Unit-II

Theory of Public revenue

 Introduction
Taxation is the primary source of public revenue for
modern governments, as it is a legal duty for
citizens to pay honestly. It can be levied on
income, property, or commodity purchases.
Economists argue that taxation is a compulsory
payment without any expectation of return.
However, taxation can be seen as a convenient
method for raising revenue, which is linked to the
welfare of the people. The tax-payer is not entitled
to claim any return against their tax payments, but
modern taxation policies aim to fulfill social welfare
objectives.
 What is tax?
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:

Definitions
“A tax is a contribution from citizens for the
support of the state.”
Adam Smith
 Definitions
“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 a penalty for any legal
offence.”
Dalton
It is clear that the taxes are compulsory contributions by
taxpayers, reducing inequalities in income and wealth,
securing employment, and promoting economic stability.
Taxes are not voluntary but can reduce purchasing
power, while public expenditure may boost productivity.
Dr. RN Bhargava believes taxes are as compulsory as
fees.
 Non –tax revenue
Other than taxation being a primary source of income, the
government also earns a recurring income, which is called non-
tax revenue. While sources of tax revenue are few, the sources
of non-tax revenue are many, with the number of collections per
source. Although there are many sources of non-tax revenue,
the amount per source is much less than that for tax revenue.

For example, when citizens use services offered by the

government, they pay bills, which are categorized as non-tax
revenue, as the government provides infrastructure support to
implement the services. Non-tax revenue also includes the
interest collected by the government on the loans or funds
offered to states.
 Non-tax revenue
The difference between tax revenue and non-tax revenue is that
the former is charged on income earned by an entity, which is a
direct tax and on the value of transaction of goods and services,
which falls under indirect tax.

On the other hand, non-tax revenue is charged against services

provided by the government. It is mandatory to pay a part of the
income generated and the amount of goods and services
consumed as tax. However, non-tax revenue becomes payable
only when services offered by the government are availed of.

There are various services provided by the government that

become sources of non-tax revenue, such as police services,
electricity, municipal services, etc. These sources become a
medium of non-tax revenue for the state government concerned.
 Features of a Tax System
Tax is an important tool in the development of the
economy. It affects the overall structure of the
whole economy. The idea of taxation is not only
difficult but hard to achieve.
Edmund Burke has rightly emphasized,

“It is difficult to tax and to please as it is

to love and to be wise.”
 Features of a Tax System
The main characteristics of good tax system are:
1. Tax is Compulsory Payment: Payment of
taxes is compulsory if the tax-payer has attained
the sufficient conditions for the imposition of a tax.
Thus, taxes are compulsory to be paid under
certain conditions only.
“Tax is a compulsory contribution
although it can be paid voluntarily.”

Buchler
 Features of a Tax System
2. Element of Sacrifice: Tax payment carries
a sense of sacrifice, as it is a commercial
transaction, but also a legal obligation for public
interest. Tax payers pay for the provision they buy,
demonstrating their responsibility to the public.

3. Tax is a payment to the Government:

Taxes are payments made by the public to the
government, not by individuals or the government.
Authority Full institutions impose taxes on the
public, with the government being the only one.
 Features of a Tax System
4. Aim of tax collection of Public Welfare:
Taxes are levied and collected for the general
public's welfare and community's maximum
benefit. They are not used for vested interests or
specific sections, as they focus on the aggregate
welfare of society.
 Features of a Tax System
5. Tax is not at the cost of Benefit: Tax is not
the cost of government-provided benefits, as they
are independent. Taxation is designed to provide
benefits to the general public, but not as a cost to
individuals.
“The tax is the price which each citizen
pays to the state to cover his share of
the cost of general public services,
which he will consume.”
De Macro
 Features of a Tax System
6. The Benefit received is not directly the
Return of Tax: A person may receive benefits
from tax-deductible expenditures, but the State
doesn't guarantee they receive them in proportion
to their tax payments.

“The essence of tax is the absence of a

direct quid-pro-quo between the tax
payer and the public authority.”
F. W. Taussig
 Features of a Tax System
7. Taxes are paid out of Income: Taxes are paid out of
income though they may be saving a part out of income.

“ Distinction between taxes assessed on income and

capital respectively is often confused with the quite
separate distinction between taxes paid out of
income and capital respectively. But a tax assessed
on capital may be paid out of income and
conversely. A man liable to death duties may pay
them out of income, a man may sell securities or
borrow from his bank in order to pay income tax.”
Dalton
Hence the distinction has no importance.
 Features of a Tax System
8. Taxes are paid by the Persons: Taxes are paid
by an individual though they may be levied upon
individuals or property or commodities. To pay tax is the
personal responsibility of an individual as the possession,
which he has. Therefore, all taxes are paid by individuals
an not by the goods or properties on which they are
levied.

9. Legal Sanction: In the only after the levy of a tax

becomes an Act of the Government that taxes are levied.
It is the authority of State that can impose taxes. Taxes
have a legal sanction, their collection is legal and person
falling to paty.
 Direct and Indirect Taxes
Definitions
“That a direct tax is really paid by a
person on whom it is legally imposed,
while an indirect tax is imposed on one
person, but paid partly or wholly by
another, owing to consequential change
in the terms of some contract or
bargaining between them.”
Prof. Dalton
 Direct and Indirect Taxes

“A direct tax is one, demanded from the

very person who is intended or desired
should pay it. Indirect tax are those
which are demanded from one person in
the expectation and intention that he
shall identify himself at the expenses of
another”
JS Mill
Direct Taxes Indirect Taxes Other Taxes
Income Tax Sales Tax Property Tax

Wealth Tax Goods & Services Tax Professional Tax

(GST)

Gift Tax Value Added Tax (VAT) Entertainment Tax

Capital Gains Tax Custom Duty Education Cess

Securities Transaction Coctroi Duty Toll Tax

Tax

Corporate Tax Service Tax Registration Fees

 Principles of taxation
Principles of taxation refer to the parameters or criteria
for arriving at an optimal tax structure. There are 3
principles of taxation and they can be briefly discussed
as follows:

 Absolute equality- It implies equality in tax

payment. In this approach, each individual or tax
paying unit pays equal absolute amount of tax. The
individual’s tax liability is simply computed as the total
amount of government spending divided by the total
number of tax paying units. But equality does not
imply equity, that is, fairness in the distribution of tax
burdens.
 Principles of taxation
 Ability to pay- It determines equity on an equal sacrifice
basis. It suggests that all tax payers should bear an equal
sacrifice in the payment of tax. Tax should be levied
according to an individual’s capacity to pay, given by his/her
income, wealth etc. This principle leads to 2 tenets or types
of equity, namely, horizontal equity and vertical equity.

Horizontal equity implies that individuals having the same

ability to pay, say given by income, must bear equal burden
of the tax. Vertical equity implies that people having different
incomes, that is, abilities to pay must share different burden
of the tax.
 Principles of taxation
 Benefit principle- It is a major alternative to the ability-
to-pay principle. According to this principle, tax should be
related to the extent of benefit/utility derived from the goods
or services provided by the government. This principle has
the advantage of directly relating the revenue and
expenditure sides of the budget. It involves combining
efficiency (allocational) and equity (distributional)
considerations. This principle is based on quid- pro-quo
relationship. A person voluntarily exchanges purchasing
power in the form of taxes for the purchase of public goods
that provide a certain utility.
 Taxable Capacity
Definitions
“ It is always wise and useful for a government to
know even roughly the limit that the country
can contribute by the way of taxation, both in
ordinary and extra-ordinary circumstances.”
Prof. Findlay Shirras
 Taxable Capacity
Definitions
“ Relative taxable capacity is a reality, which can,
however, be equally expressed in other terms,
while absolute taxable capacity is a myth.” he
further comments that “Taxable capacity is a
common phrase but a confused conception.”
Hugh Dalton
 Taxable Capacity
Definitions
“ Taxable capacity refers to sacrifice the
community is able to sustain.”
Prof R Musgrave

“ The limit of taxation as also of expenditure, is

indicated by the principle of public finance and
should be called the optimum of public
finance.”
RN Bhargava
 Taxable Capacity
Normally, taxable capacity is used into two senses named as:
1. Absolute Taxable Capacity
2. Relative Taxable Capacity

1. Absolute Taxable Capacity

Dalton dismisses the concept of absolute taxable capacity as
vague and unpractical. He believes that every tax has an
unpleasant effect on taxpayers' income, making it difficult to
determine the limit of taxable capacity without producing
unpleasant effects. He also argues that the practical limit to
taxable capacity lies somewhere in the middle, but cannot be
correctly identified. Dalton's rejection of absolute taxable
capacity highlights the need for a more precise understanding
of the practical limit to taxable capacity.
 Taxable Capacity
2. Relative Taxable Capacity
The concept of relative taxable capacity is
more definite and concrete than absolute
taxable capacity. It refers to the proportion of
two or more communities contributing to
common expenditure through taxation. A
community may be exceeding its due share,
indicating that relative taxable capacity has
been exceeded.
Factors determining Taxable Capacity
1. Size of the National Income
2. Size and Rate of Growth of Population
3. Distribution of Income and Width
4. Stability and Growth of Income
5. Pattern of Taxation
6. Purpose of Taxation
7. Psychology of the Tax Payers
8. Natural of Public Expenditure
9. Standard of Living of the People
10. Price Level
Factors determining Taxable Capacity
11. Stability of Income
12. Administrative Efficiency
13. Economic Situations
14. Political conditions
15. Savings , Investment and Economic Growth
16. Comparative Income-Population Growth
Rate
17. Pattern of Propensity to Consume
18. Monetary and Fiscal Policy
19. Nature of Government
20. Patriotism and Emergent Situation
 Incidence of Taxation

Statutory Incidence, Economic Incidence

and Tax Shifting

We know that taxes are not voluntary purchase

payments but mandatory impositions payable in line
with whatever statue has been legislated. Although,
these statues in the end are a reflection of voter’s
preferences, once legislated they become mandatory
levies, imposing burden which the individual tax payer
will try to avoid or pass on to others.
 Incidence of Taxation
Statutory incidence may be different from economic incidence
because of the process of shifting the tax burden. For
example, the imposition of an income tax may lead to reduce
working hours, thereby driving up the gross wage rate and
burdening the consumer. Or, an automobile excise duty
levied on the sellers may cause them to raise their prices,
hoping to pass the burden of the tax to buyers, who in turn
attempt to avoid it by substituting other purchases. In each
case the tax payer’s ability to make such adjustment will
depend on the willingness of the other transact or to go
along. The process of shifting the tax burden may lead to
final distribution of the burden or economic incidence.
 Incidence of Taxation
In brief, statutory incidence is the legal liability for
the payment of tax on the individuals and business
firms. It indicates the impact point. The process of
its transfer is known as shifting of the tax. The
settlement of the ultimate burden of the tax is
called its incidence.
Impact & Incidence of a Tax
The terms impact and incidence of taxation may be distinguish
as follows:

 Impact refers to the initial burden of the tax while incidence

refers to the ultimate burden of the tax.

 Impact is at the point of imposition but, incidence occurs at

the point of settlement.

 The producers may succeed in collecting it from consumers

by raising the prices of detergents by the amount of the tax.

 The impact may be shifted but incidence cannot. Incidence

is the end of shifting process.
Incidence & Effects of taxation
The term incidence and effects of taxation have
different meanings in economic analysis.
Incidence refers to the eventual money burden
of the tax.
Effects of taxation refers to the economic
consequences of a tax on production and
distribution. Effects imply the real burden of
taxation on the production and distributional
aspects in the economy.
 What is Laffer Curve?
In economics, the Laffer Curve is a graphic
representation of the relationship between rates
of taxation & the resulting levels of govt revenue.

The theory tries to arrive at an optimal tax rate

beyond which tax revenues for an economy tend
to fall.
 What does it say?

The Laffer curve was developed in 1979 by Economist

Arthur Laffer. According to Laffer’s theory, tax revenues
are almost zero at extreme rates. At zero tax rate,
particularly the income-tax, it is natural that tax
revenues are zero. But at an extreme of a 100 % tax
rate, the Govt theoretically collects zero revenue
because the assumption is that taxpayers have no
incentive to work as they would be left with nothing to
spend at such high or they find a way to avoid paying
taxes.
 What is its significance for
consumers and investors?

The Laffer curve formed the basis of supply side

economics and the policy of tax cuts that US president
Ronald Regan pursued in the eighties. He cut taxes so
that the tax payers have more money at their disposal to
spend and the multiplier effect from such spends would
result in more demand for goods and services and
employment and income. This policy was very successful
in the US in the eighties and helped the US economy
come out of a recession by the end of the decade.
 Why is it relevant in the
Indian context?

Income-tax rates in India have been gradually coming

down with the economic reforms over the last 25 years.
But with the budget coming in there is an expectation
from the consumers who fall in the lowest slab of
Income Tax could benefit if the government lowers taxes
as it would help them spend more and an increase in
consumption demand could revive the economy over a
period of time
 What are the limitations?

Whether a decrease in tax rates would increase tax

revenues depends to a large extent on the elasticity of
labour supply, that is, on how much workers respond to
increased incentives. Also, a decrease in tax rates would
also increase saving and capital formation and would
reduce the incentive to acquire tax shelters.
 The Division of Tax burden
The burden of the tax can be transferred to others through
a process of shifting. It may be noted that the whole
burden of the tax may not be shifted to others. It may be
that a part of the tax may be shifted to others and a part
be borne by the one who initially pays the tax.
As a matter of fact, a part of the tax burden rests on all
the persons to a larger or smaller degree in the chain of
transferring the burden so that at the ultimate end only a
small burden rests. The process of shifting the burden of a
tax goes on so long as different persons who come in the
chain are able to pass on the burden to others till it
ultimately rests on a person or a group of persons who
cannot shift this unwelcome baby further.
 The Division of Tax burden

Theory of incidence of tax studies in what proportion

the burden or incidence of a tax is shared among
different persons. It may be noted that a tax can be
shifted through a process of exchange or, in other
words, an individual or a firm can shift the burden of
the tax if there occurs exchange relations which are
conducted on the basis of prices of goods and factors.
 The Division of Tax burden
Tax payer can shift burden by increasing or lowering
prices of goods sold or buying factors, depending on
factors affecting the tax burden.
1. The Nature of a Tax
The nature of a tax as to whether it is a tax on the
production or sale of some commodities or it is a
personal income or property tax. Tax shifting can easily
take place in the case of taxes on the production and
sale of commodities. The taxes on pro­duction or sale
of commodities are called indirect taxes. The important
examples of indirect taxes are excise duties and sales
tax. On the other hand, the burden of direct taxes
such as income and wealth taxes cannot be shifted.
 The Division of Tax burden
2. Market Conditions

Whether commodity is being produced under

conditions of perfect competition, monopolistic
competition or monopoly goes to determine the extent
to which the burden of the tax can be shifted. A
monopolist who has a full control over the supply of a
commodity is in a better position to shift the burden of
a tax on the commodity produced.
 The Division of Tax burden
Likewise, a producer working under monopolistic
competition who produced a product somewhat
different from others, exercises a good deal of
influence over the price of its product and therefore
can pass on a part of the burden of the tax to the
buyers.

Even the firms working under perfect competition can

shift the tax burden as the tax levied on a commodity
raises its supply price for all of them. The difference in
the three market forms lies in the extent to which the
burden of the tax can be shifted.
 The Division of Tax burden

3. Physical Conditions of Production

The shifting of the tax burden on a commodity also
depends upon whether the commodity is being
produced under increasing, constant or diminishing
returns.
 Shifting of Taxation

Shifting of taxation involves transferring

the burden of a tax from one person to
another, allowing someone else to pay the
tax, reducing the incidence of the tax on
the individual who cannot shift it further.
 Shifting of Taxation
Tax shifting is of two types:
1. Single Point Shifting: Producer transfers tax
burden to consumer, resulting in higher prices for
their product.

2. Multi Point Shifting: Producer shifts tax burden

from one point to multiple points, paying excise duty
on cloth, then shifting to wholesale dealer, retailer,
and consumer.
 Shifting of Taxation
Process of Tax Shifting
1. Shifting through Price
Tax shifting occurs through price transactions,
where sellers raise the price of a commodity to
shift the tax burden on consumers. This
process depends on economic factors and can
be achieved through product quality changes.
Deliberate efforts are made to disclose hidden
taxes that are shiftable.
 Shifting of Taxation
2. Shifting through Tax Capitalization
Shifting occurs when durable goods face
annual taxes, and the taxes are capitalized
and deducated in lump sums at the time of
purchase. This can be partially or wholly done
due to different conditions. For example, a
purchaser may buy a residential building with
annual taxes but ask the seller to deduct the
taxable amount from the price.
 Shifting of Taxation
3. Shifting of Tax: Forward and Backward
Tax shifting involves manipulating commodity prices,
occurring in forward or backward directions.
 Shifting of Taxation
Forward shifting is a tax shifting technique where a
commodity producer transfers tax burden to
middlemen, wholesalers, retailers & customers,
raising or reducing prices to shift tax to all
consumers.
Backward shifting occurs when a tax on a commodity
is shifted backward to production agents, causing the
price to remain unchanged. This can lead to lower
prices for consumers or producers. For example, a
wholesaler may force workers to accept lower wages
or remunerations, while employers' contributions to
the Employee's State Insurance Fund may be shifted
back to employees due to low bargaining power.
 Lindahl's Model

Lindahl tries to solve three problems:

 Extent of state activity

 Allocation of the total expenditure among various goods
and services
 Allocation of tax burden
 Lindahl's Model
In the Lindahl model, if SS is the supply curve of state
services it is assumed that production of social goods
is linear and homogenous. DDa is the demand curve
of taxpayer A, and DDb is the demand curve of
taxpayer B. The vertical summation of the two
demand curves results in the community’s total
demand schedule for state services. A and B pay
different proportions of the cost of the services. When
ON is the amount of state services produced, A
contributes NE and B contributes NF; the cost of
supply is NG. Since the state is non-profit, it increases
its supply to OM. At this level, A contributes MJ and B
contributes MR (the total cost of supply). Equilibrium
is reached at point P on a voluntary-exchange basis.
 Direct Taxes and Indirect Taxes – Comparison
1. Welfare Aspect : Traditional economists believe
direct taxes are superior to indirect taxes in terms of
welfare, as indirect taxes cause more burden and
reduce welfare.
 In figure, Commodity X and income of an individual is
represented by X-axis and Y-axis respectively. C1 is the
indifference curve which touches PB line at S1. Hence, the
consumer will be able to purchase OB amount of commodity Y
with OP amount of income. But he is in equilibrium at point S1
where he can purchase PQ1 amount of X with Q1 amount of
income. This is the condition when no tax is being imposed.
Suppose excise duty is imposed on commodity X in such a way
that an increase in price is equal to tax imposed. In this way,
consumer enable to purchase OA amount of OX only with
similar amount of income as OP. Now PA will be the new price
line. Thus, equilibrium point shifts from S1 to S2 where new
indifference curve i.e., C2 touches the new price line and he
can buy only PQ2 amount instead of PQ1 before taxation. In
fact, he spends more and get less with Q2S2 amount of
money because S2T is excise duty. It follows that amount of
excise duty and changes in the price are of the same
In order to find the difference between direct & indirect taxes,
if same amount of revenue S2T is collected by the govt,
resulting disposable income will be reduced by amount of S2T.
Thus, new price line will be P1C but actually there will be no
change in price of commodity. Therefore, new price line will
be parallel to the original price line. In this case, equilibrium
point shifts to S3 where the new indifference curve touches
the price line. It means S3 point will provide more satisfaction
than the S2 which proves that consumer will get more
satisfaction under direct taxes instead of indirect taxes. In
other words, indirect taxation imposes an excessive burden on
the consumer.
 Direct Taxes and Indirect Taxes – Comparison
2. Administrative Aspect : Direct and indirect
taxes can be compared based on administrative cost
and efficiency. In India, many people are exempt
from income tax due to low income levels. Before the
First World War, indirect taxes were considered
superior due to administrative costs. However, now,
direct taxes are considered more suitable and
superior due to administrative costs. Direct taxes are
inferior to indirect taxes, but indirect taxes are
desirable in backward and underdeveloped countries.
 Direct Taxes and Indirect Taxes – Comparison
3. Distributive Aspect : Direct and indirect
taxes are compared based on their distributive
aspect, as they aim to collect revenue and
ensure equitable distribution of income and
wealth. Direct taxes are progressive & remove
inequalities, while indirect taxes are regressive
& may not be suitable to address significant
income and wealth disparities.
 Optimal Taxation
Meaning

Optimal taxation is the term used to describe

the design of tax systems to minimize excess
burdens and also achieving a socially desirable
re-distribution of income. The problem is to
strike a correct balance between equity and
efficiency.
 Optimal Taxation

One possibility would be to have lump sum

taxes that varied with the ability. Those with
great ability who had the capacity to earn large
incomes would be faced with a high lump sum
tax. Those with lower ability would be required
to pay a smaller lump sum tax and those with
the lowest ability would be receiving a lump
sum transfer from the government.
 Optimal Taxation
The government can recommend a tax rate
schedule that balances equity and efficiency,
based on knowledge of societal ability
distribution and labor supply elasticity. This
approach, originating from Ramsey's work and
revived by Mirrlees & Diamond, focuses on net
income & leisure, without considering savings.
 Optimal Taxation
Optimal linear income tax
 There is only form of taxation is an income tax
with a constant (linear) marginal rate t.
 The only type of government expenditure is on
lump sum transfer, LST to households. Thus there
are no government expenditures on goods and
services.
 The government must balance its budget.
 There are only two individuals, Mr. Low and Mr.
High.
 There are two goods, a generalized current
consumption good called net income, NY and
leisure, L.
 Optimal Taxation
 Both individuals have the same preferences
between NY and L.
 Mr. High has more ability than Mr. Low and
as a consequence Mr. High’s wage rate
exceeds Mr. Low’s wage rate.
 The individuals maximize their welfare
subject to their budget constraint.
 The government knows the preference
function of both individuals.
 Optimal Taxation
Each individual’s gross income, GY is his gross wage
W times the number of hours H that he works, i.e.
GY = WH. Net income is gross income less the
income tax paid plus the lump sum transfer,

That is, NY = (1 – T) GY + LST. So GDP will be the

sum of Low’s and high’s gross income (i.e. GYL and
GYH) and the total government revenue T is GDP
times the marginal tax rate: T = tGDP. As the
budget is balanced, tax revenue equals the sum of
lump sum transfer, T = LST = LSTL + LSTH.
 Optimal Taxation
The two person society is represented in the diagram 3.3 that
follows. The upper panel in the diagram refers to Mr. Low and
the lower panel to Mr. High. If there were no government, each
budget constraint, shown by lines AB, would be determined
entirely by the wage rates, and the equilibrium would be at E L
and E H.

Fig. Optimal linear income tax

 Optimal Taxation
In the diagram budget constraints without tax, with tax, and
with tax along with lump sum transfer are represented. An
increase in lump sum transfer with a given wage rate has a
pure income effect, causing a movement up an income-
consumption curve ICC. An increase in LST results in an
increase in leisure, which is an increase in work. Higher LSTs
financed by taxes cause a movement up an ICC decreasing
work. The after tax budget constraints are DLST. As tax rates
increase, work decreases, and tax revenue increases. However,
when tax receipts start to fall, the optimal rate depends on
society's view of desirable redistribution. The optimal linear tax
depends on the shapes of individuals' preference maps for net
income & leisure, as well as society's view about redistribution.
 Optimal Taxation
Optimal non-linear income tax

Figure-Optimal non-linear Diagram income tax

 Optimal Taxation
Two people have similar income & leisure preferences,
but differ in abilities. Mr. High has a high wage rate,
while Mr. Low has a low wage rate. They are in
equilibrium at E0L and E0H, based on their budget
constraints and preferences.
The total income of the society is GDP = GY0L + GY0H
Disposable income of the society is DY = GDP – T = NY0L +NY0H.
The total tax revenue of the government is:
T= TL + TH= GY0L–NY0L + GY0H – NY0H= GDP – DY.
 Optimal Taxation
If we give equal weightage to High’s and Low’s
welfare, the total welfare of the society is
U = U0 H + U0L and the distribution of welfare is
.
given by the relative position of U0L and U0H
 Optimal Taxation
One of the robust findings of the work on optimal taxation is
that marginal tax rates on the highest income should be zero.
High’s post-tax budget constraint is ADF. With the new segment
DF shown as a broken line. It should be noted that with a zero
marginal tax rate the new segment DF is parallel to AB, i.e. the
gross and net marginal wage rates are equal. It should be also
noted that High’s total tax liability will be the same on any point
on DF as it is at E0H. However, with the new budget constraint
ADF, High’s equilibrium would be at E1H rather than at E0H.
High’s gross income has increased at E1 H and GDP has risen
to GY0L + GY1H. Disposable income has risen to NY0L +
NY1H. Tax receipts are unchanged. Total welfare has risen to
U0L + U1 H. So, using Pareto’s criterion we have a clear
improvement in welfare.
 Conclusion

If society places no weight or negative weight

on High’s welfare and a great weight is placed
on Low’s welfare then it would not be attracted
to a Pareto improvement that increased
inequality. Lowering High’s marginal tax rate to
zero would be more attractive to most people if
it were accompanied by more rather than less
equality.
What are the 5 features of tax?
Taxes can be of various types. Income tax is one
of the most common taxes in the country.
It is compulsory for all liable citizens to pay tax,
and refusing to do so is a punishable offence.
Tax is payable periodically and regularly as
determined by the tax authority.
It is levied in order to meet the government’s
public expenditure.
Tax does not have any direct quid-pro-quo
between the public authority and taxpayers.
 The 5 heads of income tax

Income from salary

Income from house property
Income from profits and gains from
business or profession
Income from capital gains
Income from other sources
 Income from salary

Any income that you receive in terms of the

service you provide on a contract of
employment is applicable for taxation under
this head. This includes salary, advance
salary, perquisites, gratuity, commission,
annual bonus and pension.
 Income from house property
An individual’s income from his or her property or
land is taxable under the head of income from
house property. To put it simply, this head
includes the policy for calculating
tax on rental income that you receive from your
properties.
In case you own more than one self-occupied
house, then only one house is considered to be
occupied & the rest are considered to be rented
out. The taxation occurs on income received from
both commercial & residential property.
 Income from profits and gains
from business or profession

Profits generated from the sale of a certain license

Gains earned by an individual during an assessment
year
The profits that an organisation makes on its income
Cash received on the export of a government scheme
The benefits that a business receives
Gains, bonuses or salary that an individual receives
due to a partnership with a firm
 Income from capital gains
When you earn profits by transferring or selling an asset that was
held as an investment, that income is taxable under the head of
income from capital gains. A large number of assets, like gold,
bonds, mutual funds, real estate, stocks, etc., fall under capital
assets. You can subdivide capital gains into short-term capital
gains and long-term capital gains.

When you sell your capital assets after holding them for a period
of 36 months or more, they will fall under long-term capital gain
and will have a tax rate of 20%. Alternatively, if you sell your
capital assets within a period of 36 months, the tax deduction will
be under short-term capital gain at the rate of 15%. In the case
of securities, this is applicable if you sell your holdings within 12
months from the purchase date.
 Income from other sources
Among the five heads of income tax, this one
includes any other income that does not have any
mention in the above 4 heads. They fall under
Section 56 sub-section (2) of the Income Tax Act
and include income from lottery, bank deposits,
gambling, card games, sports rewards, etc.