1. Why should you pay taxes?
You often wonder why you should pay any taxes. Some people think that taxes are paid only by the rich. Some people think that if they do not pay due taxes, nobody will notice. Some people wonder why taxes should be paid, since there is little that one gets in return. You may be surprised by the answers to all of these questions. All of us pay taxes all the time. The services that we get in return are significant and valuable. But you also come across many opportunities for not paying your taxes. A shopkeeper may tempt you not to pay the due tax on a purchase if you choose not to take a proper receipt. A house-owner may show reluctance to give a rent receipt where you may be a tenant. Tax evasion and tax avoidance makes tax authorities aggressive and forces them to make complex provisions in law to plug loopholes. Over time, the tax system becomes extremely complex and difficult to comply with. Interaction between taxpayers and tax authorities often leads to corruption and generation of black money, which has many harmful effects on the economy. It is best if each side, namely, the taxpayer, the policy makers, the spending departments, and tax authorities appreciate their relative roles and their place in the common endeavour towards building a better society and a stronger Indian economy. As a taxpayer, you have a key role to play in this common endeavour. It is illegal not to pay one’s due taxes; by voluntarily paying your due taxes, you contribute to the common good.
We pay taxes all the time, sometimes without realising it
Rich or poor, knowingly or without being aware, reluctantly or willingly, all of us are paying taxes all the time. As we step out of the house to purchase fruits or vegetables, without realising it, the price that is to be paid is likely to contain a tax component. Fruits or vegetables may be in the exempt list of indirect taxes charged by the government. However, if diesel has been used to transport it from the place of production to the market, a tax might have been paid on that diesel, which would already be part of the price. Many taxes are embedded in the prices of goods and services that we purchase. These are called indirect taxes.
There are, of course, more direct taxes that are clearly visible. A salaried employee will be paying an income tax, which may get deducted from his income every month. Every year he will be filing an income tax return. A company will be asked to pay a corporate income tax. A property owner will be asked to pay a property tax. Direct taxes are paid by individuals and companies. Indirect taxes are collected through dealers registered with the tax authorities although the tax is eventually paid by the consumers of goods and services. As you read the newspaper, not only will you be intrigued by the tax cases going on in the courts of law but you yourself will be paying an electricity duty for the light under which you may be reading the newspaper. The list of taxes is long. There are central taxes such as personal income tax, corporate income tax, central excise duty, customs duty, and service tax. There are state taxes such as sales tax and value added tax, stamp and registration duties, state excise duties, motor vehicle tax and entertainment tax. There are taxes charged by municipalities like the property tax. Even local rural bodies like the panchayats have powers of taxation.
We also enjoy the benefits of services provided by governments, sometimes without appreciating it.
As you step out of the house, you would unavoidably walk on a road built by the state government, who finances it by taxes that you have paid. You might take a bus to your college of university and pay a price for the bus ticket, which is much less than the cost of providing that transport service. You would then be benefited by a subsidy, also financed by tax revenues. When you decide to go abroad to pursue higher studies, the government will issue a passport so that you are allowed entry in a foreign country. That service is also run by the government and the expenditure that the government incurs for providing that service is financed by tax revenues. Just as there are many taxes, there are also many services that governments provide. The central government provides services like defence, system of justice, and the currency system. It builds national highways and nurtures universities and institutions of higher education like the Indian Institutes of Technology (IITs). State governments also provide many services. They build state level highways, facilitate setting up of industries, run hospitals and schools and colleges, and build irrigation canals.
If you are a citizen living in an urban area, three tiers of governments are responsible for your welfare and well-being – the central government, the government of the state where your city is located and the municipal body that provides you civic or local services. Your elected representatives have been entrusted with the responsibility of forming that government, formulate policies and provide administration with the help of administrators. If you are a citizen living in a rural area, there would be, according to our constitutional scheme, five tiers of government entrusted with the responsibility for your welfare and well-being. Starting with the tier of government closest to you and moving upwards, you would have a gram panchayat, a block or anchal panchayat and a district committee or panchayat, a state government, and then at the apex of this vertical structure, the central government. All the elected members of panchayats, state legislature, and the Parliament and the appointed officials of the executive are meant to serve you. In terms of economics, you are the principal and they are the agents entrusted with the responsibility of meeting your needs and carrying out your wishes. But they need resources to perform those duties.
Tax is a compulsory payment by law
Taxation is by definition a compulsory payment. It is compulsory by law. There is no one-to-one link between the tax that you pay and the service that you receive. The law has been made because of the special nature of goods and services provided by the government that are financed by tax revenues. The nature of these goods and services is such that they cannot be sold or financed in the same way as private goods that are bought and sold in the market place. When we go to the market, we pay a price according to the quantity we purchase and the type of goods we buy. Whatever we purchase, we have the full right to enjoy the benefits of that exclusively if we so desire.
The book that we buy from a bookstore or the meal that we have ordered in a restaurant need not be shared with anyone else. But many services that governments provide are different in nature. In their case, the one-to-one ownership once purchased cannot be applied. These are special economic goods called ‘public goods’. It is difficult to finance them adequately except through taxation, which has to be levied on principles that are different from market principles. In the market, if you do not pay the price, you go without the good. It is your choice. In the case of public goods, if you do not pay the price, you would still enjoy the benefit of the good, because such goods are meant for collective consumption and one individual cannot be isolated from enjoying that service. Since you know that, you may not be willing to pay anything voluntarily. If everybody is allowed that choice, no tax would be raised, and the public good cannot be financed at all. Hence, tax has to be made a compulsory payment.
Need for taxes: case of public goods
Governments finance a category of goods, extremely critical for meeting the combined or joint needs of all citizens in the country that would not be provided unless these are paid for by taxes. Such goods are called public goods. Examples of such goods are defence, general administration, and administration of justice. If you are asked what price you are willing to pay for th country’s defence, you might say that this is a servi e not for you a one but for everybody. If everybody pays something, you might also pay something. But let others pay first. The difficulty is that it is very difficult to charge people according to their preferences, as one would in a normal market. It is not possible to divide defence into each citizen’s separate defence nor is it possible to charge them according to how much they are individually willing to spend for the country’s defence.
Left to be paid by individuals according to what might please them, such goods will either be not provided or under-provided. These goods have then to be paid for by taxes, which is a payment that is compulsory and not voluntary. Voluntary payments often fail for such goods when people mistakenly think that since everybody has to contribute only a little, your contribution is going to be small and nobody would notice if you did not contribute. A good example of this wisdom is contained in one of the Akbar-Birbal stories recounted in Box 1. There are two characteristics of services that are jointly consumed where normal market principles do not work. These characteristics, in technical terms used by economists, are called ‘non-rivalry and non-excludability’, which are defined in Box 2.
|Box 1: Akbar-Birbal and the filling up of pond with milk
Once, Akbar and Birbal were travelling together talking about how trustworthy Akbar’s subjects were to him. They came across animpty pond. Birbal asked, “If you were to ask your subjects to fill this pond with milk, will they respond voluntarily because of their loyalty to you?” Akbar was confident of their loyalty. Birbal said that this could only be tested if they were each asked to contribute a glass of milk but let them be told that this will have to be done during the night. Each came bringing a glass. Next morning the pond was full of water. There was not a drop of milk. Each person thought that if he were to put a glass of water, nobody could tell since the pond would be full of milk since my neighbours are in any case going to bring their glass of milk. Since everybody thought in the same way, the result was no milk but only water.
|Box 2: Defining a public good
Public goods have two special characteristics. In technical terms, these are called non-excludability and non-rivalry in consumption. Non-excludability means that any single individual cannot be effectively excluded from the consumption of the public good. Non-rivalry means that the consumption of a public good by one individual does not reduce the quantity available for consumption by another individual. Examples of public goods include national security, judicial system, and lighthouses.
Taxation is helpful to finance subsidies: case of merit goods
There is another set of services to which government must contribute because, left to themselves, people will not fund enough of the provision of such a service to meet the needs of the society. Education is a good example of such a good. A poor family may think that her child is better off working and contributing to the family’s income. Why waste time on going to school? But if many children do not get enough education, their productivity in their adult life may be much less than if they had received adequate education and training. Their total contribution to the country’s economy over a lifetime would be much more when time and resources are spent in first educating and skilling them than it would be if they earn as uneducated and unskilled workers from their childhood. But parents may not fully understand this or their economic circumstances may force them to ask their children to forego education because it is very costly. On the other hand, left to earn low income or remain unemployed, they may become criminals and cost a lot to the rest of the society. There may also be faulty social or cultural values that lead families to under-educate their children. Education of the girl child in India has long suffered from this malaise. For some, it might the accepted practice in the caste or village they belong to. Some might think that if the girl child is uneducated, she will be more submissive and it would be easy to marry her off. Some parents may think that family income is limited and it is better to focus the limited resources on the boys because in any case the girl will eventually go away after she comes of age and gets married. All of this reflects faulty thinking and society as a whole cannot permit this. Every child has to be educated to become better equipped to realise her full potential. It is her right. But even from the narrower viewpoint of the indivdual s life time contribution to the country’s income and output, the country will be much better off if all children independent of their gender are educated to their full potential so that they can earn for themselves and contribute fully to the country’s income. In this case, if the family is not adequately inclined to educate their children to their full potential, society will have to intervene and impose a ‘social preference over the family’s preference. Such goods of services are called merit’ services. Box 3 gives the technical definition of merit services. Health is another good example of a merit service.
|Box 3: Defining Merit goods
Merit goods are goods whose consumption can be justified from a social viewpoint. Merit goods are such that the social benefit is often more than the sum of individual benefits. When this is clearly the case, the concerned good or service is characterised by ‘positive externalities’. Education and health services are considered to be prime examples of merit goods. Inoculation against a contagious disease benefits not only the person inoculated but also his neighbours who would have a reduced risk of catching the disease. Clearly, there is a positive externality.
In the case of merit goods, it is often argued by economists that the level of consumption of the goods would be less than is desirable for society if the choice is left to free market forces to be done on the basis of individual preferences. In order to further promote its consumption, some intervention needs to be done in the form of subsidies, which would reduce market prices and hence, promote more consumption. These subsidies need to be financed by taxation. The desire to provide universal education can be justified on this ground. In laying the foundations of modern India, Gandhiji was one of the first to recognise the value of education for society.
Taxation can be good for you and your family: case of demerit goods
In the case of merit goods, subsidising the purchase of such goods is justified. The case of demerit goods is the opposite of merit goods where taxation is good for the individual. Good examples of demerit goods are alcohol and tobacco. Both are bad if they become habits. Many families are ruined if the family head or any other member becomes addicted to alcohol or tobacco. Governments try to discourage these either by prohibiting these or taxing these relatively heavily compared to other goods. Taxation is good in these cases because it increases the price and discourages consumption.
Taxation is good for society: case of protecting environment
Just like there are positive externalities, there are also negative externalities. Environmental pollution is a good example of negative externalities. Examples of pollution are atmospheric pollution, soil pollution, water pollution, and noise pollution. Pollution caused by the consumption of one individual or industry leads to a poorer quality of environment for other individuals or for the society as a whole. One method of discouraging polluting activities is to levy a tax on the polluting activity.
|Box 4: The Tragedy of Commons
There is an insightful theory in economics called “The tragedy of the commons”. It says that individuals, acting independently and rationally, according to each one’s self-interest, behave contrary to the whole group’s long-term best interests by depleting resources commonly owned by the group or society. Examples of such commonly owned resources are atmosphere, oceans, rivers, public parks and, in general, all earth’s natural resources. The basic idea conveyed in the notion of ‘tragedy of commons’, first formally analysed by an ecologist [Hardin, 1968 published in the well-known journal ‘Science] is that if individual members in a group, acting in rational self-interest, used common resources for their own gain and with no regard for others, all resources would be degraded and eventually depleted. By recognising resources as ‘commons’, we can develop strategies to better use and preserve our natural resources. This requires intervention by governments that are nothing but representatives of the group of individuals comprising a country by regulation, taxation and subsidies.
Since environment itself is a common resource (see, Box 4) consisting of the atmosphere, water and land resources, environmental taxation or green taxation provides a powerful tool to oversee the management of the environment. In India, the importance of managing the environment has been recognised in our constitution in Article 21 and other related provisions. Green taxes are levied on energy products like petroleum, diesel, and coal and in general, on polluting inputs or outputs.
There are two main mechanisms by which governments can affect the behaviour of polluters so that our environment can be kept acceptably clean. One is regulation and the other is fiscal incentives like subsidies and disincentives like taxation. Taxes reduce the use of natural resources and pollution by making them more expensive.
In India, the Government has to play a key role in promoting economic development
As a citizen of a developing country, we look to the government to drive economic development, so that we can get employment, earn incomes and lead a fruitful and satisfying life. The government has to build roads, run railways, build and run schools, colleges and universities, build hospitals and make sure that the services of health, education, and transport are all provided to us at reasonable prices. Governments also invest in infrastructure, irrigation, power, and other economic activities. Governments may also run its own industries. Many of these services or activities can be provided or undertaken by the private sector also but the supply may not be adequate and sometimes, the prices charged may be too high.
Government has to plan for the growth of the economy such that the fast rising population of young people can get productive employment. It has to make sure that there is a balance in economic development across different parts and regions of the country and also ensure income inequalities do not become excessive. It has to make sure that poverty is eliminated in the country within a reasonable time. In order to meet these responsibilities, massive resources, which are primarily raised through taxes, are required.
Taxation affects savings in the economy and, therefore, investment and growth in significant ways. Taxation is nothing but a transfer of resources from individuals and companies into the hands of the government. Economists say that a good tax system is one where there are only a limited number of taxes, tax rates are low, tax laws are simple and easy to comply with. If there are high tax rates, these are only for goods that are considered ‘bad’ for one’s health or welfare such as tobacco or alcoholic products. On the other hand, a bad system would have too many taxes, excessively high tax rates, very complex laws, and similar tax rates whether or not the goods are bad for your health or whose consumption causes damage to the environment. We need to have a good tax system not only for its own sake; a country with a good system attracts a lot of foreign investment, which can be very important if domestic savings are not enough to provide sufficient growth and employment to our growing and young population.
Who collects taxes?
In India, since we are a federal country, we have governments at three levels. At the apex, there is the central government. The next tier is that of state government and governments of union territories. The third tier consists of local governments consisting of urban and rural local bodies. Since we chose to be a federal country with multiple tiers of government, our constitution makers made sure that each tier or level of government was given reasonable taxation powers so that it has both the responsibility and autonomy to at least partly raise its own resources. Diagram 1 depicts the structure of the Government of India.
Diagram 1: Structure of the Government of India
Taxation powers have been given in our constitution mainly to the central and state governments. This has been illustrated in Table 1.
Table 1: Main central and state taxes
|Central Taxes||State Taxes|
|Personal Income tax
Corporate income tax
Union excise duties
Import (Customs) duties
|Land revenue and agricultural income tax
Sales tax/State VAT
Stamp duty and registration fees
State excise duties
Motor vehicle tax
Entertainment tax Electricity duty
Source: Based on Schedule VII of the Constitution of India
The list of taxes is actually much longer. There are also a number of cesses and surcharges that the central and state governments levy on top of these taxes. By two constitutional amendments in the early nineties, namely, the 73rd and 74th amendments, local bodies in India have also been given constitutional recognition. While the basic power of taxation belongs to the state government, they can by legislation pass on some of the taxation powers to local governments. Some of the taxes that are usually given to local bodies include property tax, entry tax, goods and passenger tax and local bodies tax.
II: What kind of government do you deserve?
If you were a law abiding and responsible citizen of India, you would take payment of taxes a part of your duty. While payment of tax is a responsibility, it also confers on you an important right. It is your right to ensure that you get the right kind of government.
Principal and agent: reversal of roles
Government is not abstract. It consists of a set of people. You have elected members to Parliament and state legislatures and municipal bodies and panchayati raj institutions with the expectation that they would make the best kind of policies for you. These bodies perform their functions by appointing a number of officials, who together constitute the executive (also referred to as the bureaucracy). By following certain rules of appointment, a judiciary has also been put in place to provide a system to deliver justice and resolve different kinds of conflicts according to law. We govern ourselves by law that emanates from and remain consistent with the Constitution of India. All members of Parliament and other elected bodies, members of the executive and the judiciary are meant to represent you and to serve you as the common citizen of the country. They are all your agents and you are the principal. They exist in their roles only because you have put them there.
The difficulty is that these roles often mistakenly get reversed. Ministers and members of Parliament find themselves with a lot of power and privileges. You do not deserve a government where your role as the principal has been reversed and your agent has become your master. It is your right to ask for a government where elected members of Parliament, the bureaucracy and judiciary act with that objective in focus.
Transparent, non-corrupt government
As a law-abiding, voluntarily tax-paying citizen, you have the right to ask for a transparent government that consists of people who are neither corrupt nor corruptible. When laws including tax laws are simple and straightforward, powers are decentralised and there is transparency and sharing of information with the public on what the policies are and why they have been made in one way rather than another, corruption does not flourish. You deserve and you can ask for a transparent government.
Standards of service
You are entitled to a reasonable and acceptable level of services that governments, be they central, state, or local, provide. You deserve to walk, cycle, or drive on a road that is smooth and well-paved and not marked by potholes, traffic on which is well managed, and, when maintenance and repairs on some patch of road is required, it happens automatically. If you fall ill, you should be able to go to a government hospital and get appropriate treatment at reasonable costs. Your experience in reality may still be quite different. If the organs of government are not able to provide services that they are expected to provide at an acceptable standard, there is a government failure.
As a law-abiding tax-paying citizen, you deserve better. But this is not a good enough reason for you to consider that taxes should not be paid. Not only would you violate law and undermine your responsibility but you would also lose the moral right to demand better services. The fact that you have voluntarily paid your taxes gives you tremendous moral power to ask for and get the governments to perform according to your expectations and the expectations of your fellow citizens.
Tax evasion and black money
You frequently hear the word ‘black money’in newspapers, media debates, and debates in
Parliament and state legislatures. Tax evasion is the main reason for the generation of black money. The incentive to evade taxes arises from a combination of factors. The fact is that it is possible to evade taxes and get away with it because the tax administrators have limited resources to ensure that everybody pays the correct tax liability. Often, black money gets generated because of collusion between the tax administrators and taxpayers. Tax laws happen to be so complex that it is difficult to make sure that all provisions have been properly complied with. You may need to spend resources such as taking the help of a chartered accountant or tax experts to file your returns properly Thus, limited resources with the tax administration, collusion between tax administrators and taxpayers, complex tax laws and high tax rates are some of the reasons for tax evasion. Black money damages the prospects of an economy in a number of ways. In particular, it drives prices up and forces investment to go in certain sectors where black money can be easily absorbed such as the realty sector.
Simple tax systems with reasonable tax rates
You deserve a tax system that is simple and straightforward, easy to comply with, a system where you do not have to depend on too many external experts to file your tax returns or deal with tax officials excessively.
Fiscal responsibility and inter-generational equity
If you put resources in the hands of the government, be it the central or state government, you will be correct in expecting that the government will exercise the required fiscal discipline in spending these resources. With considerable resources flowing into the hands of the government from tax as well as non-tax sources, governments develop the necessary base to also borrow from the market. But any expenditure incurred on the basis of borrowing raises important problems of sustainability and inter-generational equity. Borrowing can be spent on current consumption or for creation of assets. Any debt as a result of current borrowing must be serviced and eventually paid from future tax flows. In this sense, borrowing, which is also
called the fiscal deficit, always leaves a liability for future generations. It is only to be expected that such liability should be accompanied by the creation of assets so that there are both liabilities and assets for future generations.
Efficiency and public expenditure management
Resource allocation is based on the principle that budgetary allocations should reflect strategic priorities and that could be done by spending money on the “right” things, and spending it efficiently so that the country gets value for money.
III: Relationship between the taxpayer and tax administration Role of the tax administration
Levying of taxes requires a legal framework. No tax can be levied without the authority of law. The tax administration implements and enforces tax laws. But this does not imply that all regulatory details to enable levying of taxes should be included in the law. These details of implementing rules and regulations are delegated to the tax administration. Such delegation to the tax administration does not mean that it has power to reduce tax obligations under the law. While tax law ensures responsiveness of potential revenue to overall economic growth, tax base and tax rates, the tax administration seeks to secure potential tax revenues effectively and efficiently.
The core business of any tax administration is levying and collecting taxes imposed by law. But the relationship between taxpayers and the tax administration must go beyond transactional exchanges and must involve strong emotional ties and loyalties based on trust.
Helping taxpayers comply
Improving taxpayer service by educating and assisting taxpayers is an integral part of the functions of a responsible and responsive tax administration.
Tax evasion and tax avoidance
While tax compliance is important, taxpayers sometimes do not follow the spirit or the underlying purpose of the tax law but only the letter of the law. Taxpayers explore the loopholes in tax laws if they are not clear or have ambiguities. These legal loopholes or ambiguities in law are exploited by taxpayers for tax planning. Such tax planning, often termed as tax avoidance, is different from tax evasion, which refers to illegal practices to escape taxation. An example of tax avoidance can be strategic tax planning where financial affairs are arranged in such an order to minimise tax liabilities by using tax deductions and taking advantage of tax credits. In tax evasion, taxable income, profits liable to tax or other taxable activities are concealed, the amount and/or the source of income are misrepresented, or tax reducing factors such as deductions, exemptions or credits are deliberately overstated. Both tax avoidance and tax evasion have revenue-reducing effects, thereby creating a compliance gap, i .e., a gap between the taxes collected and the theoretical tax due.
IV. Cultivating voluntary tax payment habits
Taxation is compulsory, but it is best paid voluntarily
We all know that taxes are compulsory payments. Our constitution has given powers to the central government, to each state government and to urban and rural local bodies to collect taxes according to the provisions of law that Parliament and legislatures make. Not paying taxes is illegal. Non-payment of tax, if it is due, can lead to fines and penalties. Serious lapses can lead to more serious punishment. The best strategy for each individual, as an individual and as a member of society, is to pay taxes voluntarily and in a timely manner. This makes matters easy for you as an individual since you do not have to think of the law catching up with you.
Best habits for voluntary tax payment
Here is a list some desirable habits to develop to become an ideal taxpayer:
i) Keep a calendar of important tax-related dates: For any type of tax relevant for you, there would be some important dates. Prepare, keep, and update a calendar of relevant dates for each of the taxes that you are liable to pay. This way you can avoid a last minute rush.
ii) Learn to take and give receipts: Whenever you buy and sell anything, you should inculcate the habit of taking and giving receipts. Often, the shopkeeper will tell you two prices: one with tax and one without tax and leave the moral choice of paying or not paying the tax to you. Not only must you insist on taking a proper receipt, you must ensure that the tax element is listed separately both in your receipt and his receipt.
iii) Learn to keep records: Keeping and filing of documents and records would make your tax-paying life very easy. Develop the habit to keep records like your monthly salary slip, bank account details, receipts of all purchases and sales, receipts of tax deposits.
A country’s real strength is the aggregation of the moral fibre and values of its people. Being voluntarily tax compliant is a necessary component of this strength, which can ensure common good and shared prosperity. (Source 3rd TARC Report)