India’s Taxation System: Types, Objectives & Challenges

• India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies. The Central Government levies taxes on income (except agricultural income, which falls under the State Governments), customs duties, excise duties, and service tax.
• The taxation framework is governed by constitutional provisions ensuring fairness, transparency, and federal balance.

Classification of Taxes in India

• Taxes can be categorised based on their impact, structure, and method of collection. The key classifications are:

Based on Tax Burden Distribution

• Progressive Tax: The tax rate increases as income rises, ensuring wealthier individuals contribute a larger share. E.g., Income tax in India follows a progressive structure, with higher slabs for higher earnings.
• Proportional Tax: A fixed tax rate applies to all taxpayers, regardless of income level. E.g., Corporate tax in India is applied at a uniform rate for companies in specific categories.
• Regressive Tax: The tax rate decreases as income increases, disproportionately affecting lower-income groups. E.g., Indirect taxes like GST on essentials impact lower-income individuals more than the wealthy.

Based on Calculation Method

• Specific Tax: A fixed amount is levied per unit of a good or service, irrespective of its value. E.g., Excise duty on cigarettes, charged per pack rather than as a percentage of price.
• Ad-Valorem Tax: Levied as a percentage of the item’s value, rather than its quantity or weight. E.g., GST, which is imposed as a percentage of the selling price of goods and services.

Based on Taxation Principle (Applicable to Indirect Taxes)

• Production-Based Tax (Origin-Based Tax): Applied at the place of production, regardless of where the good is consumed. E.g., Earlier versions of VAT in some countries were origin-based.
• Consumption-Based Tax (Destination-Based Tax): Levied at the point of consumption rather than production. E.g., India’s GST follows a destination-based taxation model.

Based on Mode of Collection

• Direct Tax: Paid directly to the government by the taxpayer without intermediaries. E.g., Income tax, property tax, corporate tax.
• Indirect Tax: Collected by an intermediary (e.g., retailers) from the end consumer, who bears the financial burden. E.g., GST, excise duty, customs duty.

Objectives of India’s Taxation System

• Revenue Generation: Taxes are the primary source of government revenue, funding public services, infrastructure, defense, and welfare schemes. E.g., As of January 2025, India’s net tax receipts stood at ₹19.04 trillion, achieving 74.4% of the annual target.
• Wealth Redistribution: Progressive taxation reduces income inequality by imposing higher tax rates on wealthier individuals and allocating resources to social welfare. E.g., The top 1% of India’s population holds 40.1% of total wealth, while taxation policies aim to bridge this gap.
• Economic Growth & Stability: Taxation helps regulate inflation, prevent fiscal deficits, and maintain economic balance. E.g., Reduction in corporate tax from 30% to 22% (2019) aimed to boost private investment.
• Regulation of Economic Activities: Taxes control the consumption of harmful goods through sin taxes and excise duties. E.g., The GST rate for pan masala containing gutkha is 204%, discouraging its use.
• Employment Generation: Favorable tax policies encourage entrepreneurship and investment, leading to job creation. E.g., Tax incentives for startups under Section 80-IAC provide income tax exemptions for eligible businesses.
• Reducing Regional Disparities: Tax revenues are distributed to states and backward regions to ensure balanced growth. E.g., Aspirational Districts Programme (2018) directs resources to 112 underdeveloped districts for inclusive development.

Challenges in Taxation System in India

• High Corporate Tax Rate: While rates have been reduced, India’s corporate tax remains relatively high compared to other emerging economies, impacting global competitiveness. For example,corporate tax rate in India is 25%. ( Economic Survey 2024-25)
• Informal Economy: A significant portion of India’s economy operates informally, reducing tax compliance and revenue collection. According to the Periodic Labour Force Survey (PLFS), over 80% of India’s workforce is employed in the informal sector.
• Tax Evasion and Black Money: Widespread tax evasion and unaccounted wealth reduce government revenue and distort the economy. India ranks eighth globally in generating illicit funds (Global Financial Integrity Report).
• Narrow Tax Base: A large section of the population remains outside the tax net, limiting revenue collection.For example, Agriculture contributes about 17-18% of India’s GDP, but farmers are exempt from income tax
• Complexity in GST Implementation: Frequent changes in GST rates, compliance burdens, and technical issues create challenges for businesses. Standard GST rate is 18%, which is approximately among the highest globally (World Bank).
• High Compliance Burden: Businesses and individuals often face bureaucratic hurdles and excessive documentation requirements in tax filing.
• Litigation and Dispute Resolution: Lengthy tax litigation processes create uncertainty and delay revenue realization.

Way Forward

• Simplify GST: Introduce a streamlined and uniform GST rate structure, reducing complexities and improving ease of doing business.
• Expand Tax Base: Bring more individuals and businesses into the formal economy by integrating sectors like real estate and agriculture.
• Ensure Tax Certainty: Establish a stable tax regime by minimizing frequent amendments, arbitrary tax demands, and retrospective taxation.
• Enhance Revenue Collection: Leverage digital platforms, AI, and data analytics to improve tax compliance and curb evasion.
• Promote Economic Growth: Align taxation policies with long-term economic expansion rather than focusing on short-term revenue maximization.

India’s taxation system is vital for fiscal stability and economic growth. While reforms have improved compliance, challenges like a narrow tax base and high compliance costs persist. A transparent, technology-driven, and predictable tax framework will enhance ease of doing busin-ess, boost investment, and ensure equitable growth, aligning with Viksit Bharat 2047.

Reference: Livemint | PMFIAS: Direct tax

UPSC Mains PYQs – Theme – Taxation In India

1. [UPSC 2020] Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions?
2. [UPSC 2019] Enumerate the indirect taxes which have been subsumed in the Goods and Services Tax (GST) in India. Also, comment on the revenue implications of the GST introduced in India since July 2017.
3. [UPSC 2013] Discuss the rationale for introducing the Goods and Services Tax (GST) in India. Bring out critically the reasons for the delay in roll out for its regime.

PMF IAS Pathfinder for Mains – Question 106

Q. India’s taxation system is complex, leading to lower compliance and higher tax evasion. Discuss the challenges and suggest measures to simplify the tax structure (150 Words) (10 Marks)

Approach

• Introduction: Define India’s taxation system & highlight complexity, compliance, and tax evasion.
• Body: In the body, discuss the challenges and measures to simplify India’s tax structure.
• Conclusion: Emphasise the need for a transparent, stable, and business-friendly tax regime to boost revenue and economic growth.