Get the answer of: What should be the Objectives of Tax Policy in Developing Countries?
Taxation is the compulsory means by which government finances its activities and expenditures. A distinction is often made between direct taxes and indirect taxes. Direct taxes are assessed upon the tax-paying capacities of assesses such as their income or wealth.
Indirect taxes are imposed upon objects or transactions regardless of the capacities of the taxpayers. Income taxes on individuals and companies are the most important forms of direct taxation and excise duties, customs duties and sales tax dominate the indirect tax category.
Purposes of Taxation:
Although the primary purpose of taxation must always be to finance government expenditure, the tax system of developing countries like India should be used for a variety of other goals. Because taxes comprise a significant share of total income in the economy attempts should often be made to use taxes both to redistribute income and to influence the growth rate of the economy.
1. Redistributing income:
The distributive goals are usually sought through the use of progressive rate structures—the imposition of high taxes on those with greater ability to pay. Higher tax rates on higher-income individuals may limit their accrual of wealth and may also finance transfers to persons with lesser means. Lower tax rates on lower-income individuals correspondingly represent an attempt to provide them with government services at little cost.
2. Influencing the Economy:
Taxes should also be used to influence the economy. One goal is to dampen the size of a cyclical downturn or to promote faster economic growth. Tax cuts should be used (1) to stimulate the economy by putting more money in taxpayers’ pockets, and (2) to provide incentive for work and saving. As the U.S. Supreme Court has rightly commented: “The power to tax is not only the power to destroy, but also the power to keep alive.”
Equity among equals means that those with equal ability to pay taxes, all other things being equal, should pay the same tax. In case of income tax, for example, this principle suggests that those with equal incomes should pay equal income tax.
Efficiency implies that the damaging effects of taxation should be kept to minimum. Efficiency often requires that taxes should not arbitrarily be used to favour some form of consumption, income, or production.
A tax system should be simple so as to minimise waste and to limit the amount of time and resources extracted from taxpayers in compliance costs. Putting more resources into tax enforcement, moreover, prevents those resources from being more productive elsewhere.
6. Other goals:
Taxes should also serve various other socio-economic purposes. The primary purpose of taxation is to raise revenue. As J.F. Due puts it: “Most governmental activities, by virtue of their community benefits, must be financed by taxation”. But it is not the only goal.
Taxation in our days is used as an instrument of economic policy. It affects the total volume of production and consumption, the volume of investment, choice of industrial location and techniques, the balance of payments, distribution of income, etc.
The following are the other goals:
(i) Sometimes taxes are imposed to protect domestic industries from foreign competition:
A high import duty on watches may reduce the import of a commodity and enable domestic producers to produce the commodity at home. Similarly, a subsidy on export of a particular good like jute can increase its competitiveness in the world market by reducing its price and raising its export. These two measures, if adopted simultaneously, may not only give encouragement to domestic industry but also may have favourable (beneficial) effects on the balance of trade.
(ii) Fiscal policy, especially tax policy, can be used to enhance growth, by encouraging the efficient use of any given amount of scarce resources:
Market forces tend to encourage efficiency. The profitable ventures succeed, harder working, earn higher incomes and the efficient firms attract the capital. The government may increase the efficiency of the economy by using taxes to increase the market forces which lead to efficient use of scarce resources.
(iii) Taxes are also imposed to reduce the inequality of income distribution which is a characteristic of all modern mixed economies where all factors of product ion are privately owned:
This can be done by taxing the rich at a much higher rate than the poor, or by introducing a system of progressive taxation. This is known as the redistributive effect of taxation.
(iv) Taxes are also used to raise the total volume of investment of the private corporate sector:
There are various methods of reducing tax rates on business enterprise, e.g., by reducing taxes on profits or granting relief on capital investment in some way. There are many devices of the latter kind, e.g., initial allowances, subsidies for investment, investment allowances, free depreciation, investment grants, etc. Accelerated depreciation is also provided for in certain countries. It means that tax relief is brought forward in time.
(v) Tax policy is also used to ensure balanced regional development:
Entrepreneurs desirous of setting up industries in select backward areas of a country are given special tax concessions so that they are induced to move to such areas. Such enterprises are given tax holidays during the initial stages of their operation.
(vi) Taxation can also be used to ensure price stability:
Taxes reduce the disposable income of individuals and reduce their purchasing power. Naturally the pressure on the commodity markets is reduced. However, this is only a part of the argument. High indirect taxes like excise duty or sales tax raise the prices of the taxed goods and lead to inflation. A fall in the demand for such goods may lead to sectoral recession.
(vii) Taxes are also used for exercising control over the behaviour of consumers:
It is sometimes used to discourage the consumption of unnecessary or harmful items like liquors, tobacco, certain drugs, etc. The resources released thereby are devoted to the production of necessary goods.
(viii) Taxes like customs duties are also used to control imports of certain goods which are domestically available like T.V. sets, refrigerators, motor cars machinery, wines and other luxury goods. The idea is to cut the import bill, while, simultaneously, encouraging domestic production of import substitutes.
(ix) Tax system is also used to promote vertical integration among firms. This can be done by a cumulative excise duty. This tax is levied on the total value of each firm’s output. This means that goods might be taxed many times in the course of production if there are several vertically un-integrated firms involved in their production.
Great savings in tax liability are to be made by buying up one’s suppliers and the firms to whom one sells one’s goods. If it is believed that vertical integration is the most efficient way to organise industrial production, then the introduction of a cumulative excise duty will, if it is large enough, induce the desired integration.
(x) Profits indicate to investors which are the most efficient firms and, therefore, the firms to invest in. Profits also indicate to firms which products to produce and which productive processes make more economical use of scarce resources.
A tax system which accentuates the differentials between the profitable and the unprofitable usually helps steer resources into the most efficient firms and processes and into the most rapidly growing sectors of the economy.
There are often conflicts among these goals. A simple tax system is not always efficient and equity may require giving up some simplicity.