Role of Taxation in Financing Economic Development!

Since most of the LDCs are characterized by ill-organized money market, a great importance is attached to the fiscal policy, particularly taxation policy, for the mobilization of internal resources. Taxes are employed to garner as much resources as possible to finance the programme of economic development.

Socio-economic development of these countries largely hinges on the availability of not only physical resources but also on the financial resources as well as their employment in the construction of particularly infrastructural sectors.

Above all, recently, in LDCs, public sector has witnessed a rapid expansion. Financing of public sector industries can be facilitated through proper taxation policy. Thus, taxes play an important part in mobilizing adequate resources for development in these countries. The role of taxation in financing economic development will be discussed here.


Firstly, LDCs reel under vicious circle of poverty due to the low rate of capital formation. To break this vicious circle, capital accumulation has to be stepped up. Taxes are viewed as an instrument of raising the investment rate. Tax rates are to be increased or new taxes are to be imposed in such a way that the rates of saving/investment to national income rises and thereby the rate of capital formation.

By curtailing unnecessary consumption expenditure, investment can be stepped up. Taxes play an important part in raising savings as well as investment rates. By mobilizing resources in this way and channelizing them in the productive as well as priority sectors, economic development can be ensured in LDCs.

It is true that taxes of progressive nature will put a burden on the rich whose saving propensities are high. As savings and investment are hampered due to high rate of taxes, economic development, so to say, is hampered.

Further, investment pattern gets distorted following the high tax rate. This is not desirable from the point of view of development. Thus, taxation policy is to be employed in such a way that such adverse effects of taxation do not occur.


But the other side of the picture must not be lost sight of Taxation laws of a country concerned deal with tax exemption. To get the benefits of tax exemption, richer people invest their surplus funds in tax-free bonds, or in life insurance policy programme, etc. As a result, adverse effects of taxation get minimized and financial resources are thereby collected.

Secondly, in the realm of provision of finance, public borrowing is another means. In a poor country, all the resources for planned development may not be available through taxation. Hence the necessity of borrowing. But between taxation and borrowing, taxes are better than borrowing from a long term point of view.

It is to be remembered here that borrowing always involves the problem of repayment of interest along with capital in future. No such problem arises in the case of taxation. That does not mean that the entire development programme should be financed by taxation since it generates some adverse effects on the economy.

Thirdly, the most popular method of financing economic development in LDCs is the method of deficit financing. But this method is viewed as a self-defeating one as it is an inflationary method of financing. On the other hand, as an anti-inflationary method, taxation is an important instrument. That is why a greater reliance on taxes is made.


Finally, there is a limit to tax financing since ability to pay taxes of the taxpayers is limited. In India, as the majority of the population has a low income, the role of taxes as an instrument of mobilizing resources is limited. Thus, taxes are not to be viewed as the only instrument of raising resources for economic development. Public borrowings as well as deficit financing are being given much emphasis.

By employing all these methods, necessary financial resources for planning can be obtained. Judicious use of resources in different directions will ensure rapid economic development.