Question

Read the passage below and answer the questions that follow.

Taxation is the major source of revenue for the government. Tax structure of a country plays an important role in the functioning of the government and its economy. India has a well-developed tax structure. The most important feature of Indian tax structure is multiplicity of taxes. The tax structure in India is classified into direct taxes and indirect taxes. Although there is an increase in tax revenue over the years, still the tax revenue is insufficient looking into the requirements of the country. Tax to GDP ratio in India is low at 11.1 per cent in 2022-23 compared to the developed countries where it is in the range of 30 to 40 per cent. Tax base in India is very low in case of both direct taxes and indirect taxes. Despite considerable efforts for widening the tax base only 6.25 per cent of Indian population pays income tax. With a high percentage of indirect taxes, the tax structure in India is considered to be regressive since the burden of such taxes, falls on every one, irrespective of their capacity to pay. In the Indian tax structure, the incidence of taxation is much higher in the urban areas as compared to the rural areas.

1. Distinguish between direct taxes and indirect taxes.  [2]
2. What is meant by a regressive tax?  [1]
3. State the relative shares of direct taxes and indirect taxes in the Indian tax structure.  [1]
4. Why is the tax base in India narrow?  [1]
5. Why is the incidence of taxation lower in the rural areas?  [1]
6. 'Tax revenue is the main source of revenue receipts of the central government'. Illustrate this statement. [1]
7. Is income tax in India progressive? Explain.  [1]

Answer 1

i.

Basis of Difference	Direct Taxes	Indirect Taxes
Ultimate burden	Cannot be shifted; impact and incidence fall on the same person	Can be shifted; impact and incidence fall on different persons
Tax base	Income, property, wealth and profits	Expenditure or consumption of goods and services
Levied on	Individuals, companies and property owners	Producers, sellers and importers, with the burden ultimately falling on consumers
Examples	Income tax, corporation tax, property tax and capital gains tax	GST, excise duty, service tax and import duty
General nature	Generally progressive and capable of reducing inequality	Generally regressive, especially when imposed on essential goods

ii. A regressive tax is one in which the rate of taxation falls as income rises, so the tax burden falls more heavily on the poor. Indirect taxes are regressive because they are levied at the same rate on goods and services, irrespective of the buyer’s ability to pay.

iii. In the Indian tax structure taken as a whole, indirect taxes have a relatively higher share than direct taxes. For the Centre and states combined, direct taxes were about 37% of total taxes in 2016–17, leaving about 63% for indirect taxes. However, at the Central government level alone, direct taxes were about 54.6% and indirect taxes about 45.4% of gross tax revenue in 2022–23.

iv. The tax base is narrow because only about 6.25% of India’s population pays income tax. Most people earn low incomes or work in agriculture and unorganised sectors, many incomes fall below the taxable limit, and tax evasion and exemptions keep the base narrow.

v. Rural areas have lower incomes, and a large part of rural economic activity is agricultural and non-monetised, which remains outside the tax net. Rural households also consume fewer taxed goods and services, so the incidence of taxation is lower than in urban areas.

vi. Tax revenue forms the largest part of the central government’s revenue receipts. It includes direct taxes such as income tax and corporation tax, and indirect taxes such as GST, customs and excise duties. Non-tax revenue, like interest, dividends and fees, is much smaller. Thus, taxes mainly finance government expenditure.

vii. India’s income tax is not purely progressive; it is degressive. The tax rate rises with income slabs, for example, from 5% to 25%, so it is progressive in the lower and middle slabs. But beyond about ₹15 lakh, the rate remains constant at 30%. Thus, it is progressive only up to a limit and proportional thereafter.