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Friday, September 22, 2017

Public Revenue

Unit – 3: Public Revenue
A government needs income for the performance of a variety of functions and meeting its expenditure. Thus, the income of the government through all sources like taxes, borrowings, fees, and donations etc. is called public revenue or public income.
However, Prof. Dalton has defined the term in two senses – broader and narrow sense. In broad sense, it includes all the income and receipts, irrespective of their sources and nature, which the government happens to obtain during any period of time. In the narrow sense, it includes only those sources of income of the government which are described as revenue resources. In broader view of the concept is that is includes all loans which the government raises under the term ‘public revenue’ or public income. The distinction in both can also be explained as the term ‘public revenue’ used in public finance. It includes only those sources of government income which are not subject to repayment. In a broad sense, it means all receipts of the government irrespective of the fact whether they are subject to repayment or not.
In a modern welfare state, public revenue is of two types:
(a)    Tax revenue and
(b)   Non-tax revenue.
(a) Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred.
Examples of Tax Revenue 

Ø  Income Tax(on income of the individual as well as joint Hindu families) 
Ø  Corporation Tax (on income of the companies both domestic and foreign companies operating in India ) 
Ø  Interest Tax (on the gross interest income of the financial institutions like Bank) 
Ø  Expenditure Tax(expenditure incurred in luxury hotels and restaurants) 
Ø  Wealth Tax(total wealth of individuals and Hindu undivided families) 
Ø  Custom Duty.(import and export duty) 
Ø  Central excusive Duty.(duties on industrial products) 
Ø  Service Tax.(on services provided by hotels,telephones,port services etc.) 
(b) Non Tax Revenue: The revenue obtained by the government from sources other then tax is called Non-Tax Revenue. The sources of non-tax revenue are:
1. Fees: Fees are another important source of revenue for the government. A fee is charged by public authorities for rendering a service to the citizens. The government provides certain services and charges certain fees for them. For example, fees are charged for issuing of passports, driving licenses, etc.
2. Fines or Penalties: Fines or penalties are imposed as a form of punishment for breach of law or non fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. But while taxes are generally imposed to collect revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.
3. Surplus from Public Enterprises: The Government also gets revenue by way of surplus from public enterprises. In India, the Government has set up several public sector enterprises to provide public goods and services. Some of the public sector enterprises do make a good amount of profits. The profits or dividends which the government gets can be utilized for public expenditure.
4. Special assessment of betterment levy: It is a kind of special charge levied on certain members of the community who are beneficiaries of certain government activities or public projects. For example, due to a public park in a locality or due to the construction of a road, people in that locality may experience an appreciation in the value of their property or land. Thus, due to public expenditure, some people may experience 'unearned increments' in their asset holding.
5. Grants and Gifts: Gifts are Voluntary contributions by individuals or institutions to the government. Gifts are significant source of revenue during war and emergency. A grant from one government to another is an important sources of revenue in the modern days. The government at the Centre provides grants to State governments and the State governments provide grants to the local government to carry out their functions.
6. Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
Different classifications of public revenue
Different economists have given various classifications of public revenue. Looking from different angles, they classified public revenue in one manner or another. The following are the main classifications given by different economists or authors:
                    I.            Adam Smith’s Classification: Adam Smith was of the opinion that revenue of the government ultimately depends on the property in possession of the inhabitants of the country and the extent to which the state has control over the wealth of the country. Adam Smith classified public revenue into the following two categories:
1)      Revenue from Public: Revenue from public includes all those sources which are generally known as the sources of revenue of the government from the public.
2)      Revenue from State Property: Revenue from state property includes revenue obtained from public enterprises as well as those revenues which are derived from the property in possession of the state.
This classification as given by Adam Smith does not serve the purpose of modern finance. Hence it is subject to criticism.
                  II.            Bestable’s Classification: Like Adam Smith, Bestable also classified public revenue into the following two categories:

1)      Those incomes which the state receives from its various functions just like a private individual or corporation. It includes all the incomes which the state derives in the form of fees and prices.
2)      Thos incomes which the state derives in its own capacity as ‘state’. It includes taxes and levies.
Like Adam Smith this classification is also limited and narrow.
                III.            Adam’s Classification: Prof. Adam classified public revenue into the following three categories:
1)      Direct Revenue: It includes income which the state derives from public land, public enterprises like rail, roads, highways, posts and telegraph and all other revenues which the state derives on account of the ownership of productive enterprises.
2)      Derivative Revenue: It includes the income derived from the citizens, such as, taxes, fees assessments, fines, penalties etc.
3)      Anticipatory Revenue: It includes income from the sale of bonds or other forms of commercial credit. It also includes income from the treasury notes.
This classification suffers from the defect of overlapping and there is no clear-cut demarcation of different heads. It has a wide range of revenues, as it includes both commercial and administrative revenues in one group in spite of the fact that both are fundamentally different in nature. Hence this classification is also not satisfactory.
                IV.            Seligman’s Classification: Seligman classified public revenue into the following three categories:
1)      Gratuitous Revenue: Gratuitous revenue is that revenue which is derived by the government free of cost, such as, gifts from the public and others.
2)      Contractual Revenue: It is that revenue which is derived by the state as a result of the contracts entered into between the public and government. It includes income from land mines and public enterprises.
3)      Compulsory Revenue: It includes the income derived from state’s authority for administration, justice and taxation, such as, taxes fees, fines etc.
This classification suffers from various lacunae and may not be regarded as satisfactory. However, it is more comprehensive that the earlier classifications already discussed.
                  V.            Lutiz’s Classification: Lutiz classified public revenue into the following six categories:
1)      Administrative Revenue;
2)      Commercial Revenue;
3)      Taxation;
4)      Public Debt;
5)      Subventions and Grants; and
6)      Book-keeping revenue or transfers.
This classification is outdated and thus unsatisfactory. For example, the last three, i.e. public debt, subventions, and grants and book-keeping revenues or transfers are not included in public revenue now.
                VI.            Dalton’s Classification: According to Dalton, there are two main sources of public revenue, i.e. taxes and prices. A tax is a compulsory charge imposed by public authority, whereas prices are paid voluntarily by private persons, who enter into contracts with authorities. Thus, taxes are paid compulsorily, whereas, prices are contractual payments. Dalton classified public revenue into the following twelve categories:
1)      Taxes;
2)      Gifts and Reparations;
3)      Compulsory Loans;
4)      Public Property;
5)      Public enterprise;
6)      Fines in courts;
7)      Fees and other Payments;
8)      Special Assessment;
9)      Public Monopolies;
10)   Mint;
11)   Voluntary Gifts; and
12)   Tributes and Indemnities whether arising out of war or otherwise.
As a matter of fact, it is not a classification of public revenue on some sound principles, but actually it is a list of items enumerated above.
              VII.            Taylor’s Classification: Taylor classified public revenue into the following four categories:
1)      Grant-in-aid: Grant-in-aid are the means by which one government provides financial assistance to another, usually in the performance of a specified function in a specified manner, e.g. education and health. Grants are made to the state government by the central government for some specific purpose. The state government has no obligation to repay the amount of grant-in-aid sanctioned by central government.
2)      Administrative Revenue: These revenues include fees, licenses, fines forfeitures, escheat and special assessment. Most of these are voluntary in nature on the part of the payer as to whether or not he will pay and more or less for the direct benefit conferred upon him. They generally arise as a by-product of administrative control or function of government, and hence, they are called as administrative revenue by Taylor.

3)      Commercial Revenue: These revenues are received in the form of prices paid for government-produced commodities and services, such as, payments for postage, tolls, tuition fee of public educational institutions, interest on funds borrowed from government credit corporations, price paid for liquor in government stores, electricity and water distributed by government authorities etc.
4)      Taxes: Taxes are compulsory payments to government without expectation of direct return in benefit to the tax-payer, such as, income-tax, toll-tax, property tax etc. they involve varying degrees of coercive powers.
There are various principles of public revenue as under:
1.       Principle of Least Aggregate Sacrifice.
2.       Principle of Equity.
3.       Principle of Economy.
4.       Principle of Productivity.
5.       Principle of Certainty.
6.       Principle of Uniformity.
1. Principle of Least Aggregate Sacrifice: Prof. Pigou and Prof. Dalton developed the principle of least aggregate sacrifice. According to them, “State should raise money in such a manner that the sacrifice imposed on the people is the least. As pointed out earlier, taxation is irksome and the act of raising money a necessary evil. Taxation therefore imposes sacrifice and pain. The State exists for the welfare of the masses and therefore should see to it that the sacrifice or pain is least.”
2. Principle of Equity: Economists like A. Smith and Chapman, Robert Jones considers equity or equality as the right principle of taxation. Seligman and Cohn accept this principle but understand it to imply progressive taxation while walker and some other classical economists think that equality or equity leads to proportional taxation. All these economists, however, believe in equity. It is worth while therefore considering in some detail the meaning and implications of equity, as the basis of taxation.
3. Principle of Economy: Hobson, Wicksteed and Jones believed in the principle of economy. According to them, Taxation is an act of production and therefore one must effect as much economy in production as possible. Whatever the demand side may be, if a certain amount has to be produced that producer’s has concern is always to produce it at the lowest cost. Economy is then the correct principle of taxation. But since the cost of taxation consists in the sacrifices made by the tax-payers, the cost is least when the sacrifice is the lowest. Thus, the principle of economy is precisely the same as the principle of least aggregate sacrifice.
4. Principle of Productivity: Principle of productivity was propounded by Bastable. According to Bastable, the idea of productivity comes close to that of economy. Taxation is an act of production. And therefore it should be as productive as possible. Taxation should be as productive of revenue as the State can make it to be.
5. Principle of Certainty: This principle was dates back to the name of President Hadley. According to him, tax should be certain in its manner of imposition and its rate, is not to be doubted. Uncertainty is never desirable. The statesmen as also the tax payers should know how and when and what taxes are imposed. It gives greater confidence to the govt. about its estimates and the tax payers feel certain about his budget. Certainty reduces the cost of paying taxes for the tax payers and the cost of them for the govt. certainty helps to reduce cost and thereby increases welfare.
6. Principle of Uniformity: Principle of uniformity was analyzed by Nitty and Conrad. According to them, “If uniformity implies that the taxes should burden the people uniformly, then it is the same principle as that of equal sacrifice. But if the word uniformity refers to the manner of levying taxes or the rates of taxes no such similarity between this principle and that of equal sacrifice can be deduced. It is desirable of course that tax should possess the feature of uniformity even in the rates and the manner of their imposition. That reduces the complexity of the system and thereby conduces to smooth working of the entire machinery.
The effects of public revenue can be discussed under the following heads as:
1. Effects of Revenue-Direct and Indirect: For the consideration of effects of public revenue on social welfare it is best to suppose that revenue is raised and then destroyed. That would enable us to ignore effects that the knowledge and expectation of public expenditure has the minds of the tax payers. When a tax is levied on an individual his income decreases. If pays out of his income, then it is directly and immediately reduced. He decides to pay it out of his savings and current income is not used but future income derived from his saving decreases. In any case the effect of taxation is thus to reduce the income of people. This accounts for the sacrifice of taxation. We may study effects of direct reduction of income and indirect reduction of it.
The immediate decrease of income takes place, as we have when the tax payer pays tax out of his current consumable income when that happens he is force to cut down his present consumption of goods and services. If he consumes less of luxuries, the adverse effect of taxation occurs. But if he cuts down his consumption of necessaries more than luxuries the effects are more pronounced.
2. Effects of Present and Future Generation: This brings us to the consideration of the effects of taxation on the present and future generation. When taxes are paid out of current consumable the present generation directly and immediately suffers. However, they are affected in two ways. First, the reduction of consumer goods may decrease the efficiency of the people and thereby the amount of wealth they can produce and save for succeeding generation. But they also such effects will be partly or wholly offset by expenditure policy of the govt. But the payment of taxes will themselves have the effect of shifting the incidence of sacrifice on future generation to some extent. In the second place, they may suffer due to adverse effects on production caused by increased demand for consumption goods.
3. Effects on Tax Distribution: The effects of taxes do not only differ according to the aggregate volume of revenue raised or according to its impact on current consumable income and savings; they also depend on the distribution of the tax burden between the tax payers. Taxes not levied equally on all. They are so levied as to minimize the sacrifice. Thus some have to pay more than others. If the Govt. is successful in so fixing the rates of taxes as to minimize sacrifice jointly made by the tax payers, we have to consider only effects of taxation on the people in the manner that we have done. But the government is not likely to succeed in minimizing the aggregate sacrifice.
4. Other Effects on Public Revenue: It is worthwhile considering if taxation can produce some favourable effect on social welfare. We had seen while considering the favourable effects of public expenditure on social welfare; how such expenditures can also have an adverse effect on the well-being of the people.
The public revenue of one country differs in amount from that of another country. The difference is due partly to the size of country and partly to other causes. India is not a small country. It is sub-continental in itself. Its stages are as big as some counties of the west. But its public revenue is not very big in size. What does the size of public revenue then indicate. It depends on the following aspects.
1. Sign of Prosperity: A man who has a big income is in general respected more than the other who has a smaller income. It is only rarely that people with small income are held in high esteem by society. And in the same way a country that has a small volume of public revenue is not regarded as a big power and consequently not respected by other counties. A State that has a big volume of public revenue considered as a power to be reckoned with. America and United Kingdom have public revenue that is several times higher than that of our country. And we knows they do, that they can afford to do things that require much money.
2. Welfare of Country: Other things being equal, however, the welfare of a country can be judged from the size of its public revenue. A country whose resources, both natural and human, are not fully developed is a poor and backward country. And the government of such a country must necessarily be poor also. And with poverty of wealth goes also the poverty of welfare unless other things are not the same.
3. Composition of Public Revenue: Yet, it is not merely the size of public revenue the one should look to in order to form some idea of the prosperity or otherwise of a country. The composition of public revenue is as much important as its size. If a large part of the wealth of the government comes from the poor it is not a sign of a healthy state of affairs.

4. Mere Availability of Means: Public revenue is only, a means and the mere availability of means indicates nothing. All depends on how the means are utilized. It is not safe, therefore, to reckon with merely the size of revenue. Some countries of the world have public revenue in thousands of millions. The tendency today is on the one hand to spend an increasing percentage of public revenue on social services and social security. On the other hand, everywhere more and more money is being diverted to the building up of strong defensive and offensive force.
5. Manner of Public Revenue: A word may again be said about the manner in which revenue is obtained from the people. Every government tries to get more money from the rich that from the poor. But not all succeed in so doing. Some fail because they are ignorant and some fail because they are careless. And we have to say also that some fail because they are mischievous.
Meaning and Definition of Tax
In simple words, it is a compulsory payment by the people. If a person defies the tax payment, he may be punished in the court of law. However, different economists tried to define taxation in a different style as stated below :
Adam Smith : “A tax is a contribution from citizens for the support of the state.”
Saligman: “A tax is compulsory payment from a person to govt. to defray the expenses incurred in the common interests of all without reference to special benefits conferred.”
Bastable : “Tax is a compulsory contribution of the wealth of a person or body of persons for the service of the public powers.”
Taussig : “The essence of a tax is distinguished from other charges by govt. in the absence of direct quid pro quo between the tax-payer and public authority.”
Dalton : “A tax is a compulsory contribution imposed by a public authority irrespective of the exact amount of service rendered to the tax-payer in return and not imposed as penalty for any legal offence.”
From these mentioned definitions, it is clear that the taxes are not a voluntary contribution by the tax-payer but it is compulsory in nature. Therefore, one can say that every payment by individuals to the state is not a tax. It is just like withdrawal from the people’s income which reduces their purchasing power. It should be noted here that tax checks production where as public expenditure may spurt the productive process. In the opinion of Dr. R.N. Bhargava, taxes are as much compulsory as other payment, like fees etc. In this context, Dalton says, “Where taxation, taken alone, may check production, public expenditure taken alone, should almost certainly increase it.” So, tax is a necessary contribution by the tax-payer to social objectives like reducing inequalities in income and wealth, securing high level of employment as well as promoting economic stability with growth.
The main objectives of taxation are as follows:
1)      Raising Public Revenue: Normally, the foremost objective for the imposition of taxes, that is, to collect revenue for the govt. Today the govt. has assumed responsibilities of providing social services, promoting economic development and meeting war expenditure. All these expansions in the scope of economic activities have created necessity of greater funds to be spent by the govt. The greater the need of funds, the greater is the resort of taxation.
2)      Regulation and Control: The objective of taxation is regulation and control. The govt. not only raises public revenue through taxation but also imposes restrictions on the use of certain goods and service in a way desirable and respectable for a healthy state of society. To restrict the consumption of harmful goods – excise duty on tobacco, liquor etc. is imposed to restrict the consumption of these harmful goods. On the other hand, there are import and export duties which also raise public revenue but their specific objectives are otherwise. Import duties (taxes) are levied in order to restrict imports of these goods which may harm the infant industries in the country. Similarly, luxury goods may be taxed heavily while being imported so as to divert the national funds to some other forms of production necessitated inside the country.
3)      Reduction of Inequalities in Income and Wealth: Another objective of taxation is to reduce the inequality of income and wealth. One of the chief characteristics of underdeveloped countries is that there is a vast gap between the income of persons in the highest income group and of those in the lowest income group. That is why one of the objectives of taxation is to redistribute income and wealth in such a way as to ensure more just and equitable distribution.
4)      Promotion of Capital Formation: Another objective of taxation is the promotion of capital formation. In underdeveloped and developing countries, one of the main objectives of taxation is to make savings more dynamic and promote capital formation. Thus, the savings can be easily directed towards production and capital formation through the assistance of taxation.
5)      Business Stability and Maintaining Full Employment: Another objective of taxation is to bring about business stability and maintain full employment conditions. Low rate taxation during a business depression shall accelerate more income to the people and help in raising demand and, thus, revive business activity. On the contrary, high rates of taxes and additional taxes may be useful to check inflationary pressure on prices.
6)      Political Objectives: In democratic countries taxation is used as weapon for attaining political objectives. For instance, lower and middle-class voters may be attracted by imposing high taxes on rich people and luxury goods and nominal or no taxes on goods consumed by poor and middle-class people. Thus, it also fulfils the need of political objective in a country.
7)      Increase in National Income: Another objective of taxation is to increase the national income. Tax is the main source of the govt. income. This income is used for productive purposes and thereby overall production is increased. This increase in production leads to increase in national income of the country along with increase in per capital income.
8)      Restriction on Unnecessary Consumption: Another objective of taxation is to restrict the unnecessary consumption particularly of harmful commodities, such as wine, cigarettes, biris, bhang etc. When heavy tax is imposed on such commodities, the consumption of such commodities are automatically reduced. According to A.P. Lerner, “Individuals should be taxed only to the extent to make the tax-payer poorer.”
9)      Proper Standard: Another objective of taxation is the maintenance of proper standard. According to A.P. Lerner, “Taxes should not be imposed simply because the govt. needs money. Economic transaction should be taxed only when it is thought desirable to discourage these transactions. Individuals should be taxed only when it is desirable to make the tax-payer poorer.”
A good or ideal tax system is one which fulfils all the canons of taxation, which is helpful to provide sufficient revenue to the government for meeting the expenditure and at the same time offer minimum inconvenience to the tax-payer. According to Edmund Burke, “It is difficult to tax and to please as it is to love and to be wise.” That we mean by a good or deal tax system is simply the predominance of good taxes; taxes which fulfils most the canons taxation. The following characteristics should be there in order to be called a good or deal tax system:
1)      Tax Ratio: It is difficult to determine the tax ratios by a fixed norm. The opportunity cost of raising more revenue, the benefit to be derived from extra public spending and cost of servicing public sector debt all changes over time and differ across countries. Decisions on public spending, borrowing the revenue are highly interrelated, if they are to set, they must be set jointly.
2)      Efficiency and Growth: It is often difficult to design a tax structure that will satisfy the aims of efficiency as well as growth. In order to raise higher revenue, there is need to change the base or rate of some taxes at least. In that case firms and individuals will bring about a change in the allocation of resources from heavily taxed industries to lightly taxed one. In the event of market prices reasonable reflecting social costs and benefits, the above tax change will require a tradeoff between revenue and efficiency. When market price do not reflect social costs and benefits, taxes can be utilized to improve allocation of resources.
3)      Equity in Taxation: Equity is another issue that is associated with any tax reform. There are two types of equity viz. horizontal equity and vertical equity. The former is concerned with the treatment of person with similar incomes, while the latter is more concerned with reduction in income inequality. Tax system of developing countries fails miserably in terms of horizontal equity. In the case of vertical tax equity too, the record is no better and it is so in spite of progressive tax structure because it is not fully applied. Another factor is large scale tax evasion.
4)      Taxes should observe all the Canons: The taxes should be so imposed that they are equitable, convenient to pay, certain, economic, productive, elastic and simple. The essence of the argument is that majority of the taxes should observe most of the canons.
5)      Taxes should ensure maximum Social Advantage: Another major characteristic of a good tax system is that it should ensure maximum social advantage. The imposition of taxes should be on the basis of this fundamental principle of public finance. It must ensure maximum social advantage or least aggregate sacrifice.
6)      Balanced Tax System: Another major pre-requisite of good tax system is that it should be balanced. It means that tax system is simply that it should exist not one kind of taxes but all kinds of them in a proper balance. For example, both direct and indirect tax systems have their advantages and disadvantages. But it is required of a good tax system to have both kinds of taxes in a proper balance.
7)      Many Dimensions of Tax System: A tax has many dimensions. We should look into its volume, composition, rates, coverage, timings of collection, mode of collection and so on in order to see its effects in their totality. Each system will have its own merits and demerits in terms of its social and economic effects. Thus, in general, it is very difficult to evolve a tax system which is the best or ideal in every respect.
8)      Universal Application of Taxes: Another main characteristic of a good tax system is that it should ensure universal and uniform application of taxes to each individual of the society without any discrimination.
9)      Desirable Effects on Production and Distribution: A good tax system is one which has desirable effects on production and distribution. It should ensure a rapid economic development of the country. A good tax system always promotes production, encourages people to work, save and invest, and increases national income and its equitable distribution.
10)   Source of Public Revenue: To consider a tax system ideal, it must have the quality to provide public revenue. Tax is an important part of the total revenue of the budget. It is a source of public revenue and hence it should provide necessary revenue to the government.
11)   Freedom from Harassment: A good or deal tax system recognizes that tax-payer has some basic rights. He is prepared to pay his taxes but would not like to undergo any harassment. With this in view, tax laws should be simple in language and the tax liability should be easily determinable with certainty.
In the modern age, tax is the main source of Income. Every tax is an additional burden on the tax-payer. Thus, it is essential that the burden of a tax should be divided in equitable manner. Every govt. bears the responsibility to provide certain facilities to its subject. For this purpose, the govt. has to adopt a definite principle. Further, it needs a definite machinery for imposing, collecting and utilizing the money. Therefore, a better taxation system speaks of the better taxing capacity and efficient economic administration of the governments.
It is an important question as to how the taxes can be levied and what should be pattern of distribution of the taxes. Moreover, taxation does not have only economic but also social and political implications. For every new tax, it is correct to note the ‘motive’ behind such proposals. In short, it carries the motives of capacity to pay, no discrimination and positive effect on the balance of payment.
However, these motives cannot be achieved unless a clear cut policy regarding the imposition of taxation is followed. Economists have suggested various principles regarding taxation. But none of had given the exact canons of taxation. The canons or principles given from time to time bear the testimony of a good taxation policy.
Adam Smith was the first writer to give a detailed and comprehensive statement of the principles of taxation. Basically, he laid stress on the ways in which an economy could increase its productive capacity and ultimately achieve a higher rate of economic growth. According to him, if the principles enunciated by him, were adopted in a full spirit, the govt. would have a very sound taxation policy. Findlay Shirras has strongly commented on the contribution made by Adam Smith, “No genius, however, has succeeded in condensing the principles into such clear and simple canons as has Adam Smith.” Adam Smith has enumerated the following four canons of taxation which are accepted universally:
1)      Canon of Equality.
2)      Canon of Certainty.
3)      Canon of Convenience.
4)      Canon of Economy.

1)      Canon of Equality: According to this canon, a good tax is that which is based on the principle of equality. In a broader sense, equality may be considered to be same as justice. In this principle, it is maintained that the tax must be levied according to the taxpaying capacity of the individuals. Adam Smith had defined this principle as follows: “The subject of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities that is , in proportion to the revenue which they respectively enjoy under the protection of states.”
In other words, the principle of benefit states that the burden of taxation should be fair and just. Thus, rich people must be subjected to higher taxation in comparison to poor. The higher the income and higher the tax, the lower the income of lower the tax.
2)      Canon of Certainty: Another canon of taxation is the certainty which implies that the tax-payer should determine the following manners carefully: (a) The time of payment, (b) Amount to be paid, (c) Method of payment, (d) The place of payment, (e) The authority to whom the tax is to be paid.
With this, a tax-payer will be able to keep equilibrium between his income and expenditure. There should not be any embarrassment and confusion about the payment of tax. Every tax-payer must know the time of payment, manner and mode of payment, so that he may adjust his expenditures accordingly. In the words of Adam Smith, “The tax which each individual is bound to pay ought to be certain the not arbitrary. The time of payment, the manner of payment, the quantity to be paid, all ought to be clear and plain to the contributor and to every other person.” This certainty creates confidence in the contributor of the tax.
3)      Canon of Convenience: The taxes should be levied and collect in such a manner that it provides the maximum of convenience to the tax-payers. The public authorities should always keep this point in view that the tax-payers suffer the least inconvenience in payment of the tax. For example, land revenue should best be collected at the harvest time. The income-tax from the salaried class be collected only when they get their salaries from their employers. To quote Adam Smith, “ Every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.” This canon is important both for the tax-payers and the govt. The tax-payer feel convenient in payment of tax. The authorities also come to know the incidence of taxation and get increased income by way of taxes.
4)      Canon of Economy: It implies that minimum possible money should be spent in the collection of taxes. The maximum part of the collected amount should be deposited in the govt. treasury. Thus, all unnecessary expenditure in the collection should be avoided at all costs. In the words of Adam Smith, “Every tax ought o be so contrived as little to take out and to keep out of the pockets of the people as possible over and above what is brings into public treasury of the state.” So more addition should be secured to the public revenue at the minimum maintenance cost. It also implies that a tax should interfere as little as possible with the productive activity and general efficiency of the community so that it may not create any adverse effect on production and employment.
Incidence of Tax
Incidence of tax or taxation is the burden of paying tax ultimately. In other words, when the money burden of a tax finally settles or comes to rest on the ultimate tax payer, it is called the incidence of a tax. The incidence of tax remains upon that person who cannot shift its burden to any other person, i.e. who ultimately bears it. The burden of a tax falls either on the buyer or on the seller. If the price of a commodity rises by the full amount of the tax, the incidence is wholly on the buyer. On the contrary, if the price of the commodity does not rise at all, the incidence is wholly on the seller. In case the prices rise by less than the full amount of the tax, the incidence is partly on the buyer and partly on the seller.
The concept of incidence of tax or taxation has been variously defined by different economists. According to Dalton, we may say that the incidence is upon those who bear the direct money burden of the tax. For example, when a sales tax is imposed on Tata Steel, but the company’s shop recovers it from the buyers, so the incidence of this tax lies on the buyers since they ultimately bear its money burden. Mrs. Ursula Hicks, however, classified incidence of taxation into two categories: formal incidence and effective incidence of taxation. The Taxation Enquiry Committee also adopted the definition as given by Mrs. Hicks while studying the problem of incidence of taxation in India. The Taxation Enquiry Commission defined the formal and effective incidence of taxation as Formal incidence is the money burden of taxes resting with the subject on whom the burden is intended by taxing authority to fall, and effective incidence is the real or final distribution of tax burden after its shifting in consequences of changing demand and supply condition of taxed commodity or services. In this sense, formal incidence refers to the concept or incidence of taxation and effective incidence to the effects of taxations.
Factors Influencing the Incidence of Taxation: The following are the factors influencing the incidence of taxation are as follows:
1)      Elasticity of Demand and Supply: In case, the demand of the commodity is elastic, the burden of the tax shall fall on the trader because if the trader tries to pass on the burden to the consumer in form of a higher price, the consumer will reduce the consumption of the commodity to the minimum. As such, he would prefer to bear the burden of tax himself. On the contrary, if the demand of the commodity in question is inelastic, the trader can easily shift the burden of the tax to the consumer.
In case the supply of the commodity is elastic or if the commodity is not perishable, the burden of the tax will fall on the consumer because the bargaining power of the trader is much higher than that of the consumer. On the contrary, if the supply of the commodity in question is inelastic or if the commodity is easily perishable, the incidence of the tax will be on the shoulders of the trader because the trader cannot store it for long on account of the perish ability of the commodity. The entire burden will fall on the trader.
2)      Availability of Substitutes: Another factor affecting the incidence of taxation is the availability of substitutes. For instance, take the case of tea and coffee. If the government levies a high excise duty on coffee, the coffee merchant cannot pass this burden to the consumers because if he shifts the burden of excise duty to the consumers in the form of higher coffee prices, the consumers may start using tea which is a good substitute of coffee.
3)      Amount of Tax and the Taxation System: In case the amount of the tax on the commodity in question is very small, then, in such a situation, the trader may not like to pass the burden on to the consumers because he may not like to displease his valued customers, e.g. 5% tax imposed on brokers of Stock Exchanges in India.
4)      Mobility of Capital: Mobility of capital is another factor which also influences the incidence of a tax. In case the capital is not mobile, the producer has invested a major part of his capital in his business in fixed assets (land, building, machinery etc.) and thereby he cannot withdraw it easily, then he may not be in a position to shift the burden of taxes to the consumers. He will have to bear the burden himself. On the contrary, if the capital is mobile, the producer has invested most of his capital in stock of raw material and partly finished goods etc. and thereby he can withdraw it easily, then he is in a position to shift the burden of taxes on to the consumers. Thus the consumers will bear the burden.
5)      Influence of the Laws of Production: Laws of production also influence the incidence of a tax. Let us take the law of increasing returns and law of decreasing returns:
a)      Law of Increasing Returns: Let us take a product which is being produced under the law of increasing returns. In case, the government levies new tax or increases the present levy, the price of the commodity is liable to increase. In that case, the price of the commodity will increase in step with the extent of the tax so imposed or increased. For example, suppose a firm is producing 1,000 units of the commodity and the cost of production comes to Rs. 10 per unit. Now the government levies excise duty to the extent of Rs. 1 per unit. The price of the commodity will now rise to Rs. 11 per unit. As a result of this rise in price, the demand of the commodity will decline necessitating a cut in its production. In case the production is cut down, its cost per unit will automatically rise on account of the reduction in the output because the commodity is being produced under the law of increasing returns. Assuming that the cost of production per unit rises up to Rs. 11 per unit, and commodity is being taxed at the rate of Rs. 1 per unit. Thus, the overall price of the commodity will rise to Rs. 12 per unit. It is clear that the price of the commodity in this case has increased in proportion greater than the increase in the tax. The tax is only Rs. 1 per unit whereas the price of the commodity has increased by Rs. 2 per unit.
b)      Law of Diminishing Returns: Let us assume that the production of the commodity is subject to the law of diminishing returns. In the above example, if the government levies the tax as the rate of Re. 1 per unit, the price of the commodity will now rise to Rs. 11 per unit. With the rise in price, the demand for the commodity will go down, and, consequently production will have to be cut down. Since the commodity is being produced under the law of diminishing returns, the cost of production per unit will also decline consequent upon the reduction in the production. Assuming that the cost of production falls down to Rs. 9.50 paise per unit and the commodity is taxed at the rate of Re. 1 per unit, the overall price will come to Rs. 10.50 paise per unit only. In other words, the price of the commodity rises to an extent less than that warranted by the imposition of the tax.
c)       Tax Area: Tax area is also an important factor which influences the incidence of taxation. It may be very difficult or impossible to shift a purely local tax, if it is relatively high, i.e. Municipal Corporation Tax. But when a local tax is light, it may be possible to shift it without any great difficulty. For example, State Sales Taxes tend to be more easily shifted then local taxes because they are uniform over a wider area, and national sales taxes tend to be even less difficult to shift.
Distinguish between:
a)      ‘Impact’ and ‘Incidence’ of Taxation.
b)      Incidence and shifting of taxes.
c)       Incidence and effects of a tax.
(i) Difference between Impact and Incidence of Taxation is as follows:
1)      The impact refers to initial or immediate burden of the tax while incidence refers to the ultimate burden of the tax.
2)      Impact is felt by the tax payer at the point of imposition of the tax, whereas the incidence is felt by the tax payer at the point of settlement or rest of the tax.
3)      Impact of the tax can be shifted, but the incidence of a tax cannot be shifted.
4)      The impact of the tax is felt by the person from whom it is collected. For example, if an excise duty of Rs. 1,500 per TV set is imposed on the manufacturer of coloured TV set, the impact of tax falls on him. On the other hand, the incidence of tax is felt by the person who actually bears the burden of the tax. For example, if the manufacturer of TV set successfully passes the excise duty burden on to the customer, the incidence of tax will fall on the customer.
5)      The impact is just the beginning of taxation, whereas incidence is the end of taxation.

6)      It is illegal to escape from impact, whereas it is legal to make efforts for escaping from incidence.
(ii) Distinction between Incidence and Shifting of taxes is as follows:
The process of transferring the burden of the tax from one person to another is called tax shifting. Hence, when the burden of the tax is passed on to other persons by the tax payers, such as sales tax, it is known as shifting of taxation. As a matter of fact, every tax payer tries to shift the burden of the tax on to the shoulders of the other persons. In case, he succeeds, it is called shifting of taxation. On the contrary, the incidence of tax falls upon the person who cannot shift it further but actually bears it.
(iii) Distinction between the incidence and effects of a tax is as follows:
The tax incidence means the final money burden of a tax. While studying incidence, we try to find out where actually the money burden of the tax falls. However, the term ‘effects of tax’ is used in a wider sense. Whenever any tax is levied, it produces several other effects, besides its money burden. For example, when excise duty is levied on tea, its money burden no doubt falls on the consumer, but besides that, the excise duty on tea also produces other effects. It may lead to the reduction in the consumption and production of tea besides cutting down the profits of the tea companies. It also includes all the economic and non-economic problems which arise consequent upon the imposition of the excise duty. According to Dalton, the incidence of a tea is the direct money burden whereas the effect of a tea is the indirect money burden of a tax.
Taxable capacity of a country
Taxable capacity refers to the maximum capacity that a country can contribute by way of taxation both in the ordinary and extraordinary circumstances. It represents maximum limit to which the government can tax the people of the country. If the government exceeds this limit, it shall result in over taxation, which, besides being injurious to the long-term interests of the community, may pose a serious threat, to the political stability of the country concerned. The concept of taxable capacity, thus, indicates the limit to which the government can tax the citizens.
Taxation Inquiry Commission defined it as, Taxation capacity of different sections of the community may be said to refer to the degree of taxation, broadly speaking, beyond which productive effort and efficiency as a whole begin to suffer. The concept of taxable capacity has been interpreted by the economists in the following two senses: (i) the absolute taxable capacity of one single community, and (ii) the relative taxable capacity of two or more communities.
1.       Absolute Taxable Capacity: Absolute taxable capacity refers to the maximum amount of taxation that can be collected from a community without causing any unpleasant effects. If the operation of a tax system causes unpleasant effects, the absolute taxable capacity can be said to have exceeded. According to Josiah Stamp, “the absolute taxable capacity of a country is represented by the difference between total production and total consumption.” In other words of Fraser, “When the tax-payers are compelled to lend money from the banks we should think, the limit of taxable capacity has reached.” In this case, the tax payers are forced to borrow money from their banks so as to pay tax dues.
2.       Relative Taxable Capacity: The relative taxable capacity refers to the taxable capacity of two or more communities/countries. It is the proportion in which two or more communities/countries can contribute in the form of taxes in order to meet some common expenditure. In other words, the relative taxable capacity is the capacity of the community to contribute some common expenditure in relation to the capacities of other communities. Thus, if two separate communities are required to meet some common expenditure, it should be in proportion to their relative taxable capacities. This principle is commonly applied in a federal system of government in which different states are expected to contribute to the common expenditure of the country.
Factors Determining/Affecting/Influencing Taxable Capacity
The taxable capacity of a country/community/nation depends on the factors given below:
a)      Size of National Income: The taxable capacity of a country depends upon the size of national income and the size of national depends upon its natural resources and other resources and their proper utilization. The higher the size of the national income of a country, the greater is the taxable capacity of that country. The richer a community, the higher is the capacity to pay taxes.
b)      Size and Growth of Population: The size and growth of population is also one of the important factors determining taxable capacity. With a given volume of income of a country, the taxable capacity is indirectly proportional to the size of its population, i.e. the larger the population, the lower will be the taxable capacity. Again, if the growth rate of national income is lower than the population, per capita income will be reduced and vice versa.
c)       Stage of Economic Development: The stage of economic development also determines taxable capacity. Generally, there is a positive correlation between the fate of economic development and the taxable capacity of the economy. Ordinarily, the taxable capacity in industrially advanced countries is higher than that of the backward and underdeveloped countries.
d)      Distribution of Income and Wealth: The distribution of income and wealth also influences the taxable capacity of the people. The greater the inequality in the distribution of income and wealth in a country, the greater is the taxable capacity. Since a richer community can pay a higher percentage of taxation, so also a system of distribution which leads to concentration of income and wealth in the hands of a few may yield a higher volume of tax revenue and the one which brings about more or less equal distribution of income and wealth.
e)      Nature or Pattern of Taxation System: The taxable capacity also depends on the nature or pattern of taxation system in a country. If the taxation system of a country has been devised on a scientific basis, a well thought out mixture of taxation, the taxable capacity shall be inevitably high. The tax levies by the government under scientific system will satisfy the canons of taxation, i.e. canons of certainty, simplicity, equity, convenience etc. Hence, the taxable capacity shall automatically be high.
f)       Nature or Pattern of Public Expenditure: The nature or pattern of public expenditure also influences the taxable capacity. If the government incurs a major portion of its expenditure on encouraging production and increasing the level of efficiency of workers, this will raise the taxable capacity of the country.
g)      Nature of the Government: The taxable capacity is also influenced by the nature of the government. A democratically elected government by winning public sympathy and cooperation is in a position to raise more revenue from the people.
h)      Standard of Living of the People: Another, factor on which taxable capacity depends is the standard of living of the people. If the standard of living of the people is high, their production power shall also be high. Hence, their income shall be high and consequently, their capacity to pay taxes will also increase in the same proportion.
i)        Psychology of the Tax Payers: The taxable capacity of a country is also influenced by the psychology of the tax payers. In developed and developing countries when the people are satisfied that the government is spending the tax revenue on development activities and for the betterment of whole nation, the taxable capacity naturally goes up. In such a situation, the government can collect more and more revenue by way of taxation.
j)        Stability of Income: The stability of national income also influences the taxable capacity of the country. For example, the national income in developed countries like the U.S.A , U.K. Japan, Germany etc. is generally stable in the sense that there are no violent fluctuations in the national income of such countries. But in countries like India, Pakistan, Bangladesh, etc. there is lack of stability in national income. The taxable capacity in such countries is generally low.
k)      Political Conditions: Political conditions are another important factor which determines the taxable capacity of a country. Stable political conditions and successful planed economic development create confidence in the minds of tax payers. They feel that whatever is taken out from their pockets has been properly utilized for the welfare of the community as a whole. This encourages the tax payers to fulfill their tax obligations in time. On the contrary, if political conditions are instable and there is no planned economic development and the rich are becoming richer and the poor getting poorer, this may shatter the faith of the tax payer and community as a whole in the government resulting in tax arrears, tax evasion and the general disorder in the country.
l)        Other Factors: Besides the above-mentioned factors, fiscal, monetary and income policies of the government also affect the taxable capacity. For example, favourable tax balance of a country increase its taxable capacity.
State whether India has reached the limit of taxable capacity
India has not reached the limit of taxable capacity on account of the following reasons:
1)      In India most of the public expenditure is being incurred on development programmes. Since development programmes increase prosperity, thereby taxable capacity also increases.
2)      National income is directly related with taxable capacity. Since national income is increasing in India, taxable capacity is also increasing.
3)      Economic inequality is reducing on account of planned economic development in India. Hence taxable capacity is increasing in India.
4)      On account of rapid increase in family development programmes in India during the last 5 years, the rate of population growth is less as compared to increase in production. The standard of living of the people has risen leading to increase in taxable capacity.

5)      Monetary economy has replaced barter system in India. Further emphasis is being given to rapid industrialization and thereby the taxable capacity has also increased in India.