“Nothing is certain except for death and taxes.”
–Benjamin Franklin
It’s almost the end of July, and in a “no-COVID” era, at this time, almost everyone would have been in the process of filing their income tax returns (for those who don’t know, for the majority of the income taxpayers, the last date of filing the income tax return is 31st July, which has been extended to 30th November this year, due to the ongoing pandemic). In today’s #tfpforall let’s try to understand some basic concepts relating to How Taxes Work?
What is Tax?
Starting with the most obvious question, what is tax? Tax is something that is paid to the government. So, who pays this tax to the government? Well, to give an example, have you bought a Parle-G biscuit? If yes, then you have paid tax to the government! WHAT? If this is true, the next obvious question is how did the money paid to the Kirana store, end up with the government? Well, you paid the cost of the biscuit to the Kirana store, and they, in turn, paid a certain portion of that amount to the government. So, you “indirectly” paid something to the government when you bought the biscuit. Voila, you’ve already learnt what is an indirect tax!
In slightly technical language, indirect tax is a tax that is levied on goods and services. It is collected by one entity in the supply chain (usually a producer or retailer) and paid to the government. The consumer ultimately pays the tax as a part of the purchase cost of the goods or services.
Essentially, the income is earned by the producer/ retailer, and so they are liable to pay the tax to the government. This is known as the ‘incidence of tax’. However, as we see, the burden or incidence is ultimately borne by the consumer, i.e. the ‘impact of this tax’ is felt by the consumer. This implies, that in the case of indirect taxes, the burden of tax can be shifted by the taxpayer to someone else. Since the amount is almost negligible, in most cases, the consumers don’t even realise that they are paying tax on the goods purchased by them.
The other type of tax is the direct tax. As the name suggests, it is a tax which is “directly” paid by the taxpayer to the government. Let’s take the example of the tax deducted every month from our salary. Here, we are the ones earning the salary, and we are also the ones paying the tax, i.e. the taxpayer cannot shift the tax to someone else. It may appear that our company is paying tax on our behalf, but it is important to remember that the company is not paying the tax from its pocket. We receive salary net of the tax amount, and thus ultimately, we are the ones bearing the tax.
Regressive and Progressive Taxes
Another term which is commonly used in case of taxes is the progressive/ regressive nature of the tax. What do we mean by this? Well, a progressive tax structure means that the tax rates will be applicable basis the income earning capacity of the person. Simply put, the more you earn, the greater proportion of your income will go towards payment of tax.
Remember the Budget for FY 2020-21? As per the new tax regime, the income tax rates ranged from 10% for income slab of Rs. 5 lakhs to 7.5 lakhs, to 30% for income greater than Rs. 15 lakhs. These rates are not flat i.e. a different rate is applicable for each slab, and so, the effective rate on the total income will be much lower. For example, a person earning say Rs. 20 lakhs will not have to pay 30% tax on the entire amount, but only on the amount above Rs. 15 lakhs i.e. only on Rs. 5 lakhs. (To know what are the tax slabs applicable for FY 20-21, you can visit https://www.incometaxindia.gov.in/Pages/charts-and-tables.aspx). Thus, income tax rates are said to be ‘progressive rates’ as they increase with an increase in the level of income.
A regressive tax structure means that the tax rates are the same for everyone, irrespective of the income-earning capacity of the person. For example, you will pay the same amount of tax on a Parle-G biscuit packet as Mr Ambani (if he decides to buy Parle-G!). This tax structure is known as regressive because it seems quite harsh to levy the same rate of tax for everyone. Here, the flat rate levied is also the effective tax rate paid by the person. Essentially, if a certain luxury item falls within the 28% tax bucket, then the person is in effect paying 28 paise extra for every one rupee paid towards the purchase of that luxury item. The government often uses this as a tax tool, meaning that they try to influence the consumption of certain items. It is not a simple coincidence that cigarettes are levied GST at 28% and essential commodities attract nil or very low GST rates.
We have used words like Income tax and GST above, so its time to see what are the different types of taxes. Direct taxes include Income Tax, Property Tax, Wealth Tax, Corporate Tax, Gift Tax, etc. Indirect taxes include GST (Goods and Service Tax), Sales Tax, VAT (Value Added Tax), Excise Duty, Service Tax, Customs Duty, etc. I will cover these different taxes in a separate article
Hope you have a better idea of taxes after reading this article! Please provide suggestions in case you want me to cover any other topics related to tax!
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