because they are automatic, their operation is already incorporated in the
curve itself.
Certain government expenditure and taxation policies tend to insulate individuals from
the impact of shocks to the economy. Transfer payments have this effect. Because more
people become eligible for income supplements when income is falling, transfer payments
reduce the effect of a change in real GDP on disposable personal income and thus help to
insulate households from the impact of the change. Income taxes also have this effect. As
incomes fall, people pay less in income taxes. Any government program that tends to reduce
fluctuations in GDP automatically is called an automatic stabilizer. Automatic stabilizers tend
to increase GDP when it is falling and reduce GDP when it is rising.
To see how automatic stabilizers work, consider the decline in real GDP that occurred
during the recession of 1990–1991. Real GDP fell 1.6% from the peak to the trough of that
recession. The reduction in economic activity automatically reduced tax payments, reducing
the impact of the downturn on disposable personal income. Furthermore, the reduction in
incomes increased transfer payment spending, boosting disposable personal income further.
Real disposable personal income thus fell by only 0.9% during the 2001 recession, a much
smaller percentage than the reduction in real GDP. Rising transfer payments and falling tax
collections helped cushion households from the impact of the recession and kept real GDP
from falling as much as it would have otherwise.
3.2: Discretionary fiscal policy tools
As we begin to look at deliberate government efforts to stabilize the economy through fiscal
policy choices, we note that most of the government’s taxing and spending is for purposes
other than economic stabilization. For example, the
increase in defence spending in the early 1980s under Discretionary fiscal policy is a change in
government spending or taxes. Its
President Ronald Reagan and in the administration of purpose is to expand or shrink the
economy as needed. It often occurs in
George W. Bush were undertaken primarily to promote periods of recession or economic
turbulence.
national security. That the increased spending affected
real GDP and employment was a by-product. The effect
of such changes on real GDP and the price level is secondary, but it cannot be ignored. Our
focus here, however, is on discretionary fiscal policy that is undertaken with the intention of
stabilizing the economy.
Discretionary government spending and tax policies can be used to shift aggregate
demand. Expansionary fiscal policy might consist of an increase in government purchases or
transfer payments, a reduction in taxes, or a combination of these tools to shift the aggregate
demand curve to the right. A contractionary fiscal policy might involve a reduction in
government purchases or transfer payments, an increase in taxes, or a mix of all three to shift
the aggregate demand curve to the left.
 Taxation
Taxes have been the main source of income for the government upon which it relics. Hence,
India has a huge and complicated structure of taxation. So, the basic concept of this system
must be discussed.

Figure-1: Types of taxes based on type of payment

1. Direct Taxes: Direct Tax is levied directly on individuals and corporate entities. Under
such taxes there is no chance of shifting of the burden of tax, like income tax.

1.1: Income tax

According to Income Tax Act 1961, every person, who is an assessee and whose total income
exceeds the maximum exemption limit, shall be
Assessee means a person by whom
chargeable to the income tax at the rate or rates (any tax) or any other sum of money is
payable under the Income Tax Act
prescribed in the Finance Act. Such income tax shall be 1961.

paid on the total income of the previous year in the relevant assessment year. Income tax is an
annual tax imposed separately for each assessment year (also called the tax year). Assessment
year commences from 1st April and ends on the next 31st March.

1.2: Wealth tax

Income-tax is levied on the income of the taxpayer, whereas wealth tax is levied on the
wealth of the taxpayer. Wealth tax is governed by Wealth Tax Act, 1957. Persons other than
individuals, Hindu Undivided Families (HUFs) and companies are notliable to pay wealth
tax. A partnership firm is not liable to wealth tax, but the assets of the partnership firm are
charged to tax in the hands of the partners of the firm in the form of “Interest in partnership
firm”. In other words, a partnership firm is not liable to wealth tax, but the value of the assets
held by the firm is to be ascertained and this value will be distributed amongst the partners of
the firm and will be charged to tax in the hands of the partners. The wealth tax is calculated at
1% on net wealth above Rs 30 lakh. If a person's net wealth for that relevant year is Rs 50
lakh, the 1% wealth tax is charged on Rs 20 laks.

1.3: Gift tax

Applied to an individual giving anything of value to another person. For something to be
considered a gift, the receiving party cannot pay the giver full value for the gift, but may pay
an amount less than its full value. It is the giver of the gift who is required to pay the gift tax.
If the total amount of money received by an individual from one or more persons during a
previous year exceeds Rs. 50,000/-, the whole of such amount will be chargeable to tax. If
you receive Rs. 40,000 as gift from anybody, there is no tax liability, but if you receive
another Rs. 20,000 in the same year, you have to pay tax on the entire Rs. 60,000, because
you have exceeded the limit of Rs. 50,000. From 201-20, Now this Rs. 60000 will be added
to your total income and taxed according to your tax slab. Suppose you are in 20% of tax slab
and by adding Rs. 60000 you come in 30% tax slab, you would be taxed accordingly.

1.4: Capital gain tax

Capital Gains are the gain on selling of any of the capital assets which includes stocks,
mutual funds and real estate. The tax liability depends on the period that the asset was held by
the seller. In case of real estate, if it was held for less than 3 years, then gains (sale minus
purchase price) from the transfer will be considered short-term capital gains (STCG). It gets
added to the seller's other incomes and is taxed at the applicable slab rate. If the property was
held for more than 3 years, then the gains are considered long-term capital gains (LTCG) and
taxed at 20% with indexation. Mint Money explains the steps to calculate LTCG arising from
transfer of assets.
 Step1: First you need to know the acquisition cost. This is the cost that the seller has
incurred while buying and holding the property. Apart from the basic cost paid to the
previous owner, you can also consider expenses such as stamp duty, registration fee,
brokerage and legal fees paid to acquire the property. All these collectively contribute
to the cost of acquisition.
Step2: Calculate the indexed cost of acquisition. To arrive at this figure, multiply the
purchase price and improvement cost by the Cost Inflation Index (CII) number of the
current year (the year of sale) and divide the resulting number by the CII for the year
of purchase or improvements. Get CII for the relevant year from the income tax
website www.incometaxindia.gov.in.
Step3: Once you have calculated the indexed cost of property acquisition and know
the selling price, you can calculate LTCG by deducting indexed cost of property
acquisition from the selling price. Say, you plan to sell a house that was bought in
May 2011 for Rs50 lakh, and which is worth Rs80 lakh now. According to this
formula, the inflation adjusted cost of acquisition would be Rs50 lakh×1125 (CII
number for 2016-17)/785 (CII number for 2011-12). This comes to Rs71,65,605. So
your LTCG would be Rs80 lakh minus Rs71.66 lakh, or about Rs8.34 lakh.

2. Indirect Tax: Indirect taxes are taxes which are indirectly levied on the public through
goods and services. It is generally is imposed on producers (suppliers) by the government.
Examples include duties on cigarettes, alcohol and fuel and also VAT. A carbon tax is also an
indirect tax. The burden of tax partially or fully shifted to other person.

Figure-2: Types of Indirect Taxes

2.1: Value-add tax
VAT is a tax placed on the expenditure / a tax set as a percentage of the price of a good. It is
levied on goods sold in the state. The rate depends on the government. The tax a dealer pays
for purchases is input tax. Many purchases will carry a VAT charge, but when a dealer is
registered under VAT, they can normally claim a credit for VAT charges on most business
purchases. Input tax includes not only the VAT on your purchases of raw materials or on
goods purchased for resale but also VAT on capital goods, such as machinery or equipment.
VAT = Output Tax – Input Tax
Suppose, A dealer pays Rs.10.00 @ 10% on his purchase price of goods valued
Rs.100.00. He sells the goods at Rs.150.00 and collects tax amounting to Rs.15.00 (@ 10%).
He will pay Rs.5.00 (Rs.15.00- Rs.10.00) as he has already paid Rs.10.00 to his seller while
purchasing those goods.

2.2: Octroi tax

It is levied on goods which move from one state to another. The rates depend on the state
governments. The State government in India levies the Octroi charges when the product
enters the state.

2.3: Service tax: Government levies the tax on service providers. Service tax is a tax levied
by the Central government on service providers on certain service transactions, but is actually
borne by the customers. It is categorized under Indirect Tax and came into existence under
the Finance Act, 1994.
Dr. Raja Chelliah Committee on tax reforms recommended the introduction of service
tax. Service tax had been first levied at a rate of five per cent flat from 1 July 1994 till 13
May 2003, at the rate of eight percent flat w.e.f 1 plus an education cess of 2% thereon w.e.f
10 September 2004 on the services provided by service providers. It was increased to 14% for
transactions that happened on or after 1 June 2015 and then for transactions that occurred on
or after 15 Nov 2015, the new Swachh Bharat Cess at 0.5% was also added to the Service
Tax. Therefore, the effective rate became 14.5% with effect from 15 Nov 2015. For
transactions that occurred on or after 1 June 2016 this tax is at 15%. Union budget of India in
2016, has proposed to impose a cess, called the Krishi Kalyan Cess, at 0.5% on all taxable
services effective from 1 June 2016. The current service tax is at 14%.
2.4: Customs duty: It is a tax levied on anything which is imported into India from a foreign.
Custom duty is a variant of Indirect Tax and is applicable on all goods imported and a few
goods exported out of the country. Duties levied on import of goods are termed as import
duty while duties levied on exported goods are termed as export duty. Countries around the
world levy custom duties on import/export of goods as a means to raise revenue and/or shield
domestic institutions from predatory or efficient competitors from other countries.
Custom duty in India is defined under the Customs Act, 1962 and enables the
government to levy duty on exports and imports, prohibit export and import of goods,
procedures for importing/exporting and offences, penalties etc. All matters related to custom
duty fall under the Central Board of Excise & Customs (CBEC). The CBEC, in turn, is a
division of the Department of Revenue of the Ministry of Finance.

2.5: Excise duty

Excise Duty is a form of indirect tax that is levied on goods that have been manufactured in
the country. Excise Duty can easily be classified into two types:
2.4.1: Specific Tax - When taxes are imposed on the basis of weight and quality fall under
this category. A specific tax is where the tax per unit is a fixed amount – for example the duty
on a pint of beer or the tax per packet of twenty cigarettes. Another example is air passenger
duty.
2.4.2: Ad valorem Tax - When taxes are imposed on the basis of value or price. In India
custom Duty often imposed according to the value. Where the tax is a percentage of the cost
of supply – e.g. value added tax currently levied at the standard rate of 20%. In the diagram
below, an ad valorem tax has been imposed on producers. The equilibrium price rises from
P1 to P2 whilst quantity falls from Q1 to Q2.
Figure-3: Impact of Ad Valorem tax
2.6: Central sales tax
The Central Sales Tax (CST) is a levy of tax on sales, which are affected in the course of
inter-State trade or commerce.
Insight-1: Who pays income tax?
1. Resident: An individual is treated as resident in a year if present in India:
 For 182 days during the year or;
 For 60 days during the year and 365 days during the preceding four years.
Individuals fulfilling neither of these conditions are non-residents. (The rules are slightly
more liberal for Indian citizens residing abroad or leaving India for employment abroad).
2. Resident but not Ordinarily Resident: A resident who was not present in India for 730 days
during the preceding seven years or who was non-resident in nine out of ten preceding years
is treated as not ordinarily resident.
3. Non-Residents: Non-residents are taxed only on income that is received in India or arises
or is deemed to arise in India. A person not ordinarily resident is taxed like a non-resident but
is also liable to tax on income accruing abroad if it is from a business controlled in or a
profession set up in India. Non-resident Indians (NRIs) are not required to file a tax return if
their income consists of only interest and dividends, provided taxes due on such income are
deducted at source. It is possible for non-resident Indians to avail of these special provisions
even after becoming residents by following certain procedures laid down by the Income Tax
act.
Status Indian Income Foreign Income
Resident and ordinarily resident Taxable Taxable
Resident but not ordinary Taxable Not taxable
resident
Non-Resident Taxable Not taxable

Insight-2: Who pays wealth tax?

 an individual
 a Hindu undivided family (HUF); and
 a company

Insight-3: Exemption of gift tax?

 Any amount/property received from a relative (spouse, brother, brother-in-law, sister,
sister-in-law, lineal ascendant/decedent)
 Money/property received by way of a Will or inheritance
 Money/property received on the occasion of marriage

3: Types of Direct Taxes Based of Rate of Imposition

3.1: Progressive Taxes
Under this structure, the rate of tax increase as income
increase. Under a progressive tax system, the taxes
assessed – say, on income or business profits – are
based on the taxable amount, and follow an accelerating
A tax rate is the percentage at which an
individual or corporation is taxed.
A tax liability is the total amount of tax
debt owed by an individual, corporation
or other entity to a taxing authority. It is
the total amount of tax you're
responsible for paying to the taxman.
schedule. High-income earners pay more than low-income earners, and the tax rate, along
with tax liability, increases as an individual or entity's wealth increases. The overall outcome
is that higher earners pay a higher percentage of taxes and more money in taxes than do
lower-income earners. This sort of system is meant to affect upper-class people more low- or
middle-class individuals – to reflect the fact that they can afford to pay more.
Insight-4: Income tax brackets for India

In India, income tax is levied on individual taxpayers on the basis of a slab system where
different tax rates have been prescribed for different slabs and such tax rates keep increasing
with an increase in the income slab. Such tax slabs tend to undergo a change during every
budget. Further, since the budget 2018 has not announced any changes in income tax slabs
this time, it remains the same as that of last year.
There are three categories of individual taxpayers:
1.Individuals (below the age of 60 years) which includes residents as well as non-residents
2.Resident Senior citizens (60 years and above but below 80 years of age)
3.Resident Super senior citizens (above 80 years of age)

Table-1: Tax slabs in India for FY 2018-19

Tax Rate
Income Tax Slabs Individual Senior Citizens (more than 60 Super Senior Citizens Domestic
Tax Payers Less than 80 Years) (80 Years or above) Companies
Income up to Rs 3,00,000 No No No
Income from Rs 3,00,000 – Rs 5% 5% No
5,00,000
Income from Rs 5,00,000 – 20% 20% 20%
10,00,000
Income more than Rs 10,00,000 30% 30% 30%
Gross turnover upto 250 Cr. in 25%
the previous year
Gross turnover exceeding 250 Cr. 29%
in the previous year

3.2: Regressive Taxes

Under this structure, the rate of tax decreases as income increase. Under a regressive tax,
individuals and entities with low incomes pay a higher amount of that income in taxes
compared to high-income earners. Rather than basing the tax on the individual or
entity's earnings or income level, the government assesses tax as a percentage of the asset that
the taxpayer purchases/owns.
For example, a sales tax on the purchase of everyday products or services, such as food
and clothing, is assessed as a percentage of the item bought, and
A sales tax is a consumption
is the same for every individual or entity. Shoppers pay, say, a 6%
tax imposed by the
sales tax on their groceries, whether they earn $30,000 or government on the sale of
goods and services.
$130,000 annually. Because the buyer's wealth (and hence, ability
to pay) is not taken into consideration, this sales tax – while nominally the same for all
shoppers – effectively places a greater burden on lower-income earners than it does on the
wealthy: The former end up paying a greater portion of total income than the latter. For
instance, if a person makes $20,000 a year and pays $1,000 in sales taxes on clothing and
other consumer goods, then 5% of his annual
income goes to sales tax. If a person makes Property tax is the annual amount paid by a land
owner to the local government or the municipal
$100,000 a year and pays the same $1,000 in
corporation of his area. The property includes all
sales taxes, then only 1% of his income goes to tangible real estate property, his house, office
building and the property he has rented to others.
sales tax.
Excise taxes are taxes paid when purchases are
Aside from state and local sales taxes, made on a specific good, such as gasoline. Excise
taxes are often included in the price of the product.
regressive taxes include real estate property
A sin tax is an excise tax on socially harmful goods
taxes and excise taxes (a fixed tax included in such as alcohol, cigarettes, gambling, and
pornography etc.
the price of the product or service) on
consumables such as gasoline or airfare. Sin
taxes, a subset of excise taxes, are imposed on certain commodities or activities perceived to
be unhealthy or have a negative effect on society, such as cigarettes, gambling and alcohol (in
an effort to deter individuals from purchasing those products). Sin-tax critics argue that these
disproportionately affect the less well-off not just because of economics, but because these
lower-income groups tend to indulge more in these items or activities.
Many also consider Social Security a regressive tax. Social security tax obligations are
capped at a certain level of income. This means
The Social Security tax is applied to income earned
that once an individual reaches the income by employees and self-employed taxpayers.
threshold, say, $128,700 in USA in 2018, any Employers usually withhold this tax from the
employees’ pay checks and forward it to the
wages he earns above that are not subject to the government. The funds collected from employees
for Social Security are not put into a trust for the
6.2% FICA bite. In other words, the annual individual employee currently paying into the
system, but rather are used to pay existing retirees.
maximum that one pays in Social Security tax is
"capped" at $7,979 (in 2018) – whether one
earns $128,701 or $300,00 or $1 million. Because of this cap, higher-income employees
effectively pay a lower proportion of their overall income into the Social Security system
than lower-income employees do.

Example-1: Instance of regressive tax.

Last weekend, John and Sam went shopping. They both bought new clothing, and each spent $300. The sales tax rate
is 13%. Therefore, each of them paid $39 in taxes. However, John’s salary is $3,000 per month, while Sam makes
$4,000 monthly.

While both John and Sam paid the same amount of tax, the proportion of the tax amount to income for Sam was only
$39/$4,000=0.975%, while John’s rate was $39/$3,000=1.30%. Thus, the sales tax is regressive.
3.3: Proportional Taxes
Under this structure, the rate of tax is fixed, irrespective of any increase or decrease in the
income. A proportional tax system, also referred to as
A flat tax system applies the same tax rate
a flat tax system, assesses the same tax rate regardless to every taxpayer regardless of income
bracket.
of income or wealth. It is meant to create equality
A marginal tax rate is the tax rate incurred
between marginal tax rate and average tax rate paid. on each additional dollar of income.
Proportional taxes are applied equally to all income
groups. For example, under a proportional income-tax system, individual taxpayers would
pay a set percentage of their annual income, regardless of the size of that income. Say the
fixed rate is 10%. Since it does not increase or decrease as income rises or falls, an individual
who earns $20,000 annually pays $2,000, while someone who earns $200,000 each year pays
$20,000 in taxes.
Some other specific examples of proportional
taxes include per capita taxes, gross receipts taxes, A gross receipts tax or gross excise tax is a tax
on the total gross revenues of a company,
and occupational taxes. Proponents of proportional
regardless of their source.
taxes believe they stimulate the economy more by
A flat rate of 25% corporate tax is levied on
encouraging people to work more, as well as spend the income earned by a domestic corporate
that has its base location in India and is of
more. They also believe businesses are likely to Indian origin.

spend and invest more as well under a flat tax

system, putting more dollars into the economy.

3.4: Degressive Taxes

Under this structure, the rate of tax decreases as the amount being taxed increases. A
digressive tax is partly progressive since tax rate increases as
Digressive tax is an
income increases; and partly proportional because tax rate remains admixture of progressive
and proportional tax.
unchanged even if income increases. Thus, digressive tax is an
admixture of progressive and proportional tax. Under digressive tax, tax payable increases
only at a diminishing rate but up to a certain limit beyond which a flat rate of tax is charged.
List of government schemes in India under social security system

1. Sukanya Samriddhi Yojana

Sukanya Samriddhi Yojana is a small-scale savings scheme for your daughter’s education and marriage. It’s a
part of government’s ‘Beti Bachao and Beti Padhao mission’. The government through this scheme wants to
convey a message that if a parent could make a proper plan for their girl child, they can definitely improve and
secure their daughter’s future.

Key points:
For whom– The scheme is suitable for every parent with a girl child with the aim of channelizing savings for
their education and marriage.
Eligibility– Suitable for your daughter up to 10 years of age
Costs involved– Annual contribution ranges from a minimum of Rs 1000 to a maximum of Rs 150000.
Benefits– Provides an annualized return of 8.1%

2. National Pension Scheme

It’s a voluntary pension scheme introduced with an aim of fulfilling retirement needs. It is regulated by the
Pension Fund Regulatory & Development Authority (PFRDA) which provides the tax benefits for investment
up to Rs 50,000 under section 80CCD in addition to Rs 150000 under section 80C. Hence, your total annual
deduction comes to Rs 200000.

Key points:
For whom– It is ideal for individuals who do not have anyone to look after them post-retirement.
Eligibility– Suitable for individuals between 18 to 60 years of age
Costs involved– The minimum contribution is Rs 1000 while there is no cap on the maximum contribution.
Benefits– Fulfills your retirement need and also offer a tax benefit

Costs involved– Annual contribution ranges from a minimum contribution of Rs 500 to a maximum of Rs
1,50,000.
Benefits– Tax-free interest on maturity and provides an annualized return of 7.6%.

3. Pradhan Mantri Jan Dhan Yojana

This is suitable for the economically weaker sections of the society who do not even have a bank account.
Pradhan Mantri Jan Dhan Yojana offers basic financial services like a Savings Account, Deposit Account,
Insurance, Pension, Remittances etc.

Key points:
For whom- For individuals who do not have any access to basic financial services. It is suitable for individuals
working in an unorganized sector.
Eligibility– Anyone belonging to the weaker section of the society.
Costs involved-There are no minimum and maximum contributions for this scheme.
Benefits– It provides zero balance savings account, debit card facility and accident and life cover of Rs 100000
and Rs 30000 respectively.

4. Public Provident Fund (PPF)

It’s a government-backed long-term savings scheme which aims to benefit self-employed people to save for
their retirement. It offers tax benefit under 80 C of the Income-Tax Act and provides a tax-free return on
maturity. You can also open PPF account for your wife and children.

Key points:
For whom- Suitable for salaried class people and small business owners.
Eligibility– Any adult can open the account on his or her own name or on behalf of a minor.

5. National Savings Certificate (NSC)

National Savings Certificate is a small scale saving and tax savings investment in India. It is a government
savings bond issued for a time period of five and ten years and is very popular among the rural masses. You can
purchase this bond from any Post Office in India and can be kept as collateral security to get a loan from banks.

Key points:
For whom- Suitable for Government employees, Businessmen and other salaried classes who are Income Tax
assesses.
Eligibility- Any adult can open the account on his or her own name or on behalf of the minor.
Costs involved- Minimum investment can be Rs 100 and investment up to INR 1,00,000/- per annum qualifies
for IT Rebate under section 80C
Benefits- Provides annualized return of 7.6% and qualifies for IT rebate under 80C.

6. Atal Pension Yojana

Atal Pension Yojana, a government backed pension scheme intended to provide pension benefits with a
minimum contribution per month. This scheme is targeted to the unorganised sector and provides pension
benefits with a minimum contribution per month.
Under this social security scheme, for every contribution made to the pension fund, the Central Government
would also co-contribute 50% of the total contribution or 1,000 per annum, whichever is lower, to each eligible
subscriber account, for a period of 5 years. But the subscriber has to contribute for a period of 20 years or more
under this scheme. It was introduced to help the low-income group of the society like maids, drivers or security
guards. Upon the death of the contributor, the nominee can claim for the accumulated corpus or pension money.

Key points:
For whom- It’s for people under the low-income group or who’s not a part of the tax bracket
Eligibility- Suitable for all individuals between 18 to 40 years of age
Costs involved- For a monthly pension of Rs 1,000, an 18-year-old will have to contribute Rs 42 per month for
42 years while a 40-year-old subscriber will have to invest Rs 291 per month for 20 years
Benefits- Provides fixed monthly pension between Rs 1000 to Rs 5000 post retirement.

7. Pradhan Mantri Jeevan Jyoti Bima Yojana

It is a life insurance scheme backed by the Government of India. It was introduced in the 2015 budget by our
finance minister, Arun Jaitley. This scheme aims to increase the number of insurers in India which is currently
very low.

Key points:
For whom- It’s for an individual who is the sole earning member of the family and have dependents under
him/her
Eligibility- Anybody who has a bank account and falls under the age group between 18 to 50 years can avail the
scheme
Cost involved- The premium is Rs 330 every year
Benefits- It ensures a term insurance cover of Rs 200000 to the dependants in case of the policyholder’s death.
 Rental earnings are assessed like income tax rates. But property owners can deduct all costs. Losses from
any one property can be deducted from other properties. Some wealthy landlords can use those deductions
to avoid all taxes. As a result, taxes on rentals are both progressive and regressive, depending on how the
business is run.

The estate tax is very progressive. It is levied on assets children inherit from their parents. It is 40 percent
on amounts greater than $5.43 million. The Trump tax plan has increased the exemption level for this tax,
making it a bit less progressive.

Tax credits for the poor are also progressive. They are subtracted from the person's tax owed, reducing
taxes by the amount of the credit. They are progressive because the amount saved means more to a person
with less income. Some credits are even more progressive because they are only available for those living
below a certain income level.

Note: A ripple effect is a situation in which, like ripples expanding across the water when an object is dropped into
it, an effect from an initial state can be followed outwards incrementally. Ripple effect is often used colloquially to
mean a multiplier in economics.

3.5: Comparison among the income taxes under various types of taxes
 Figure-4: Kinds of Tax Rates

4: Impact of tax on demand and supply

A tax increases the costs of production causing an inward shift in the supply curve. The
vertical distance between the pre-tax and the post-tax supply curve shows the tax per unit.
With an indirect tax, the supplier may be able to pass on some or all of this tax onto the
consumer through a higher price. This is known as shifting the burden of the tax and the
ability of businesses to do this depends on the price elasticity of demand and supply.

Figure-4.1: Impact of indirect tax with extreme PED

Figure-4.2: Impact of indirect tax with between zero and infinity

The Government would rather place indirect taxes on commodities where demand is inelastic
because the tax causes only a small fall in the quantity consumed and as a result the total
revenue from taxes will be greater. An example of this is the high level of duty on cigarettes
and petrol.

Example: The table below shows the demand and supply schedules for a good.

Price (£) Quantity Demanded Quantity Supplied Quantity supplied

(Pre-tax) (Post-tax)

10 20 1280 600

9 60 1000 400

8 150 850 150

7 260 600 50

6 400 400

5 600 150

4 900 50

Calculate the following:

1. What is the initial equilibrium price and quantity? (Hint: Price = £6; Quantity = 400).
2. The government imposes a tax of £3 per unit. Find the new equilibrium price after the tax has been imposed. (Hint:
The new supply schedule is shown in the right-hand column of the table – less is now supplied at each and every
market price. New price =£8.)
3. Calculate the total tax revenue going to the government. (Hint: Tax revenue = £450).
4. How have consumers been affected by this tax? (Hint: There has been a fall in quantity traded and a rise in the
price paid by consumers – this leads to a fall in economic welfare as measured by consumer surplus).
5: Problems with using taxes as a way of correcting for externalities and market failure
The aim of an indirect tax is to make the polluter pay and so internalise the externality.
However, implementing taxes is problematic:
1. Setting the 'right' tax rate e.g. if the monetary value of a negative externality is hard
to measure
2. Cost of collection: e.g. road charging requires expensive infrastructure e.g. IT system
of billing
3. Inelastic demand: higher petrol prices via higher indirect taxes has little effect on
demand for fuel, likewise, would a tax on sugar get people to cut their consumption of
high-sugar products?
4. Redistribution effects: Indirect taxes are regressive and affect low-income household
most.
5. Increased costs: Higher indirect taxes may cause inflation affecting consumers who
did not pollute and international competitiveness if taxes are higher in one country
than another.

6: Fiscal reform in India

GST and Demonetization are two bold decisions taken by the Indian government to tackle the
issues which are existing and to resolve the emerging issues which arises day by day in the
Indian economy. GST and Demonetization are likely to be described as game changers of the
Indian Economy. GST will require companies to not just be tax complaint but also readjust
their structure and supply chain networks. On the other hand Demonetization is leading to
boom the cashless payments. These two will render great opportunity for customers to relook
at their structure and redesign their supply chains, since the current supply chain has been
designed according to interstate taxation. This biggest Tax reform in Independent India, the
Goods and Services Tax Act (GST) has brought on a platter, a concept called “Composition
Levy’ to its taxpayer. One of the fundamental features of GST is the seamless flow of input
credit across the chain (from the manufacture of goods till it is consumed) and across the
country. The money in the economy is circulating as a network of pipes through which water
is flowing. The banking system manages this network, and the efficiency of this system is
known as liquidity. The morally and ethically depraved society of today is an outcome of
these stark inequalities. Black economy also uses the money it makes, but focuses more on
assets and hoarding. It pushes up demand for property and gold. It hoards the cash locally and
globally, treating it as a store of value. Evaders will pay taxes on what they bring into the
bank. Therefore cash can be a store of value, as the risk of demonetisation is real.

6.1: Demonetization
Demonetisation is an act of stripping a currency unit of its status as legal tender. The
necessity for Demonetisation arises whenever there is a change of national currency. The old
unit of currency must be retired and replaced with a new currency unit. The major motive of
this demonetisation is to combat inflation, to combat corruption, and to discourage a cash
system. Therefore the process of demonetisation involves either introducing new notes or
coins of the same currency or completely replacing the old currency with new currency.

6.1.1: Economic consequences of demonetisation

People who have black money are mostly in pithole. Either they have to go to banks to
exchange their money into new forms of notes and get under the government radar. Else they
forget the money because it will turn into useless paper soon. The following are the chief
economic consequences:
 Effect on parallel economy: The removal of these 500 and 1000 notes and
replacement of the same with new 500 and 2000 Rupee Notes is expected to – remove
black money from the economy as they will be blocked since the owners will not be
in a position to deposit the same in the banks, – Temporarily stall the circulation of
large volume of counterfeit currency and – curb the funding for anti-social elements
like smuggling, terrorism, espionage, etc.
 Effect on Money Supply: With the older 500 and 1000 Rupees notes being scrapped,
until the new 500 and 2000 Rupees notes get widely circulated in the market, money
supply is expected to reduce in the short run. To the extent that black money (which is
not counterfeit) does not re-enter the system, reserve money and hence money supply
will decrease permanently. However gradually as the new notes get circulated in the
market and the mismatch gets corrected, money supply will pick up.
 Effect on Demand: The overall demand is expected to be affected to an extent. The
demand in following areas is to be impacted particularly the Consumer goods · Real
Estate and Property · Gold and luxury goods · Automobiles (only to a certain limit).
All these mentioned sectors are expected to face certain moderation in demand from
the consumer side, owing to the significant amount of cash transactions involved in
these sectors.
 Effect on Prices: Price level is expected to be lowered due to moderation from
demand side. This demand driven fall in prices could be understood as follows:
 Consumer goods: Prices are expected to fall only marginally due to moderation in
demand as use of cards and cheques would compensate for some purchases.
 Real Estate and Property: Prices in this sector are largely expected to fall, especially
for sales of properties where major part of the transaction is cash based, rather than
based on banks transfer or cheque transactions. In the medium term, however the
prices in this sector could regain some levels as developers rebalance their prices
(probably charging more on cheque payment).
 Effect on various economic entities: With cash transaction lowering in the short run,
until the new notes are spread widely into circulation, certain sections of the society
could face short term disruptions in facilitation of their transactions. These sections
are: Agriculture and related sector; Small traders; SME; Services Sector; Households;
Professionals like doctor, carpenter, utility service providers, etc.
 However in the long term, though, this is likely to drive several benefits for the
economy. India has made the first move from cash economy to a digital economy. Larger
amount of savings and cash will find a way into the mainstream economy and be deployed
for physical and financial asset creation. Use of digital currency and payment systems driven
by UPI, wallets and cards will create enormous transparency and paves way for faster
evolution of Fintech companies in India especially in transactions and Online lending space.
But however it needs to be accepted that the caricatured version of black money driving
Indian real estate is no longer applicable.
Source: Internet

6.2: GST
Goods and Services Tax which is commonly referred to as “GST” is consumption based
tax/levy. It is based on the “Destination principle.” GST is applied on goods and services at
the place where final/actual consumption happens. Though GST is a tax reform, it is going to
impact every sphere of business activity, be it procurement, supply chain; IT, logistics,
pricing, margins, working capital, etc. as a number of business decisions taken are based on
the current tax structure which may no longer be relevant in the new GST regime.
Whenever any good used to be manufactured excise duty used to be levied and
collected by the central government. Next as the good moves to the manufacturer to the
dealer and the dealer started selling the good, it become the subject of value added tax
(VAT). VAT is be collected by the state government, if the transaction happens within the
state boundary. On contrary, for inter state transaction it becomes the subject of Central Sales
Tax, which is determined by central government but been collected by the state. In case of
services, service tax is levied and solely use to handle the central government. A part of that
many taxes used to be levied by the state government like entertainment tax, entry tax, octroi
tax etc.
For example, suppose Krishna, a manufacturer from West Bengal, wants to sell a
commodity of say Rs.10,000 to a dealer, Abdullah, who stays in the same state. To do that
transaction, first he will include the excise tax (say, 10%) since, he wants to collect the taxed
amount from Abdullah. So, after imposing the excise tax the total value of the product
becomes Rs. 11,000. Now, on top of Rs.11,000, Krishna will also add the VAT (say, 10%)
that he also has to pay to the state government. So, the final value of the product will be
(Rs.11,000+ Rs.1,100=) Rs. 12100. Here, Krishna will take Rs. 10,000, pay excise duty to
central of Rs. 1000 and pay tax to state government of Rs. 1100). Note that VAT is imposed
on the value of the commodity after the excise tax was imposed – a situation of tax on tax.
Now, suppose, Abdullah will sell the commodity to a customer named John. To determine
the selling price Abdullah add two components on top of the purchased price – his mark-up
(say, Rs.5,000) and the VAT that he has to pay to the state government. After adjusting the
mark-up, the value of the product becomes (Rs. 11,000+Rs. 4000=) Rs. 15,000 and including
VAT the value will be (Rs.15,000+ Rs.1,500=) Rs.16500. Since, Abdullah has already paid
VAT of Rs.1100, so he will deduct the taxed amount and during transaction with John, he
will pay only (Rs.1,500 – Rs.1,100=) Rs. 400 of VAT. Rs.1,100 is called the Impute Tax
Credit (ITC).
Now, suppose John wants to sell Mr. Gulati in Gujrat with an added mark-up of Rs.
5,000. He will add this value to Rs. 15,000 at which he has purchased the commodity. So, the
seller’s receiving price of the product will be
Rs.20,000 and including CST (say, 5%) Rs. 21,000. A cascade tax is a type of turnover tax with
each successive transfer being taxed
Remember, here John is eligible to collect ITC of inclusive of any previous cascade taxes
(Rs.11,000+Rs.1,500=) Rs.16,500, since both CST being levied.

and VAT were collected by state government i.e. Cascading Tax Effect means tax on tax.

West Bengal. Gulati runs his business within state itself. Suppose he sold the product to a
consumer adding a mark-up of Rs.4000. So, after the inclusion of tax (10% VAT) the value
of the product becomes (Rs. 21,000+Rs.4000+Rs.2,500=) Rs. 27,500. However, Gulati
cannot claim the previous taxes that he has paid and were included in the previous
transactions, and he cannot enjoy any benefit – because, all the previous taxes were paid to
the West Bengal government but the final transaction happened in Gujrat. This incident is
called cascading effect. It used to create complications in the system and inter-state conflicts.
To avoid such problem, we moved to Goods and Services Act (GST).
In India, the three government bodies collected direct and indirect taxes until 1 July
2017 when the GST was implemented. GST incorporates many of the indirect taxes levied by
states and the central government. It was aimed to a) abolish many indirect taxes in our
country; b) removed the cascading effect; c) capture black money; d) seamless flow of market
on many occasions; and ease of business. Some of the taxes GST replaced include:
 Sales Tax
 Central Excise Duty
 Entertainment Tax
 Octroi
  Service Tax
 Purchase Tax
It is a multi-stage destination-based tax. Multi-stage because it is levied on each stage
of the supply chain right from purchase of raw material to the sale of the finished product to
the end consumer whenever there is value addition and each transfer of ownership.
Destination-based because the final purchase is the place whose government can collect GST.
If a fridge is manufactured in Delhi but sold in Mumbai, the Maharashtra government collects
GST.
A major benefit is the simplification of taxation in India for government bodies. GST
has three components:
 CGST: Stands for Central Goods and Services Act. The central government collects
this tax on an intrastate supply of goods or services.
 SGST: Stands for State Goods and Services Tax. The state government collects this
tax on an intrastate supply of goods or services.
 IGST: Stands for Integrated Goods and Services Tax. The central government collects
this for inter-state sale of goods or services.
The tax rates of GST are as follows:
Items Rates
Essential items 0%
Commonly used items 5%
Two-standard rates GST 12% - 18%
Luxurious items 28%

6.3: Impact of demonetisation and GST on the economy in the long-run

Generally Indian banks and companies will face short-term downside risks due to the cash
crunch which arises from the government’s decision to invalidate old high-value currency
notes. Indian government reforms will have long-term structural benefits but the same will
carry short-term execution and adjustment risk. The decision to demonetize Rs. 500 and Rs.
1, 000 currency notes had led to a significant cash crunch in the economy. The General public
of the Indian economy expects both demonetization and the goods and services tax (GST) to
adversely impact some sectors of the economy in the short run but have long-term benefits.
This demonetization and a goods and service tax (GST) are expected to be implemented by
September 2017 which is likely to have a higher disruptive impact on the informal, rural, and
cash-based segments of the economy. However, in the long run, demonetisation and GST
could result in a wider tax base and greater participation in the formal economy. This should
benefit India’s business climate and financial system in the long run.
As per the existing scenario in the Indian economy, the disruption from demonetisation
should be short-lived with demand revival in the next one to two quarters, limiting the impact
on Indian banks and corporate. However, in the short term, the rural and informal sectors of
the economy are experiencing large-magnitude adjustments. Business sectors that often
transact in cash, including jewelry and real estate, will also face some degree of upheavals. In
a less-likely downside scenario, the shock of demonetisation will not be absorbed within the
next few months and the economic disruption will spill over into fiscal 2018, and potentially
coincide with the introduction of the GST. Economic growth will stay lower for longer,
raising stress levels on corporate, banks, and other financial institutions; although the
sovereign rating is likely to remain resilient.”

6.4: Corporate tax reduction

India has slashed corporate tax from 30% to 22% statutory rate for existing companies and
from 25% to 15% for new manufacturing companies. The present corporate tax rate in India
is lower than the global average (23.79%) and its Asian competitors like Myanmar (25%),
Malaysia (24%), Korea (25%), Sri Lanka (28%), and China (25%). A similar initiative has
also been seen in OECD countries, US and UK in recent years. For example, OECD countries
have dropped the corporate tax from 32.5% in 2000 to 23.9% in 2018.
In India, the effective tax rate for existing companies, including a surcharge and cess,
now come down to 25.17% from 35% and the companies can opt for previous higher tax
rates or the new tax rate, they are not claiming benefits for incentives or concessions. But a
dilemma is gripping to capital-intensive companies (in sectors like steel, infrastructure and
engineering), whether to opt for lower corporate tax rates and increase profitability, or pay
higher taxes under current rates and carry forward the losses. Many capital intensive
companies have made a large capital expenditure in the last few years. Under the previous
regulations, companies can claim depreciation on new plants and machinery as net loss,
which they can carry forward over an eight-year period and use to offset future profits.
Depreciation is normally calculated on new investments like plant and machinery. At a
normal rate, up to 15% depreciation is allowed in the first year. In addition, manufacturing
companies can claim up to 20% additional depreciation on newly installed plants and
machinery each year - together they can claim a total depreciation of 35%. However, the
facility of carrying forward of loss may not be applied for the new tax slab.
According to the Finance Minister, the tax cut will have a certain favourable impact on
the Indian economy:
1. It will favour India's competitive position in the Asian economy to attract foreign
investment;
2. It will reinforce confidence among international investors towards the Indian economy;
3. It will boost economic growth through corporate investment in India for existing or new
companies.

7: Who collects the taxes?

The three bodies which collect the taxes in India have clearly defined the rules on what type
of taxes they are permitted to collect.
 The Central Government: Income tax, custom duties, central excise duty.
 The State Governments: Tax on agricultural income, professional tax, value- added
tax, state excise duty, stamp duty.
 Local Bodies: Property tax, water tax, other taxes on drainage and small services.

Insight-5: Laffer Curve

The Laffer curve is named after the economist Arthur Laffer (1974). The Laffer Curve is a theory developed by
supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue
collected by governments.

The Laffer curve became important in the 1980s because it appeared to give an economic justification to cutting
income tax rates. For politicians, such as Ronald Reagan, the Laffer Curve analysis is attractive – it appears to give the
best of both worlds.

 Lower tax rates which are politically popular.

 Increased tax revenues and lower budget deficits.
Further topics of discussion:
1. Modified Value Added Tax (MODVAT):
Central Value Added Tax (CENVAT):
2. Transport Tax:
3. Service Tax
4. Tobin Tax: A proposed tax on international financial transactions, especially
speculative currency exchange transaction
5. Winfall Tax: A tax levied on an unforeseen or unexpectedly large profit, especially
one regarded to be excessive or unfairly obtained.
6. Gift Tax:
7. Fiscal Drag: the deflationary effect of a progressive taxation system on a country's
economy. As wages rise, a higher proportion of income is paid in tax.
8. Cess and Surcharge:
9. Corporate Tax:
10. Dividend Tax:
11. Professional Tax