The Division of Tax Burden, Impact and Incidence of a tax, effects on Production & Distribution

The Division of tax burden

The tax burden is divided between the central government and the state governments. The central government levies taxes on income, customs, excise, and service taxes, while the state governments levy taxes on sales tax, entertainment tax, and property tax, among others.

Various taxes levied in India and their division between the central and state governments:

Income Tax: Income tax is a direct tax levied by the central government on the income of individuals, businesses, and other entities. The tax rates vary based on the income level of the taxpayer. The central government collects all income tax revenue.

Customs Duty: Customs duty is a tax levied on goods imported into the country. The central government levies customs duty and collects all revenue from it.

Excise Duty: Excise duty is a tax levied on goods produced within the country. The central government levies excise duty and collects all revenue from it.

Service Tax: Service tax is a tax levied on the services provided by businesses and other entities. The central government levies service tax and collects all revenue from it.

Sales Tax: Sales tax is a tax levied by the state governments on the sale of goods within the state. The tax rates vary based on the type of goods sold and the state in which they are sold. The state governments collect all sales tax revenue.

Entertainment Tax: Entertainment tax is a tax levied by the state governments on various forms of entertainment such as movies, plays, and other cultural events. The state governments collect all entertainment tax revenue.

Direct Taxes:

Direct taxes are taxes that are levied on the income of individuals and corporates. In India, direct taxes are primarily comprised of income tax, corporate tax, and capital gains tax. The burden of direct taxes is borne by the individual or entity earning the income.

• Income Tax: Income tax is levied on the income of individuals and is based on a progressive tax system. The tax rate increases as the income of the taxpayer increases, and higher-income taxpayers pay a higher percentage of their income as tax.

• Corporate Tax: Corporate tax is levied on the profits of companies, and the tax burden is borne by the company.
• Capital Gains Tax: Capital gains tax is levied on the profit made from the sale of an asset, such as stocks or property. The tax burden is borne by the individual or entity that made the profit.

Indirect Taxes:

Indirect taxes are taxes that are levied on the consumption of goods and services. In India, indirect taxes include GST, excise duty, customs duty, and service tax. The burden of indirect taxes is borne by the end consumer.

• GST: GST is a consumption tax that is levied on the final consumption of goods and services. The tax burden is borne by the end consumer.
• Excise Duty: Excise duty is a tax that is levied on the production of goods. The tax burden is borne by the manufacturer, but it is passed on to the end consumer in the form of higher prices.
• Customs Duty: Customs duty is a tax that is levied on imported goods. The tax burden is borne by the importer, but it is passed on to the end consumer in the form of higher prices.
• Service Tax: Service tax is a tax that is levied on services provided by businesses. The tax burden is borne by the end consumer.

Impact and Incidence of a tax

The impact and incidence of a tax refer to two different concepts in economics. The impact of a tax refers to the initial effect of the tax on the economy, while the incidence of a tax refers to the final distribution of the tax burden among different individuals or groups in the economy.

Impact of a Tax:

The impact of a tax refers to the immediate effect of the tax on the economy. When a tax is imposed, it leads to a change in the prices of goods and services, which affects the consumption and production behavior of individuals and businesses. The impact of a tax depends on the type of tax and the elasticity of demand and supply of the taxed item. For example, if the demand for a good is highly elastic, the impact of the tax will be more significant, as consumers will be more likely to shift to substitute goods.

There are several theories that explain the impact of taxes on the economy, including:

• The Laffer Curve: This theory suggests that at a certain point, increasing taxes will lead to a decrease in tax revenue. This is because as tax rates increase, people are incentivized to work less and to engage in more tax avoidance activities, which can ultimately reduce the amount of tax revenue collected.
• The Deadweight Loss Theory: This theory suggests that taxes can create inefficiencies in the market, which can lead to a reduction in economic activity. This occurs when taxes create a disincentive for people to engage in economic activity, leading to a decrease in production and consumption.
• The Tax Incidence Theory: This theory suggests that the incidence of a tax (i.e., who ultimately bears the burden of the tax) depends on the elasticity of demand and supply. When demand is relatively inelastic, consumers bear a greater share of the tax burden, while when supply is relatively inelastic, producers bear a greater share of the tax burden.
• Supply-Side Theory: This theory holds that taxes have an impact on the supply of goods and services in the economy. Lower taxes can incentivize individuals and businesses to work harder and invest more, leading to increased production and economic growth. On the other hand, high taxes can discourage work and investment, leading to lower economic output.
• Social Welfare Theory: This theory emphasizes the role of taxes in promoting social welfare by redistributing income and wealth. Taxes can be used to fund social programs such as healthcare, education, and housing, which can help to reduce poverty and inequality. However, high taxes can also discourage work and investment, which can have a negative impact on economic growth.
• Keynesian Theory: According to this theory, taxes can be used as a fiscal policy tool to stabilize the economy during economic downturns. During a recession, governments can increase taxes to reduce demand and slow down the economy. Conversely, during periods of economic growth, taxes can be lowered to stimulate demand and boost economic activity.
• The Public Choice Theory: This theory suggests that the impact of taxes is influenced by the political process, as politicians are incentivized to design tax policies that benefit their own interests and those of their constituents. This can lead to inefficiencies and distortions in the tax system.
• The Optimal Taxation Theory: Optimal taxation theory is a branch of economics that examines the design of tax systems to achieve certain economic and social goals. The main objective of optimal taxation is to balance the revenue-raising function of taxes with the need to minimize the negative effects of taxation on economic efficiency and equity. The theory of optimal taxation suggests that the best tax system is one that maximizes social welfare, taking into account the trade-offs between efficiency and equity.

Incidence of a Tax:

The incidence of a tax refers to the final distribution of the tax burden among different individuals or groups in the economy. The incidence of a tax depends on the relative price elasticity of demand and supply of the taxed item, as well as the market structure of the industry. The incidence of a tax is typically analyzed in terms of its effect on producers, consumers, and the government.

Producers: When a tax is imposed, the price received by producers for their goods or services may decrease, which can reduce their profits. The incidence of the tax on producers depends on the elasticity of the supply of the taxed item.

• Consumers: When a tax is imposed, the price of goods and services may increase, which can reduce the purchasing power of consumers. The incidence of the tax on consumers depends on the elasticity of the demand for the taxed item.
• Government: When a tax is imposed, the government collects revenue, which can be used for public goods and services. The incidence of the tax on the government depends on the tax rate and the amount of revenue collected.

Effects on Production & Distribution

The imposition of taxes can have significant effects on production and distribution in the economy. Taxes can affect production and distribution in several ways:

Production Effects:

1. Reducing profitability: Taxes increase the cost of production for businesses, which can reduce their profitability. When businesses face higher taxes, they may reduce their production or exit the market altogether.
2. Encouraging efficiency: Taxes can encourage businesses to become more efficient by reducing wasteful spending and improving productivity. Businesses that become more efficient can reduce their tax liability and increase their profits.
3. Distorting production decisions: Taxes can also distort production decisions by encouraging businesses to produce goods or services that are less heavily taxed or by discouraging them from producing heavily taxed goods or services.

Distribution Effects:

1. Regressive nature: Taxes can be regressive, meaning that they place a higher burden on low-income individuals than high-income individuals. This can result in an unequal distribution of the tax burden.
2. Redistributing income: Taxes can also be used to redistribute income from high-income individuals to low-income individuals. This can be achieved through progressive tax systems that impose higher tax rates on high-income individuals.
3. Affecting consumption patterns: Taxes can also affect consumption patterns by changing the relative prices of goods and services. For example, if the government imposes a tax on cigarettes, consumers may reduce their cigarette consumption and increase their spending on other goods and services.