Concept Related to Taxation: Tax Incidence, Tax Evasion, Laffer Curve, CESS and Surcharge

Key Concepts Relating to Taxation

Tax Incidence

The key to imposing the tax is who bears its burden. If the person on whom the tax is imposed have the flexibility to transfer it on to the other person, then we say tax incidence has shifted. The shifting of tax form one person to the other is known as tax incidence.

All indirect tax comes under this category. For all direct tax, the incidence of tax and burden lies with the same person.

The incidence of tax mainly depends on its elasticity. Elasticity is nothing but the responsiveness. Example: If you are walking on the road and suddenly a car comes towards you, you respond quickly to get out of the way. This is your responsiveness towards the speed of the car. The faster you get out the way, the higher is your responsiveness. The same concept is applied to income, demand and taxes. If due to a change in prices, the demand responds at a much faster rate, then we say demand is highly elastic vis-à-vis prices.

Consumer Demand Producer Burden/Incidence
Elastic Inelastic Consumer
Inelastic Elastic Producer

Tax Avoidance

It refers to minimising the tax liabilities using an available source of exemptions and tax laws. It is by means of taking advantage of shortcomings of tax structure. It usually happens at the tax planning stage.

Tax Evasion

It refers to reducing the tax liabilities using illegal measures. Tax evasion is a clear case of forgery of accounts as it uses measures which are unforbidden in law.

Cascading Effect in Taxation

A Cascading tax is one, which is not just on final product value but also on the raw materials used as input. The tax is levied at every stage of production and distribution. It is a tax on tax.

For example, resin, rubber and carbon black are necessary for manufacturing tyres. All the three inputs paid tax and the final products namely the tyres also paid tax. So, these three inputs are taxed twice. Then again, the tyre is used in a car, which also is taxed. These three inputs are now taxed thrice. So, the tax element on these inputs goes on increasing with every production and distribution chain. The cascading effect of tax makes the tax rate much higher than the original rate.

Laffer Curve

Laffer curve is named after noted economist Arthur Laffer. Laffer curve shows the relationship between Government tax revenue and tax rates.

The curve is inversely U Shape, representing as the tax rate increases, the government revenue also increases up to an optimum level. Post which, if the government tries to increase taxes, the government revenue will start falling. Thus, a government must maintain an optimum balance between tax rate and revenue.

Tax Buoyancy

Tax buoyancy is a measure of the responsiveness of the tax receipts with respect to GDP.

A tax is considered buoyant when revenue increase by more than one percent if the GDP has increased by 1 percent.

Fiscal drag

Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.

An example of this would be if a person earns Rs 10 000 per year, and has to pay 20% tax on earnings above Rs 5000 for year one. he would then pay (10 000 – 5000) *0.2, which equals 1000 or 10% of her income.

If the person pay goes up by 10% to R11000 to compensate for inflation, and the government increases the tax threshold by 2% in year two to 5 200, he would pay (11 000 – 5200) multiplied by 0.2 which equals 1160 or 10.54% of her income in taxes.

The proportion of Rahul’s income in taxes has increased. This is fiscal drag or bracket creep. This illustrates that when there is inflation, taxes rise unless the tax rates or tax accordingly.

CESS VS Surcharge

Cess Surcharge
A cess is imposed over and above the tax for a specific predetermined purpose. A surcharge is a charge levied on any tax. It is an additional charge on tax.
For example a cess on financing primary education as education cess or a cess for the cleaning and sanitation as Swach Bharat Cess. The main surcharge levied on income and corporation taxes beyond a certain threshold.
A cess is levied as an addition to the proposed taxes. Like a 3% education cess on Income tax. A sur charge of 10% in addition to the income tax of 30% for high net worth individuals earning more than 50 Lakhs.
The revenue from cess is not kept under Consolidated Fund of India. The revenue from the sur charge is kept under Consolidated Fund of India.
Cess is not to be shared with States. Sur Charge is also not to be shared with states.

 

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

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