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ASSIGNMENT ON

CRITICAL ANALYSIS OF PROGRESSIVE AND PROPORTIONAL TAXES

Submitted as per the requirement of PSDA for Tax Law Course

Submitted to:

Ms. Preetika Sharma

Assistant Professor

Submitted by:

SHREYA SAXENA

20817703815

VII Semester BA LL.B. (H)

Batch: 2015-2020

VIVEKANANDA INSTITUTE OF PROFESSIONAL STUDIES,

GGSIP UNIVERSITY, NEW DELHI


TABLE OF CONTENTS

S CONTENTS PAGE NO.


NO.
1. Introduction 3
2. Progressive taxation 4
2.1 Jurisprudential aspect: Rawls’ theory of justice 4
2.2 Advantages of progressive taxation 4
2.2.1 Reduces income inequality 4
2.2.2 Welfare of Society 5
2.2.3 Benefit to Small Scale and Medium Industries 5
2.2.4 Elastic in nature 5
2.3 Disadvantages of progressive taxation 5
2.3.1 Disincentive to Work 5
2.3.2 Tax evasion 6
2.3.3 Arbitrary Taxation by Tax Authorities 7
3. Proportional taxation 7
3.1 Jurisprudential aspect 7
3.1.1 Adam Smith’s The Wealth of Nations 7
3.1.2 Robert Nozick on Tax 8

3.2 Advantages of proportional taxation 8

3.2.1 No Scope for Ambiguity 8

3.2.2 Reduced Scope for Tax Evasion 9

3.3 Disadvantages of proportional taxation 9

3.3.1 Unfair impact 9


3.3.2 Loss of Incentives 10
4. Taxation in india 10

5. Conclusion 11
6. References 12

CRITICAL ANALYSIS OF PROGRESSIVE AND PROPORTIONAL TAXES

Shreya Saxena

Abstract: The paper delves into the origins of progressive and proportional taxation. It
involves critical analysis of both the systems of taxation, highlighting their advantages and
disadvantages and their incorporation into the Indian Taxation system.

Keywords: Taxation, Progressive, Proportional, Indirect taxes, Direct taxes, Laffer Curve

1. INTRODUCTION

In a general sense, a tax is any contribution imposed by government upon individuals, for the
use and service of the state, whether under the name of toll, tribute, tallage, gabel, impost,
duty, custom, excise, subsidy, aid, supply, or other name.1

Taxes can also be categorized as either regressive, proportional, or progressive, on the basis
of their effect on the economy.

A regressive tax is a tax where lower-income entities pay a higher share of their income in
taxes than do higher-income entities. Rather than basing the tax on the entity’s income, the
government assesses tax as a percentage of the asset that the tax payer purchases or owns.

A proportional tax (sometimes called as flat tax) is a tax where everyone, regardless of
income, pays the same share of income in taxes. It is categorised by a situation
where marginal and average tax rates are the same.

1
Black's Law Dictionary (2nd ed. 1910)
Progressive tax is categorised by the lower-income entities paying a lower share of their
income in taxes than the higher-income entities. Progressive taxes can also be thought of as
taxes where the marginal tax rate is higher than the average tax rate.

2. PROGRESSIVE TAXATION

Income tax, which is proportion to the income of the individual and the burden of tax falls on
high income individuals.2 Progressive taxes aim towards reducing the tax incidence of people
with a lower ability to pay, thus shifting burden of taxes increasingly upon those with a
higher ability-to-pay.

Progressive taxation is often suggested as a way to assuage the societal ills associated with
higher income inequality as the tax structure reduces inequality between the rich and the
poor, however economists disagree on the tax policy's economic and long-term effects.

2.1 JURISPRUDENTIAL ASPECT: RAWLS’ THEORY OF JUSTICE

John Rawls was an eminent jurist renowned for his work “A theory of Justice”. He put
forward the theory of Distributive Justice. He contemplated a situation wherein the vision of
each person was shrouded by the veil of ignorance. This meant that each person was unaware
of his or her strengths and weaknesses, in such a condition each person was bound to imagine
himself at the lowest rung, and thus safeguards the interests of the most vulnerable.
Therefore, what Rawls sought to emphasise was a level playing field for all individuals, and
therefore equality among the equals. This theory is viewed as a justification of progressive
taxation of the rich.

2.2 ADVANTAGES OF PROGRESSIVE TAXATION

2.2.1 Reduces Income Inequality

There often occurs a gross disparity between the incomes of the poor and the rich. In order to
reduce such disparities, progressive taxation puts more pressure on more capable or rich
persons while putting less pressure on the less capable or poor and middle-class persons.
When income inequality is low, aggregate demand will be relatively high, because more

2
Ibid
people who want ordinary consumer goods and services will be able to afford them, while
the labor force will not be as relatively monopolized by the wealthy.3

2.2.2 Welfare of Society

Due to Progressive rates of taxation, Government earns a larger amount of tax revenue vis-a-
vis proportional taxation system. This revenue can be utilised to improve the standard of
living of the lower income groups by providing them with benefits in healthcare, education
etc.

2.2.3 Benefit to Small Scale and Medium Industries

Small and Medium Scale industries often suffer at the hands of corporate giants and MNCs,
prominently due to insufficient funds, among other reasons. While MNCs have abundant
capital, and are thus able to invest in machinery, engage labour and publish advertisements,
most small or medium scale industries do not have that sort of capital at hand. Yet, if both
small and medium scale industries on one hand and large scale industries on the other, are
subject to the same rate of taxation, it shall not be conducive to the economic development of
the country, and shall also hamper employment and other avenues.

2.2.4 Elastic in nature

A rise in income during prosperity is automatically taxed at a higher rate and a fall in income
during recession is taxed at a lower rate. Therefore, progressive taxes can be adjusted
accordingly. Moreover, progressive taxes yield more revenue as compared to proportional
taxes.4

2.3 DISADVANTAGES OF PROGRESSIVE TAXATION

2.3.1 Disincentive to Work

3
Pigou, A. C. The Economics of Welfare. 4th ed., London, 1920
4
Ritika, Progressive Tax: Merits and Demerits Economics Help (2017),
https://www.economicshelp.org/macroeconomics/fiscal-policy/progressive-tax/.
If taxes are too progressive, then people may face a disincentive for getting a better-paid job.
e.g. a top rate marginal income tax rate of 80% may encourage people to go and work
elsewhere.

Laffer curve

Laffer curve analysis suggests that if marginal income tax increases too much, it may reduce
the incentive to work.5

Progressive taxation diminishes the impetus to work and save and, thus, lowers capital
formation. Rich people save more than the poor. Now, if the rich is taxed more as per the
progressive system of taxation, the incentive to work of the rich people may suffer, because
they won’t be able to save as much owing to the hefty taxation even if they work more.
Therefore, their savings and, hence, capital formation, will suffer.

Apart from this, progressive system of taxation may also make the poor complacent; since
they know that they shall be financially supported by the taxes paid by the rich. Progressive
Taxation is the second plank of the Communist Manifesto, given by Karl Marx which forms
the basis of Communism. History has been evidence to such a scenario during the
Communist Regime in Russia, which crumbled because of the lax attitude of the workers and
a limitation upon the profits made by businesses.

2.3.2 Tax Evasion

5
Progressive tax, Economics Help, https://www.economicshelp.org/macroeconomics/fiscal-policy/progressive-
tax/
The higher rate of taxes may encourage taxpayers to evade taxes by making false
declarations of their incomes. In a progressive taxation system there will be more cases of tax
evasion as rich people will feel that they are being exploited and they will try to use all
possible ways to make sure that they pay less tax and hence in a way under this system there
is an increase in tax evasion by the high tax paying individuals.6

2.3.3 Arbitrary Taxation by Tax Authorities

Since there is no fixed or uniform rate of taxation, Progressive system of taxation gives Tax
Authorities certain degree of freedom to impose taxes, and hence a scope for arbitrariness
towards levying of taxes.

3. PROPORTIONAL TAXATION

According to Black’s Law Dictionary, this is a tax scheme that sees every individual pay the
same rate of tax regardless of their earnings. It is also known as a flat tax. 7

A proportional tax system, also referred to as flat tax system, assesses the same tax rate
regardless of income or wealth. It is meant to create equality between marginal tax rate and
average tax rate paid. Proportional taxes apply equally to all income groups.

3.1 JURISPRUDENTIAL ASPECT

3.1.1 Adam Smith’s The Wealth of Nations

Adam Smith in his literary work, An Inquiry into the Nature and Causes of the Wealth of
Nations lays down four canons forming the basis of a good taxation system, among which the
most prominent canon – Canon of Equality pertaining to progressive taxation is as follows:

"The subjects of every state ought to contribute towards the support of the government, as
nearly as possible, in proportion to their respective abilities; that is, in proportion to the
8
revenue which they respectively enjoy under the protection of the state."

This does not mean that each person is subject to the same amount of tax, rather it means that
each person shall be taxed according to his abilities, ie. those who beget more income shall be

6
Ibid
7
Ibid
8
Adam Smith, An inquiry into the Nature and Causes of the Wealth of Nations, 1776
liable to pay more taxes as compared to another person who begets a lesser amount. He
therefore emphasised on proportional taxation as a means to achieve social justice and equal
distribution of wealth in the economy.

“Tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of
payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the
contributor, and to every other person.” 9

Another canon Adam Smith emphasised upon, was the Canon of Certainty. The Canon of
certainty speaks about the necessity of the awareness of the tax payer about the purpose,
amount and manner of the taxation. It emphasises the need of a uniform system which neither
provides a scope for arbitrary action by the Tax Authorities nor allow for Tax Evasion. Both
requirements are fulfilled by the progressive system of Taxation.

3.1.2 Robert Nozick on Tax

Robert Nozick believed in the idea of a minimal state, limited to enforcing contracts and
protecting people against force, theft and fraud. He opposed the idea of a Welfare State,
characterised by taking from the rich to help the poor. Therefore taxing the rich to ameliorate
the lives of the poor was unjustified.

The man who choses to work longer to gain an income more than sufficient to satisfy his
basic needs prefers some extra goods and services to the leisure and activities he could
perform during the possible non- working hours, whereas the man who choses not to work
the extra time prefers the leisure activities to the extra goods and services he could acquire by
working more. In such a case, if it would be illegitimate for the tax system to seize a person’s
leisure (through forced labour), then it is equally illegitimate to take away those extra goods
and services, only to redistribute it among the poor.10

3.2 ADVANTAGES OF PROPORTIONAL TAXATION

3.2.1 No Scope for Ambiguity

Since the rates of taxes are fixed, according to the tax slabs within which a person’s income
falls, there is no scope of any ambiguity either on part of the tax payer or the Tax Authorities.
This satisfies Adam Smith’s canon of Taxation- The Canon of Certainty.

9
Ibid
10
Robert Nozick on Taxation, June 12, 2013, https://jrbenjamin.com/2013/06/12/robert-nozick-on-taxation/
3.2.2 Reduced Scope for Tax Evasion

When the tax rates are high for the rich, and not so for the poor, it may give rise to a feeling
of being wronged in the minds of the rich. Thus, to avoid such undue taxation they may take
to Tax Evasion and other unfair Activities.

In Bulgaria the proportional taxation introduced at the beginning of 2008 led to a dramatic
drop in tax evasion practices as well as to a remarkable increase in the tax collection rate.

In fact – this type of tax system construction is widely acknowledged to be the most efficient
one for the future development of the state (with no serious alternative) and is claimed to
represent the most certain proof of the country’s even more investment-friendly image,
thereby being one of its greatest asset.

Bulgaria attracted a considerable share of European and non-European investments in Eastern


Europe, strictly adhering to the financial and taxation recommendations of the European
Commission as well as keeping its economic environment one of the most favorable in terms
of foreign investments within the EU. Hence, no wonder more and more large-scale
international companies show their interest in investments in Eastern Europe, specifically
paying attention to and exploring new business opportunities in Bulgaria.11

3.3 DISADVANTAGES OF PROPORTIONAL TAXATION

3.3.1 Unfair Impact

Proportional taxes are characterised by charging the same tax rate from all, regardless of the
income level of the persons. However this is a disadvantage to those with lower incomes as
wages at the lower end are least competitive with the cost of living. Therefore, if lower
income groups lose their tax advantages, it would be difficult for them to fulfil their basic
needs, let alone paying taxes. This is because their purchasing power is directly being

11
Beth Winston, The Disadvantages of Flat Tax, April 19, 2017 https://pocketsense.com/disadvantages-flat-tax-
2232.html
affected (reduced) by the taxes levied. It also maintains the status quo, thus the poor continue
to be poor while the rich continue to be rich.

3.3.2 Loss of Incentives

Deductions and credits for certain expenditures provide an incentive to citizens to behave in
certain ways. For instance, being able to deduct charitable donations provides an incentive to
give to good causes. Being able to offset the cost of new windows encourages people to save
energy. Thus the government can implement certain social policies through the tax code. A
true flat tax with no deductions would mean this tool would be lost.12

4. TAXATION IN INDIA

A direct tax is paid directly by an individual or organization to the imposing entity. A


taxpayer, for example, pays direct taxes to the government for different purposes, including
real property tax, personal property tax, income tax or taxes on assets.13

An indirect tax is collected by one entity in the supply chain (usually a producer or retailer)
and paid to the government, but it is passed on to the consumer as part of the purchase price
of a good or service. The consumer is ultimately paying the tax by paying more for the
product.14

The taxation system in India has recently undergone changes due to the introduction of the
Goods and Services Tax in 2017. Goods and Services Tax has replaced indirect taxes.
Various taxes have been subsumed in the GST. These include: Service Tax, Entertainment
Tax, Luxury Tax, State VAT, Entry Tax etc.

Indirect taxes, mainly including the goods and services tax (GST), are regressive. They affect
the poor more than the rich by virtue of being a consumption tax. This is because, almost the
entire income (or more) of the poor is spent on consumption (fulfilling basic needs), and is
hence subject to the tax as the end consumer of the goods or services. To reduce the
regressive nature of GST, items such as the basic amenities are taxed at a low 5% or 12%.
Most of the CPI (consumer price index) basket is taxed at these lower rates, or some items are
completely exempt (e.g. foodgrain).
12
Ibid
13
Direct and Indirect Tax, Investopedia https://www.investopedia.com/terms/d/directtax.asp
14
Ibid
On the other hand, direct taxes in India are characterised by being progressive in nature. Tax
Slabs for calculating income tax are as follows:

INCOME RATE

upto Rs. 2,50,000/- No tax

2,50,000/- to 5,00,000/- 5%

5,00,000/- to 10,00,000/- 20%

Above 10,00,000/- 30%

From the above, it can be clearly seen that the tax incidence, i.e. percentage of tax levied
increases with an increase in income, hence it impacts the higher income group more than the
lower income groups. Then such revenue generated may be used for the growth of the nation
as well as redistribution of wealth among the poor.

Hence, India’s Taxation System is characterised by presence of progressive, proportional and


regressive taxes to sufficiently cater to its mixed economy, and help achieve ideals of
socialism, coupled with economic development.

5. CONCLUSION

Every system of taxation has its own merits and demerits. While Progressive taxation is
largely beneficial to the lower income groups, it puts a heavy burden on the shoulders of the
middle and high income groups. Therefore, if a country solely depends upon progressive
system of taxation, over a period it shall lead to stagnation of the economic development of
businesses and industries, and the economy may come to a standstill. It may also create
dissent among the high income groups as they may feel that their savings are being siphoned
off, and complacency among the low income groups, because of the knowledge that they
shall anyway be supported upon the taxes paid by the high income group and thus need not
work hard.
A solely Proportional system on the other hand, characterised by equal rates of taxation
irrespective of the income of the persons is also not beneficial in the long run. This is because
low income earners spend most of their income on basic needs like food, clothing and shelter.
They do not have many savings whereas high income earners have significant savings, hence
an equal rate of taxation shall leave the poor with few or no savings. The rich won’t be
affected in such a drastic manner. Few savings shall result in little capital being left with the
poor to invest, they shall therefore be caught in a vicious circle of poverty. It shall also
contribute towards widening the gap between the rich and poor.

Therefore, a melange of two or more systems of taxation is required wherein the systems
supplement each other and compensate for each other’s demerits. Countries across the globe
are thriving on such unique concoction of two or more systems of taxation, including India.

6. REFERENCES

1) Direct and Indirect Tax, Investopedia https://www.investopedia.com/terms/d/directtax.asp

2) Beth Winston, The Disadvantages of Flat Tax, April 19, 2017


https://pocketsense.com/disadvantages-flat-tax-2232.html

3) Robert Nozick on Taxation, June 12, 2013, https://jrbenjamin.com/2013/06/12/robert-nozick-on-


taxation/

4) Adam Smith, An inquiry into the Nature and Causes of the Wealth of Nations, 1776

5) Progressive tax, Economics Help,


https://www.economicshelp.org/macroeconomics/fiscal-policy/progressive-tax/

6) Ritika, Progressive Tax: Merits and Demerits Economics Help (2017),


https://www.economicshelp.org/macroeconomics/fiscal-policy/progressive-tax/.

7) Pigou, A. C. The Economics of Welfare. 4th ed., London, 1920

8) Black's Law Dictionary (2nd ed. 1910)

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