THE IMPACT OF TAXATION AS AN AID TO ECONOMIC

DEVELOPMENT

A project submitted for the partial fulfilment of the requirement

for the

Degree of
B.A.LL.B.(Hons.)

By

Simran Khurana
B.A.LLB(H) Section A Semester 8
Enrollment No. A3211116061

Amity Law School

Block I-2, Sector-125, Amity Campus
Amity University, Noida

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 DECLARATION

I declare that the project entitled “The Impact of Taxation as an Aid to

Economic Development” is the outcome of my own work conducted under the
supervision of Dr. Alok Verma Sir, Professor of Law at Amity Law School, Amity
University. Noida U.P.

I further declare that to the best of my knowledge the project does not contain any
part of any work, which has been submitted for the award of any degree either in
this University or in any other University/Deemed University without proper
citation.

Simran Khurana
Dated: 18th March, 2020

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 ACKNOWLEDGMENT

This project is the outcome of the study by the author. Any material written by
another person that has been used in the paper has been thoroughly
acknowledged. As my research has concluded, there are a number of people I
would like to thank for the successful attempt.

I thank the esteemed director of this institution, Dr. Shefali Raizada for
inculcating the concept of preparing a project and allowing the researcher to
present his/ her point of views in liberal manner and encouraging the researcher
by providing all the much needed support.

I would also like to express my exceptional gratitude and acknowledgment to Dr.

Alok Verma Sir who undertook the role of a supervisor and guide for the
successful preparation of his project and for supporting throughout the time of
research and writing.

I would also like to extend my thanks and gratitude for the contribution of all
those who helped me in this work as individuals or otherwise. On a personal level I
would like to extend my appreciation to my family and friends who supported me
to conclude this research paper.

Simran Khurana
A3211116061
B.A. LLB (H) Section A
Semester 8

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 CONTENTS

 Declaration
 Acknowledgment
 Synopsis
 Introduction

Chapter-1

 GDP & Economic Growth

 Effects of Taxation on Production
 Outgrowth of Allocation of Resources

Chapter-2

 Role of Direct & Indirect Taxes in Development of Economy

 Reduction in Inequalities of Income
 Social Welfare
 Foreign exchange
 Regional Development
 Control of Inflation

Chapter-3

 Impact of GST on Economy

Chapter - 4

 Conclusion
 Bibliography

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 SYNOPSIS
INTRODUCTION:
In every economy, revenue mobilization and allocation is an essential pre-requisite
of the development process. Taxation yields very substantial revenue to
government. Therefore, it has a bearing on the Gross Domestic Product (GDP)
which is the standard indicator for measuring the economic well being of a nation.
Tax system with relatively higher rates of taxes would deter savings and
development, while a relatively lower tax rates would lead to less revenue to the
state. A tax directly influences the savings of individuals and companies, it is a
double edged sword used to curtail consumption activity and at the same time,
allows the taxpayer to save money in different development activities. It is crucial
to note that for an ideal buoyant tax system, it is essential to achieve a balance
between resource allocation and economic growth with stability. Taxes have the
force to influence entrepreneurial activities and it is with this backdrop, the
project aims at investigating the causal relationship between the tax revenue and
the economic growth in India.

RESEARCH METHODOLOGY:

This is a Doctrinal study based on the Secondary data source. The Sources of the
Secondary Data will be books, articles & journals, blogs etc.

HYPOTHESIS:

The purpose of this study is to investigate the role and impact of tax on economic
development. The author evaluates the relationship between the dependent
variables (GDP per capita and FDI rate) and independent variables (individual
income tax, corporate tax, and consumption tax) in order to identify the role of tax
in economic prosperity.

CHAPTERISATION:

I. GDP & Economic Growth

I.I Effects of Taxation on Production
I.II Outgrowth of Allocation of Resources
II. Role of Direct & Indirect Taxes in Development of Economy

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 II.I Reduction in Inequalities of Income
II.II Social Welfare
II.III Foreign exchange
II.IV Regional Development
II. Control of Inflation
III. Suggestions
IV. Conclusion

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 Chapter - 1

GDP & Economic Growth

"Tax changes have very large effects: an exogenous tax increase of 1 percent of GDP
lowers real GDP by roughly 2 to 3 percent."
Indian economy has developed in most magnificent manner. GDP acts as an
indicator of economic growth of country. Gross Domestic Product represents the
rise or fall in per capita income. Across the world GDP is calculated in different
methods. There are three methods which are most commonly used to measure
GDP. In the first method, expenditure approach, (GDP) is calculated on the basis
of the expenditure. The total of expenditure spent by three major category of users
i.e., customers, investors and Government is ascertained to know the value of
GDP.
Tax-to-GDP ratio represents the size of a country's tax kitty relative to its GDP. It
is a representation of the size of the government's tax revenue expressed as a
percentage of the GDP. Higher the tax to GDP ratio the better financial position
the country will be in. The ratio represents that the government is able to finance
its expenditure. A higher tax to GDP ratio means that the government is able to
cast its fiscal net wide. It reduces a government's dependence on borrowings.
A higher tax to GDP ratio means that an economy's tax buoyancy is strong as the
share of tax revenue rises in sync with the rise in the country's GDP. India,
despite seeing higher growth rates, has struggled to widen the tax base. Lower tax-
to-GDP ratio constrains the government to spend on infrastructure and puts
pressure on the government to meet its fiscal deficit targets. Although India has
improved its tax-to-GDP ratio in the last six years, it is still far lower than the
average OECD ratio which is 34 per cent. India's tax-to-GDP ratio is lower than
some of its peers in the developing world. Developed countries tend to have higher
tax-to-GDP ratio. The most important measure for improving tax to GDP ratio is
ensuring the citizens pay their taxes. The introduction of Direct Tax Code can help
in greater compliance in this regard. Rationalisation of GST and moving towards a
two-rate structure can also help in increasing compliance and putting an end to
tax evasion. While measures to improve tax compliance and widen the tax base

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 will yield higher tax revenue, the importance of higher economic growth cannot be
ignored. The onus to bring back the Indian economy back on a higher-growth
trajectory will be on the upcoming Budget.
Effects of Taxation on Production
Taxation can influence production and growth. Such effects on production are
analysed under three heads:
1) Effects on the Ability to Work Save:
Imposition of taxes results in the reduction of disposable income of the taxpayers.
This will reduce their expenditure on necessaries which are required to be
consumed for the sake of improving efficiency. As efficiency suffers ability to work
declines. This ultimately adversely affects savings and investment. However, this
happens in the case of poor persons. Taxation on rich persons has the least effect
on the efficiency and ability to work. Not all taxes, however, have adverse effects
on the ability to work. There are some harmful goods, such as cigarettes, whose
consumption has to be reduced to increase ability to work. That is why high rate
of taxes are often imposed on such harmful goods to curb their consumption. But
all taxes adversely affect ability to save. Since rich people save more than the poor,
progressive rate of taxation reduces savings potentiality. This means low level of
investment. Lower rate of investment has a dampening effect on economic growth
of a country. Thus, on the whole, taxes have the disincentive effect on the ability
to work, save and invest.

2) Effects on the will to Work, Save and Invest:

The effects of taxation on the willingness to work, save and invest are partly the
result of money burden of tax and partly the result of psychological burden of tax.
Taxes which are temporarily imposed to meet any emergency (e.g., Kargil Tax
imposed for a year or so) or taxes imposed on windfall gain (e.g., lottery income) do
not produce adverse effects on the desire to work, save and invest. But if taxes are
expected to continue in future, it will reduce the willingness to work and save of
the taxpayers. Taxpayers have a feeling that every tax is a burden. This
psychological state of mind of the taxpayers has a disincentive effect on the
willingness to work. They feel that it is not worth taking extra responsibility or
putting in more hours because so much of their extra income would be taken

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away by the government in the form of taxes. However, if taxpayers are desirous of
maintaining their existing standard of living in the midst of payment of large taxes,
they might put in extra efforts to make up for the income lost in tax. It is
suggested that effects of taxes upon the willingness to work, save and invest
depends on the income elasticity of demand. Income elasticity of demand varies
from individual to individual. If the income demand of an individual taxpayer is
inelastic, a cut in income consequent upon the imposition of taxes will induce him
to work more and to save more so that the lost income is at least partially
recovered. On the other hand, the desire to work and save of those people whose
demand for income is elastic will be affected adversely. Thus, we have conflicting
views on the incentives to work. It would seem logical that there must be a
disincentive effect of taxes at some point but it is not clear at what level of taxation
that crucial point would be reached.

Outgrowth of 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.

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 Chapter – 2

Role of Direct & Indirect Taxes in Development of Economy

Central Direct and indirect taxes are vital to carry adequate revenue to the state
for meeting the increasing public expenditure. Both taxes are essential to promote
economic growth, fill employment and economic stability. Direct and indirect taxes
should side by side and balance each other. However, in developing countries,
direct taxation has limited scope and hence indirect taxation plays a more
significant role. A well oriented system of taxation requires combination of direct &
indirect taxes in different proportions.
The present study is also to attempts the role of direct and indirect tax in
development of Indian economy. The study clearly shows that taxes plays an
important role in Indian economy development; Tax incentives such as tax holiday
for setting up industries in backward regions, which induces business firms to set
up industries in such regions, Tax revenue collected by government is also utilized
for development of infrastructure in backward regions.
One of the essential characteristics of our tax rising policy is ‘the ability to pay’.
Indirect taxes are to be borne by the consumers of goods and services irrespective
of their financial ability. On the other hand, the direct taxes are lesser burden
than the indirect taxes to the common people as they are payable on income or
profits rather than on goods or services. The indirect tax is also called regressive
tax as the demand for products and services decreases proportionately as the
amount of taxes increases. Excessive reliance on indirect taxes increases the rich
and poor disparity. Direct taxes facilitate in more equitable distribution of income
and wealth. Sometimes indirect taxes can facilitate equitable distribution by
levying them on luxuries and exempting them on necessaries. Both direct and
indirect taxes are alternative methods of achieving any particular redistribution of
income and wealth. The other main aspect of taxation is ‘proper administration’.
The administrative cost of collecting direct taxes is more than that of indirect

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taxes. Indirect taxes are simple and its cost of collection is stable over a period.
From point of view of efficiency and productivity, indirect taxes are better. Indirect
taxes are wrapped up in prices and hence they cannot be easily evaded. They are
more productive as their cost of collection is the least. However, improper
administration of direct taxes leads to tax avoidance and tax evasion which is a
loss to the exchequer and widens the gap between rich and poor.
Reduction in Inequalities of Income
Taxation follows the principle of equity. The direct taxes are progressive in nature.
Also, certain indirect taxes such as taxes on luxury goods are also progressive in
nature. This means the rich class has to bear the higher incidence of taxes,
whereas, the lower income group is either exempted from tax (direct taxes) or has
to pay lower rate of duty (indirect taxes) on goods consumed by the masses. Thus,
taxation helps to reduce inequalities of income and wealth.
Social Welfare
Taxation generates social welfare. The social welfare is generated due to certain
undesirable products like alcoholic products, tobacco products and such other
products are heavily taxed, which restricts their consumption, which in turn
facilitates social welfare. A part of the tax revenue is utilised for social
development activities, such as health, education and family welfare, which also
improve social welfare as well as social order in the society.
Foreign exchange
Taxation encourages exports and restricts imports. Generally, developing
countries and even the developed countries do not impose taxes on export items.
For instance, in India, exports are exempted from excise duty, VAT, customs duty
and other duties. However, there is customs duty on imported goods. Therefore,
taxation helps to: Earn foreign exchange through the promotion of exports.
Regional Development
Taxation plays an important role in regional development; Tax incentives such as
tax holiday for setting up industries in backward regions, which induces business
firms to set up industries in such regions, Tax revenue collected by government is
also utilised for development of infrastructure in backward regions.
Control of Inflation

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Taxation can be used as a tool of controlling inflation. Through taxation, the
Government can control inflation as follows:-
1. If inflation is due to high rise in prices of essential items, then the Government
may reduce the rate of indirect taxes.
2. If inflation is due to increase in demand, the Government may try to cut down
the effective demand by increasing the tax rate. Increase in tax rate may restrict
consumption, which may reduce demand, and subsequently inflation may be
controlled.

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 Chapter - 4

Impact of GST on Economy

GST the biggest tax reform in India founded on the notion of “one nation, one
market, one tax” is finally here. The moment that the Indian government was
waiting for a decade has finally arrived. The single biggest indirect tax regime has
kicked into force, dismantling all the inter-state barriers with respect to trade. The
GST rollout, with a single stroke, has converted India into a unified market of 1.3
billion citizens. Fundamentally, the $2.4-trillion economy is attempting to
transform itself by doing away with the internal tariff barriers and subsuming
central, state and local taxes into a unified GST.

The rollout has renewed the hope of India’s fiscal reform program regaining
momentum and widening the economy. Then again, there are fears of disruption,
embedded in what’s perceived as a rushed transition which may not assist the
interests of the country. Will the hopes triumph over uncertainty would be
determined by how our government works towards making GST a “good and
simple tax”. The idea behind implementing GST across the country in 29 states
and 7 Union Territories is that it would offer a win-win situation for everyone.
Manufacturers and traders would benefit from fewer tax filings, transparent rules,
and easy bookkeeping; consumers would be paying less for the goods and
services, and the government would generate more revenues as revenue leaks
would be plugged. 

From the viewpoint of the consumer, they would now have pay more tax for most
of the goods and services they consume. The majority of everyday consumables
now draw the same or a slightly higher rate of tax. Furthermore, the GST
implementation has a cost of compliance attached to it. It seems that this cost of
compliance will be prohibitive and high for the small scale manufacturers and
traders, who have also protested against the same. They may end up pricing their
goods at higher rates. The impact of GST on macroeconomic indicators is likely to
be very positive in the medium-term. Inflation would be reduced as the cascading

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(tax on tax) effect of taxes would be eliminated. The revenue from the taxes for the
government is very likely to increase with an extended tax net, and the fiscal
deficit is expected to remain under the checks. Moreover, exports would grow,
while FDI (Foreign Direct Investment) would also increase. The industry leaders
believe that the country would climb several ladders in the ease of doing business
with the implementation of the most important tax reform ever in the history of
the country.

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 Chapter – 4
Conclusion

Both direct and indirect taxes are important for our country as they are linked
with the overall economy. Both are collected by the central and respective state
governments according to the type of tax levied and are important for the
government as well as growth perspective of the country. However, taxing of both
direct and indirect is indispensable in modern public finance. In countries like
India having people with varied economic backgrounds, the Government should
more focus on direct taxes rather than indirect taxes by ensuring proper
administration of direct taxes to eradicate tax avoidance and tax evasion. It
concluded that the contribution of central direct tax to total central tax revenue
has increased year by year whereas central indirect tax contribution has
decreased. Taxation system playing important role in the growth of economic and
progressive growth are possible due to both type of taxes. On priority, it is up to
the government to address the capacity building amongst the lesser-endowed
participants, such as the small-scale manufacturers and traders. Ways have to be
found for lowering the overall compliance cost, and necessary changes may have
to be made for the good of the masses. GST will become good and simple, only
when the entire country works as a whole towards making it successful.

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 BIBLIOGRAPHY

Books:

 Taxmann's Bank Audit-A Practical Guide for Bank Auditors (5th Edition
2020)
 Taxmann's GST Ready Reckoner (13th Edition 2020)

Websites:

 https://cleartax.in/s/impact-of-gst-on-indian-economy
 https://www.insightssuccess.in/impact-indian-taxation-system-economic-
growth/
 http://www.ssarsc.org/documents/2management_final_article24_4_17.pdf
 https://madhavuniversity.edu.in/impact-of-gst-on-indian-economy.html

Dictionaries Referred:

 Broom‘s Legal Maxims, 10th ed., Universal Law Publishing Co. Pvt. Ltd.
 Garner Bryan, Black‘s Law Dictionary, 7th ed., West Group Publications,
1999.

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