Taxation is the strongest determinant of the economic structure of all countries. In India, progressive taxation is an extremely crucial instrument to be employed in the process of bridging the gap of income disparity and allocating resources in a fair manner. Progressive taxation is the system of taxation by which the taxpayer pays a greater percentage of tax when the taxpayer has a greater income, and hence the affluent are compelled to pay a greater share of their income to the public exchequer. The taxation system is not only employed to generate revenue for the state but also to redistribute income and hence reduce the gap between the affluent and the poor.
In this blog post here, we would like to address the impact of progressive taxation on income inequality in India with regard to the legal framework, economic implications and the challenges and potential of the tax regime.
Understanding Progressive Taxation in India
Progressive taxation is based on the vertical equity principle, which is the principle that the rich must contribute a higher percentage of their income in taxes than the poor. Indian taxation is on this principle: once a certain level is reached, the rate of tax rises with increasing income.
Indian Income Tax Act, 1961, has evolved a system of progressive taxation where the taxpayers fall in many slabs of taxation. The tax structure is such that the wealthy would pay the maximum amount and hence the system claims to be fair. To put it into perspective, for the financial year 2023-24, those earning up to ₹2.5 lakh annually would be exempt. Tax payable for the income group of ₹2.5 lakh to ₹5 lakh would be 5%, and the tax rate increases with the higher income groups—up to 30% for those individuals who earn more than ₹10 lakh annually.
Why Progressive Taxation is the new trend of taxation in India?
The primary reason behind progressive taxation in India is to minimize economic inequalities and ensure social justice. India is one of the largest economies with the highest-level nexus between GDP inequality and income inequality. Based on Oxfam India a report in 2021 shows the richest 10% of Indians hold more than 77% of India’s This has caused greater demands for stricter mechanisms to cut down inequality. Progressive taxation is also regarded as the most effective mechanism in cutting down income inequality by making sure the affluent provide the state with a fairer share of their incomes. These funds can be utilized by financing public amenities, infrastructure development and social protection schemes for vulnerable sections.
Legal framework and tax structure in India is currently very complicated on Corporate Taxation.
India’s taxation is governed under the Income Tax Act which has been amended more than 3 times in order to make provisions for the new economic scenario as well as for the changing notion of globalization The Finance Act passed annually by Parliament determines the tax rates through the income tax slabs and the exemption limits for the financial year. Individuals are offered deductions from taxable income in the form of expenditure on specified investment products, life insurance premiums, and retirement scheme contributions under Section 80 of the Income Tax Act. The deductions are meant to restrict taxable income as well as for reducing the burden of taxation on middle and poor classes of population. The 2017 passage of the Goods and Services Tax (GST) is another significant means of Indian taxation, though it is of a different nature compared to the income taxes The GST is itself a consumption-tax but it indirectly affects the pattern of incomes since its levy can vary based on the nature of goods and services consumed. Low-income households who consume a larger proportion of goods and services compared to their income are indirectly affected by the pattern of GST taxation.
In India the economic effect of progressive taxation on income inequality is huge but it has been factored in over the last 20 years. Progressive taxation is a strong tool in reducing income inequality by transferring wealth to different sections of society. By taxing more income at higher rates, the government earns revenue that can be used to fund various social welfare schemes that disproportionately accrue to the poor and middle-class in developing nations. These include food subsidies, healthcare education and rural development, all of which are poverty reduction and inclusive growth promoting. Public welfare spending in India is based on revenues raised through taxes like the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), the Pradhan Mantri Jan Arogy Without progressive taxation these schemes would be underfunded and the benefit to low-income groups would be minimal. Progressive taxation also aids in enhancing economic stability by enhancing aggregate demand. Lower-income groups spend a greater proportion of their income on essential goods and services which in turn generates demand and economic activity. By transferring wealth, the government ensures that more individuals have access to purchasing power, which can enhance overall economic growth.
The Advantages of Progressive Taxation in India
Reducing Income Inequality: Progressive taxation is one of the main tools in reducing income inequality in India. Taxing additional income at higher rates, the rich pay more through which the government can spend on social programs benefiting the poor.
Financing Public Services: Tax revenue generated through progressive taxation is required for the financing of public services such as education, healthcare, sanitation, and infrastructure development, which are enjoyed by all citizens, especially the marginalized ones.
Fostering Economic Growth: By promoting consumption spending among the poor through income transfer, progressive taxation stimulates demand for goods and services and economic growth. This fosters a more equitable and sustainable economic environment.
Assisting Social Welfare: Progressive taxation allows the government to implement its constitutional obligation of ensuring a minimum level of living for its citizens. Article 38 of the Indian Constitution makes provisions for the welfare of the citizens through a just social order, which progressive taxation seeks to attain.
Criticism of Progressive Taxation in India
Despite its many advantages, progressive taxation faces several criticisms:
Tax Evasion and Tax Avoidance: A higher tax rate provides a higher incentive for high-income earners and companies to evade taxes or engage in tax avoidance. This is particularly dangerous in a developing nation such as India, where tax enforcement is patchy. The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 was enacted to deal with this to some degree, but tax evasion remains a major issue.
Capital Flight: The upper-income segments can choose to invest abroad or elsewhere where there are lower tax rates, and this can undermine the overall efficacy of progressive taxation. This has moved into the center stage with the process of globalization and greater capital mobility.
Economic Disturbance: Others are of the opinion that excessive tax rates can discourage investment and entrepreneurship, especially when capital gains are taxed excessively. When higher-income earners and businesses perceive that their returns are being overly taxed, they become less likely to invest or curtail income-generating activities.
Administrative Complexity: The progressive tax system can be complicated by numerous tax brackets, exemptions, and allowances, which can make compliance difficult for taxpayers and expensive for the government to administer. Complexity can also give rise to legal controversies and loopholes that undermine the efficacy of the tax system.
Conclusion
Progressive taxation remains a powerful way of reducing income inequalities in India. By taxing wealthy people more, the state can redistribute incomes and finance public goods that are enjoyed by poor individuals. Nonetheless, problems such as tax evasion, capital flight, and bureaucratic intricacies need to be managed to ensure that the system is effective. Indian economic growth hinges on progressive taxation getting it right to reduce disparities, promote social justice, and enhance economic stability. As the nation continues to evolve, progressive taxation will remain an integral component of efforts toward making society equitable.
References
1. Income Tax Act, 1961, Government of India. Available at: https://incometaxindia.gov.in (The official document outlining the tax laws and provisions related to income tax in India.)
2. Oxfam India. (2021). “Inequality Report 2021: India’s Billionaire Boom and COVID-19.” Available at: https://oxfamindia.org (A report highlighting the growing wealth inequality in India, focusing on the wealth accumulation of the top 1% and the effects of the pandemic.)
3. Ministry of Finance, Government of India. (2023). “Finance Act 2023.” Available at: https://www.finmin.nic.in (The official publication of the Finance Act, which outlines the amendments to India’s tax policies and the tax brackets for the year.)
4. Constitution of India. Article 38. Available at: https://indiacode.nic.in (The section of the Indian Constitution that mandates the state to promote the welfare of the people and establish a just social order.)
5. Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015. Available at: https://www.indiabudget.gov.in (The legislation aimed at curbing the black money economy in India by imposing taxes on undisclosed foreign assets.)
6. World Bank. (2020). “India: Overview of Economic and Social Inequality.” Available at: https://www.worldbank.org (An overview report on income inequality in India, discussing economic disparities and the impact on social development.)
7. Economic Survey of India, 2020-21. Ministry of Finance, Government of India. Available at: https://www.indiabudget.gov.in (A key document providing insights into the economic challenges India faces, including income inequality and the need for effective taxation policies.)
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