IMPACT OF INCOME TAX ON ECONOMIC GROWTH: A CRITICAL ANALYSIS

Submitted by – Rahul Singh Submitted to – Dr. G.P. Pandey

Roll no – 1358, Faculty of Taxation Laws-I
th
7 semester, BA.LLB.(Hons.)

FINAL DRAFT SUBMITTED IN PARTIAL FULFILLMENT OF COURSE TITLED Taxation Laws-I FOR
COMPLETION OF BA.LLB. (HONS.)

AUGUST 2018

CHANAKYA NATIONAL LAW UNIVERSITY

NYAYA NAGAR, MITHAPUR,
PATNA (BIHAR)
Contents

Acknowledgement: ....................................................................................................................................... 3

Declaration: ................................................................................................................................................... 4

1. Introduction ........................................................................................................................................... 5

1.1. Aims & Objectives ........................................................................................................................ 5

2. Research Methodology: ........................................................................................................................ 6

1.1. Sources of data collection:- ........................................................................................................... 6

1.2. Method of data collection:- ........................................................................................................... 6

3. Chapters: ............................................................................................................................................... 7

3.1. Taxes: Brief Introduction & Kinds ............................................................................................... 7

3.2. Constitutional foundation of taxes in India ................................................................................. 10

3.3. Taxing system A buttress to the national Economy & Impact Of taxes on Economy: ............... 12

3.3.1. Impact of taxes On Economy; ............................................................................................. 12

3.4. Conclusions: ................................................................................................................................ 14

Bibliography ................................................................................................................................................ 15
Acknowledgement:

I have taken efforts in this project. However, it would not have been possible without the kind
support and help of many individuals. I would like to extend my sincere thanks to all of them. I
am highly indebted to Dr. G.P Pandey sir for his guidance and constant supervision as well as
for providing necessary information regarding the project & also for his support in completing
the project. I would like to express my special gratitude and thanks to my university and library
persons for giving me such attention and time. My thanks and appreciations also go to my
friends and seniors in developing the project and people who have willingly helped me out with
their abilities.

Rahul Singh
Roll no- 1358
7th semester, BA.LLB(hons.)
Declaration:

I, Rahul Singh, hereby declare that this dissertation entitled “IMPACT OF INCOME TAX
ON ECONOMIC GROWTH: A CRITICAL ANALYSIS” is the outcome of my own study
undertaken under the guidance of Dr. GP Pandey Sir, Assistant Professor at Chanakya National
Law University, Patna. It has not previously formed the basis for the award of any degree,
diploma, or certificate of this Institute or of any other institute or university. I have duly
acknowledged all the sources used by me in the preparation of this dissertation.

Rahul Singh
Roll No – 1358
7th Semester, BA.LLB (Hons.)
 1. Introduction

Taxes are considered to be common burden upon the citizens and the revenue collected form of
common revenue of the state. Taxes have the potential of molding the growth of the economy as
the net income or the changes the slab may alter the money in buyers packet and hence it turn
increases or decreases the purchasing power of the buyer. Policy makers and researchers have
long been interested in how potential changes to the personal income tax system affect the size of
the overall economy. The structure and financing of a tax change are critical to achieving
economic growth. Tax rate cuts may encourage individuals to work, save, and invest, but if the
tax cuts are not financed by immediate spending cuts, they will likely also result in an increased
federal budget deficit, which in the long-term will reduce national saving and raise interest rates.
The net impact on growth is uncertain, but many estimates suggest it is either small or negative.
Base-broadening measures can eliminate the effect of tax rate cuts on budget deficits, but at the
same time, they reduce the impact on labor supply, saving, and investment and thus reduce the
direct impact on growth. They may also reallocate resources across sectors toward their highest-
value economic use, resulting in increased efficiency and potentially raising the overall size of
the economy. Results in the literature suggest that not all tax changes will have the same impact
on growth.

In this research paper I will deal with different kinds of taxes specially direct taxes, the
legitimacy of taxing legislations, nature of tax and how it is different from fee, and how it can
give shape to the economic growth.

1.1. Aims & Objectives

This research papers aims to present:

a. Detailed study of taxes and its nature.
b. Difference between taxes and fees
c. Impact of ax on economic growth
d. Case study of India
 2. Research Methodology:

The researcher will use doctrinal method of research. The doctrinal source for this research paper
is websites, books, newspaper articles, along with online research.

1.1. Sources of data collection:-

The researcher will be using primary as well as secondary sources of data collection for
collecting the data regarding this project.

1.2. Method of data collection:-

The researcher will be doing online as well as offline research.

 3. Chapters:

3.1. Taxes: Brief Introduction & Kinds

A tax may be defined as a "pecuniary burden laid upon individuals or property owners to support
the government, a payment exacted by legislative authority. It is not a voluntary payment or
donation, but an enforced contribution, exacted pursuant to legislative authority. It may be direct
tax or indirect tax, and may be paid in money or as its labor equivalent.1 A tax is a compulsory
payment made by individuals and companies to the government on the basis of certain well-
established rules or criteria such as income earned, property owned, capital gains made or
expenditure incurred (money spent) on domestic and imported articles. Since many people object
to paying taxes, taxation involves compulsion. The taxpayers are required to make certain
payments, regardless of their individual wishes or desires in the matter. Because of this
compulsion, the collection of taxes may have very significant effects upon the behaviour of
individuals and the functioning of the economy, which must be taken into consideration in
selection of taxes if the tax structure is not to interfere with the attainment of the economic goals
of society. Furthermore, if the goals of society are to be realised, the burden of the taxes must be
distributed among various persons in a manner consistent with these goals.2

A. Difference between Tax & Fee:

Tax: Firstly, a tax is a compulsory payment levied by the government on its citizens and various
business firms. As payment of tax is compulsory, refusal to pay tax invites punishment.
Secondly, there is no direct quid pro quo relationship between the taxpayer and the tax-levying
authority. That is to say, a taxpayer cannot demand any reciprocal benefits for paying taxes.
Thirdly, a tax is levied to incur public expenditure for the benefit of the country as a whole.

1
P.K Neemansa. HISTORY, CONSTITUTIONAL FRAMEWORK, AND EVOLUTION OF INDIAN TAX SYSTEM AND GOODS
AND SERVICE TAX – A STUDY, ( 23 August 2018, 8:12 pm)
http://docs.manupatra.in/newsline/articles/Upload/197FAA37-956C-4573-8F58-20464016819D.pdf
2
Nipun S, Principles Of Taxation, ( 23 August 2018, 8:12 pm)
http://www.economicsdiscussion.net/taxes/principles-of-taxation-economics/26212
Fourthly, the basis of taxation cannot be the same for all periods. It is reviewed periodically by
the taxing authority.3

Fee: On the other hand, a fee is a voluntary payment to the government for the special services
rendered by it in the public interest, but conferring a specific advantage on the person paying it.
In the first place, a tax is a compulsory contribution made by a taxpayer. A fee, by definition, is a
voluntary payment. Secondly, as far as tax is concerned, there is no direct give-and-take
relationship between the taxpayer and the tax-levying authority. A taxpayer cannot demand any
special favour from the authority in return for taxes paid by him. A fee is a direct payment by
those who receives some special advantages or the government guarantees the services who pays
fees.4 Fees are, therefore, deemed to be the by-products of the administrative activities of the
government. Thirdly, fees are mostly imposed to regulate or control various types of activities.
But the objectives of taxation are many. It has no separate objective. Taxes are levied in the
greater interests of the country.5

B. Kinds of taxes:

Taxes can be broadly differentiated into two heads, ie. direct taxes and indirect taxes. Direct and
indirect taxes include all the different types of taxes levied by the government.

1. Direct taxes include the taxes that cannot be transferred or shifted to another person, for
instance the income tax an individual pays directly to the government. In this case, the
burden of the tax falls flatly on the individual who earns a taxable income and cannot
shift the tax to others. Direct taxes are paid in entirety by a taxpayer directly to the
government. It is also defined as the tax where the liability as well as the burden to pay it
resides on the same individual. Direct taxes are collected by the central government as

3
Rituka Muley, Difference between Tax and Fees, ( 23 August 2018, 8:12 pm)
http://www.economicsdiscussion.net/government/taxation/difference-between-tax-and-fees/17448
4
Barnet Sherman. Tax Rates And Economic Growth: Is There Really A Correlation?, ( 23 August 2018, 8:12 pm)
https://www.forbes.com/sites/investor/2017/10/17/tax-rates-and-economic-growth-is-there-really-a-
correlation/#7c576add7c3e
5
Rituka Muley, Difference between Tax and Fees, ( 23 August 2018, 8:12 pm)
http://www.economicsdiscussion.net/government/taxation/difference-between-tax-and-fees/17448
 well as state governments according to the type of tax levied. Major types of direct tax
include: 6

a. Income Tax: Levied on and paid by the same person according to tax brackets as
defined by the income tax department.
b. Corporate Tax: Paid by companies and corporations on their profits.
c. Wealth Tax: Levied on the value of property that a person holds.
d. Estate Duty: Paid by an individual in case of inheritance.
e. Gift Tax: An individual receiving the taxable gift pays tax to the government.
f. Fringe Benefit Tax: Paid by an employer that provides fringe benefits to employees,
and is collected by the state government.

2. Indirect tax, as mentioned above, include those taxes where the liability to pay the tax lies
on a person who then shifts the tax burden to another individual. Indirect taxes, on the
other hand, are taxes which can be shifted to another person. An example would be the
Value Added Tax (VAT) that is included in the bill of goods and services that you
procure from others. The initial tax is levied on the manufacturer or service provider, who
then shifts this tax burden to the consumers by charging higher prices for the commodity
by including taxes in the final price.7

In this research project I will deal with the impact of direct taxes on the economy and how the
economy responds to changes in the tax rates.

6
Difference between Direct and Indirect Taxes,( 23 August 2018, 8:12 pm)
https://www.bankbazaar.com/tax/difference-between-direct-tax-and-indirect-
tax.html?ck=Y%2BziX71XnZjIM9ZwEflsyDYlRL7gaN4W0xhuJSr9Iq7aMYwRm2IPACTQB2XBBtGG&rc=1
7
Difference between Direct and Indirect Taxes,( 23 August 2018, 8:12 pm)
https://www.bankbazaar.com/tax/difference-between-direct-tax-and-indirect-
tax.html?ck=Y%2BziX71XnZjIM9ZwEflsyDYlRL7gaN4W0xhuJSr9Iq7aMYwRm2IPACTQB2XBBtGG&rc=1
 3.2. Constitutional foundation of taxes in India

History: In ancient and medieval India the kingdoms depended mainly on land revenue, tolls,
tributes and plundering. Chanakya’s Arthasastra, of course, speaks of commercial taxes. During
the reign of Allauddin Khilji sales tax was one ofthe market taxes. But the sales tax according to
the accepted Anglo-Saxon legal tradition owes its origin to Government of India Act 1935
hereinafter referred to as G.I. Act ’35. The provinces could levy sales tax under entry 48 oflist II
in Seventh Schedule which read as follows: Entry 48 “taxes on the sale of goods and on
advertisements”. The Province of Madras under the stewardship of Late Sri C.Rajagopalachary
introduced sales tax by enacting Madras General Sales Tax Act, 1939. Many other Provinces
followed suit and so did the many native State 8

Constitutional Provision:

Constitution is the foundation and source of powers to legislate all laws in India. Parliament, as
well as State Legislatures gets the power to legislate various laws from the Constitution only and
therefore every law has to be within the vires of the Constitution. Talking about the taxation laws
and the interpretation of taxation laws, every lawyer or a tax professional practicing taxation
laws must understand the basic provisions of Constitution relating to taxation including the
powers of Parliament and State Legislatures to legislate regarding levy and collection of tax, the
restrictions imposed by our Constitution on such powers, entries concerning taxation in Central
List i.e List-1 and State List i.e List-2 of Seventh Schedule to Constitution of India. To form
clear understanding of the basic concepts relating to taxation laws one must understand the
relevant provisions of the Constitution, as the power to levy and collect tax by State
Governments or Union Government comes from the Constitution only.9

8
CONSTITUTIONAL FOUNDATION, ( 23 August 2018, 8:12 pm)
http://shodhganga.inflibnet.ac.in/bitstream/10603/64180/9/09_chapter%202.pdf
9
Constitutional provisions relating to taxation-How important to understand tax laws, ( 25 August 2018, 8:12 pm)
https://taxguru.in/income-tax/flag-message-constitutional-provisions-relating-taxationhow-important-
understand-tax-laws.html
Article 246(1) of Constitution of India states that Parliament has exclusive powers to make laws
with respect to any of matters enumerated in List I in Seventh Schedule to Constitution(i.e Union
list).10 Article 246(3) provides that State Government has exclusive powers to make laws for
State with respect to any matter enumerated in List II of Seventh Schedule to Constitution(i.e.
State List).11 Parliament has exclusive powers to make laws in respect of matters given in Union
List and State Government has the exclusive jurisdiction to legislate on the matters containing in
State List. There is yet another list i.e List III (called concurrent list) in the Seventh Schedule to
the Constitution. In respect of the matters contained in List III both the Central Government and
State Governments can exercise powers to legislate. In case of Union Territories Union
Government can make laws in respect of all the entries in all the three lists. List III of Seventh
Schedule(i.e Concurrent list) includes entries like Criminal law and Procedure, Trust and
Trustees, Civil Procedures, economic and social planning, trade unions, charitable institutions,
price control factories, etc. In case there is a conflict between the laws legislated by State
Government and Central Government in respect of entries contained in Concurrent list, law made
by Union Government prevails.12

10
Article 246(1) Constitution of India
11
Article 246(3) Constitution of India

12
Taxation Provisions India, ( 24 August 2018, 8:52 pm) http://racolblegal.com/distribution-of-revenue-in-the-
light-of-the-constitution-of-india-taxation-provisions/
 3.3. Taxing system A buttress to the national Economy & Impact Of taxes on
Economy:

The idea that taxes affect economic growth has become politically contentious and the subject of
much debate in the press and among advocacy groups. The most important source of government
revenue is tax. Nothing has been vetted more exhaustively than the relationship between tax
policy, jobs and economic growth.13 Taxes can affect the economy in a number of ways ranging
from national and local economic growth to how individuals manage their personal finances.
Although taxation itself is ubiquitous, whether taxes have a positive or negative effect on the
general economic condition of the country is the subject of much debate.14 The government
receives revenue for expenses it incurs in achieving policy objectives, asset maintenance and
debt realization through both direct and indirect taxes.15

3.3.1. Impact of taxes On Economy;

1. Creates Revenue For The Government: Taxes are the major major means by which the
government finances its activities. Therefore introduction of new taxes will surely
increase the government revenue. However, one question that one has to ask is whether
the taxes will be good for the economy as a whole. In as much as taxes improve the
government''s revenue.16
2. Reduction In disposable Income: Taxes reduces the disposable income available to
households for consumption. Consumption is the biggest component of the GDP and
therefore a reduction in consumption is likely to slow down economic growth.

13
Barnet Sherman. Tax Rates And Economic Growth: Is There Really A Correlation?, ( 22 August 2018, 5:12 pm)
https://www.forbes.com/sites/investor/2017/10/17/tax-rates-and-economic-growth-is-there-really-a-
correlation/#7c576add7c3e
14
Christina Eichelkraut, Taxes & Their Effect on Economic Conditions, ( 24 August 2018, 9:12 pm)
https://bizfluent.com/about-6162494-taxes-effect-economic-conditions.html
15
Taxes and Economy: Growth vs Development, ( 23 August 2018, 8:12 pm) https://blog.allindiaitr.com/taxes-and-
economy-growth-vs-development
16
moff J, ( 24 August 2018, 9:12 pm) https://www.kenyaplex.com/resources/4248-impact-of-taxation-on-the-
economy.aspx
 Let us look at the impact of taxes on the economy of a country in details now.
Taxes, as mentioned earlier, reduce the disposable income of consumers. Disposable
income is the income that households are left with after deducting taxes. Households
have two uses for their disposable income, that is, consumption and saving. When their
disposable income is reduced, both consumption and savings are automatically
reduced. 17
3. Savings on the other hand supply the funds which are loaned to firms for investment. As
mentioned earlier, taxes reduce the amounts available for saving. Hence, the funds
available for loaning to firms are limited or are obtained at high costs which tends to
discourage investors.18
4. Investment is another component of the GDP. Reduction in investment means that the
economic growth of a country is likely to be slowed down.In the national income
determination, consumption by households represents the biggest component of the GDP.
5. Effects on the Allocation of Resources: By diverting resources to the desired directions,
taxation can influence the volume or the size of production as well as the pattern of
production in the economy. It may, in the ultimate analysis, produce some beneficial
effects on production. High taxation on harmful drugs and commodities will reduce their
consumption. This will discourage production of these commodities and the scarce
resources will now be diverted from their production to the other products which are
useful for economic growth. Similarly, tax concessions on some products are given in a
locality which is considered as backward. Thus, taxation may promote regional balanced
development by allocating resources in the backward regions. However, not necessarily
such beneficial effect will always be reaped. There are some taxes which may produce
some unfavourable effects on production. Taxes imposed on certain useful products may
divert resources from one region to another. Such unhealthy diversion may cause
reduction of consumption and production of these products.19

17
Ibid.
18
Ibid
19
Economic Effects of Taxation: Top 6 Effects,
http://www.economicsdiscussion.net/government/taxation/economic-effects-of-taxation-top-6-effects/17454
 3.4. Conclusions:

Prime Minister Narendra Modi quoted Albert Einstein during his speech at the midnight launch
of Goods and Services Tax. Mr. Modi said: “Einstein said if there is something in this world that
is difficult to understand, it is income tax. I wonder what he would have said on seeing our
multiple tax.”20 Indeed taxes are one of the most complicated issues in order to understand and
hence the researcher in this research project has put the things in very simple form in order to
understand the concepts of taxation and especially income tax and As ,mentioned earlier by the
researches taxes have the potential of changing the whole dynamics of economy and a slight
change can have a deep impact on the economic development. A very common example in
regard to impact of taxes on economy can be witnessed in the purchasing power of the citizens
gets appreciated if there’s a leverage in the income tax, and in consequence may boost a specific
industry. if middle income group are given tax benefits on home loans then in that t=case people
of middle income group will prefer buying home as it will help them in getting tax benefits and
in consequence the real estate market will witness a boom. Such economic pattern is also called
multiplier effect in economy. A little change in the taxing system may yield to such changes in
the economy. There are various other impacts of taxation and tax laws are meant to control and
regulate the economy.

Government tries to control the flow of money in the market by using its taxing mechanism and
further controls and stabilizes the issues like inflation, deflation and stagflation. Taxes also play a
very important role in providing the way to get out of recession and hence it can be very well
asserted that taxes play a very important role in running the economy as it is the prime source of
revenue and apart from being revenue it also plays a very important role in balancing the
economic cycle and solving the microeconomic crisis.

And hence it can be validly concluded that, taxes have a great impact on the national economy
and hence is an effective tool to regulate economy.

20
What did Albert Einstein say on income tax? The Hindu, ( 25 August 2018, 8:43 pm)
https://www.thehindu.com/business/Economy/what-did-albert-einstein-say-on-income-tax/article19193062.ece
Bibliography

Books –

1. Economics for Law Students, Surabhi Arora, ISBN 9381292450

Websites-

S.No Web Address Date Visited

1 https://www.forbes.com/sites/investor/2017/10/17/tax-rates-and-economic- 23 August 2018

growth-is-there-really-a-correlation/#7c576add7c3e

2 http://www.economicsdiscussion.net/government/taxation/economic- 24 August 2018

effects-of-taxation-top-6-effects/17454

3 https://www.kenyaplex.com/resources/4248-impact-of-taxation-on-the- 23 August 2018

economy.aspx

4 http://shodhganga.inflibnet.ac.in/bitstream/10603/64180/9/09_chapter%2 25 August 2018

02.pdf

5 https://www.bankbazaar.com/tax/difference-between-direct-tax-and- 25 August 2018

indirect-
tax.html?ck=Y%2BziX71XnZjIM9ZwEflsyDYlRL7gaN4W0xhuJSr9Iq7aMYwRm2
IPACTQB2XBBtGG&rc=1

6 http://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/Tax- 24 August 2018

Concepts/Constitutional-Provision-Governing-Taxation-in-India.html