What is Taxation? | What is Indirect, direct tax | Proportional, Regressive, and Progressive tax

We know that our home cannot run without sufficient money. If our parents stopped getting their income, it would be really difficult for us to manage our day-to-day expenses. Maintaining our standard of living, and saving money for rainy day. There is no doubt that we need money to survive and to run our homes.

Just like how we need money to run house, Government also needs money to run the country. Governments’ job in any country is to improve standard of living, reduce inequalities and promote economic growth of the country. For all these activities, government needs money.

Once Government gets the funds, it can then spend it on various things like welfare projects, development projects, administration costs, and public infrastructure.

One of the methods that Government uses for collecting revenue is taxation. Taxation is a mandatory fee that we all pay to Government for smooth functioning of our country.

In India, the Central and the State Governments have the right to collect taxes according to the Indian Constitution.

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When we hear the word tax, we automatically think of money getting deducted from our salaries. We assume that people are talking about income tax when they mention word tax.

It is true that income tax is a popular method for Government to collect funds, it is not the only method. There are other different types of taxes.

Let us study some of these types of taxes:

What are the Types of taxes ?

We can classify the Indian tax system into two broad categories i.e., Direct Tax and Indirect Tax. These two categories of taxes have various subcategories as well. Lets us discuss them in detail.

Direct Tax-

Meaning of direct tax is evident from the name itself. It is tax that is paid directly by the taxpayer or legal, business entity to the government. In Direct tax system, the person who owes tax to the government cannot pass it on to someone else.

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Central Board of  Direct Taxes looks after the direct tax workings in India. There are different types of direct taxes. They are Income tax, Securities Transaction Tax, Prerequisite Tax, Corporate Tax and Capital Gains Tax.

1. Income Tax:

It is the tax which is charged to an individual taxpayer or a legal entity on their income earned. There are different income tax slabs based on an individual’s income. The current Income Tax Rate for the year 2021-2022 are:

  • Nil for income for upto Rs. 2.5 lakh;
  • 5% for income between Rs. 2.5 lakh to Rs. 5 lakh;
  • 10% for income between Rs. 5 lakh to Rs. 7.5 lakh;
  • 15% for income between Rs. 7.5 lakh to Rs. 10 lakh;
  • 20% for income between Rs. 10 lakh to Rs. 12.50 lakh;
  • 25% for income between Rs. 12.5 lakh to Rs. 15 lakh;
  • 30% for income above 15 Lakh

2. Securities Transaction Tax (STT):

This tax is imposed on traders and investors who participate in the stock market. This tax is imposed on securities that are traded in the stock market. Intraday equity trading current rate of STT is 0.025% whereas STT for future and options are 0.01% and 0.017%

3. Prerequisite Tax:

Prerequisite Tax is the tax that is imposed on various benefits that companies provide to their employees like rent-free accommodation and paying medical expenses. Current Prerequisite Tax rate is 30% of value of benefits enjoyed by the employees.

4. Corporate Tax:

This is the tax that is charged on a company’s profits. Corporate Tax has sub categories. This includes Dividend Distribution Tax, Fringe Benefit Tax and Minimum Alternative Tax. Current Corporate Tax rate for domestic companies with an annual turnover upto Rs.250 crore is 25%, for domestic companies with an annual turnover of more than Rs.250 crore is 30%, and for foreign companies is 40%.

a) Dividend Distribution Tax

it is imposed on the dividends that a company pays to its investors. Dividend distribution tax rate is 15% as per section 1150. However, in the Union Budget of 2020, Dividend Distribution Tax has been abolished.

b) Fringe Benefit Tax

it is the tax imposed on the benefits given to employees in a company like travelling allowance. When Fringe Benefit Tax was still valid, tax rate was 30% on value of  benefits provided by the company to its employees. It was abolished in the year 2009 after much debate in parliament.

c) Minimum Alternative Tax,

it is the tax where the government asked companies to pay minimum tax in order to avoid tax evasions by companies. Current Minimum Alternative Tax rate is 15% for all companies in India.

5. Capital Gains Tax:

Tax that is imposed on the sale of property or returns on any investment made by a person is the capital gains tax. It can be short-term or long-term. Short term Capital Gains Tax is 15% whereas the long term Capital Gains Tax is 20%.

Indirect Tax-

Indirect Taxes are different from Direct Taxes. Direct taxes are imposed on our income, profit or revenue from the stock market. Indirect taxes are the taxes that are charged on goods and services that we buy.

There are different types of indirect taxes like sales tax, central excise tax and value added tax. However, with start of the Goods and Services Tax, all these other forms of indirect tax has been replaced.

Indirect taxes can be shifted by one person to another person. Government receives payment of the tax from seller of a good and service.  In Indirect Taxes, tax is added to product or service bought by customer. Seller of the product collects the tax.

Goods and Services Tax-

All other forms of indirect taxes were replaced in India with the introduction of Goods and Services Tax in 2017. Earlier, due to presence of various indirect taxes like Central Excise Duty, Value Added, Central Govt. Tax and State Govt. Tax, the system of paying taxes was highly complicated. 

With GST, the system has been simplified. GST is imposed on all goods and services consumed in the country. Goods and Services Tax has made tax administration easier with its motto ‘one nation, one tax’. It has also brought more people under the tax umbrella and has been helpful in eliminating tax evasion.

Tax Rates-

Every country has a ‘tax rate’ system that they follow based on their policy.

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Tax rate is the amount of tax that a person has to pay. This amount of tax is based on their tax base. A tax base can be income, property, consumption of goods and services etc.

This tax rate can be Proportional, Progressive, or Regressive Taxation.

1. Proportional Taxation-

Proportional Taxation is a system that is based on idea of equal sharing of tax burden. According to Proportional Taxation, everyone irrespective of their income has to pay same tax.

Lets say there are three people with incomes INR 1,000; INR 2,000; INR 3,000. We can say they are Person A, Person B, and Person C respectively. We will assume that the country has a Proportional Tax System with a tax rate of 10 percent.

This means that all the above three people will have to pay 10 percent of their income for taxes. Their tax amount will be INR 100 for Person A; INR 200 Person B; INR 300 Person C respectively.

However, this taxation is not fair as it charges same tax rate to both rich and poor.

2. Progressive Taxation-

Progressive Taxation is a system where tax rate increases with increase in income. According to Progressive Tax system, responsibility of paying tax should increase with an increase in income.

We can use same example above and say that three people are having incomes INR 1,000; INR 2,000; INR 3,000. We can say they are Person A, Person B, and Person C respectively.

Let us say the country has a Progressive Tax System with a tax rate of 10% for Person A; tax rate of 15% for Person B; tax rate of 30% for Person C.

Here, we can see tax rate rises with an increase in income. So the tax amount paid by each will be INR 100 by Person A; INR 300 by Person B; INR 900 by Person C respectively.

Progressive taxation is popular now because rise of democracy and the need for social welfare.

3. Regressive Taxation-

Regressive taxation is a system where tax rate falls as income increases. According to Regressive Taxation, as a persons’ income rises, they have to pay less taxes.

Again, we use the same example as above. We assume that three people are having incomes INR 1,000; INR 10,000; INR 1,00,000. We can say they are Person A, Person B, and Person C respectively.

Let us say country has a Regressive Tax System with a tax rate of 10% for Person A; tax rate of 1% for Person B; tax rate of 0.1% for Person C.

Here, we can see tax rate decreases with an increase in income. So the tax amount paid by each will be INR 100 by Person A; INR 100 by Person B; INR 100 by Person C respectively.

Regressive Tax system is unjust to the poor as they are burdened more with tax.

Credit: EconomyHut research team

Conclusion :

Tax is a compulsory fee that government charges on its citizens, legal or business entities. It is broadly classified as Direct and Indirect Taxes. In Direct Taxes, tax is paid directly by the individual and in Indirect Tax the tax burden is shifted by seller to consumer.

Tax rate imposed on various individuals in a country depends on tax rate that country follows. This tax rate can be Progressive, Regressive and Proportional. Most countries being democratic and welfare oriented follow the Progressive system, including India.

FAQs about taxation :

  • What is taxation?

    Taxation is a mandatory fee imposed by the government on its citizens to collect revenue for spending on various activities like building public infrastructure, raising standard of living etc

  • What are the two categories of taxation?

    In India, taxes are of two broad types: direct tax and indirect tax. Direct taxes are those that are charged directly to an individual, and indirect taxes that are imposed on consumption of goods and services.

  • What are the types of Direct Tax?

    Income Tax, Capital Gains Tax, Securities Transaction Tax, Prerequisite Tax and Corporate Tax are the different types of direct tax

  • Why were the Value Added Tax, Sales Tax and Central Excise Tax replaced?

    Value Added Tax, Sales Tax and Central Excise Tax were replaced by a better and efficient indirect tax system called the Goods and Services Tax (GST). GST has bought all the indirect taxes under one umbrella.

  • What are the different types of tax rate systems?

    Proportional Tax, Regressive and Progressive Tax are the different types of tax rate systems.

  • Which Tax Rate System does India follow?

    India follows progressive tax rate system. In Progressive Tax rate system, the more income a person earns, more they are taxed.

  • What is the retrospective tax system?

    The word retrospective means ‘looking back’. In tax world, it means charging tax on transactions that happened way before the law was framed. These transactions mostly involved sale of assets by foreign entities in India.

  • What are the current GST slabs?

    The government has introduced a four-tier tax structure for all goods and services. Current slabs of Goods and Services tax are divided into four groups with slab rates : 5%, 12%, 18% and 28%.

  • How is Income Tax calculated?

    We calculate Income Tax with the help of different tax slabs. Tax slabs are the range of income based on which different rates of tax are imposed

  • Why does the government collect taxes?

    The government requires funds for carrying out various activities like the development of public infrastructure, sponsoring schemes that reduce inequality and boost economic growth. One way of collecting these funds is through taxes imposed on citizens of the country

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