“INDIRECT TAXES AND ECONOMIC DEVELOPMENT”

A Research Project of course Economics-I for the requirement of

Submitted by: Aashish Mittal

Submitted to: Dr. Shivani Mohan

Session: 2018-2023

CHANAKYA NATIONAL LAW UNIVERSITY, PATNA

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 DECLARATION BY THE CANDIDATE
I hereby declare that the work reported in the B.A. LL.B(Hons.) Project Report Entitled
“Indirect taxes and Economic Development” submitted at Chanakya National Law
University, Patna is an authentic record of my work carried out under the supervision of Prof.
Dr. Shivani Mohan.

I have not submitted this work elsewhere for any other degree or diploma. I am fully
responsible for the contents of my Project Report.

(Signature of the Candidate)

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 ACKNOWLEDGEMENT

Firstly, I would like to thank my faculty of Economics Prof. Dr. Shivani Mohan
for providing me an opportunity to make my project on such an interesting
topic. Secondly, I would like to thank all my colleagues and friends for helping
me out in arranging of the accumulated collected study material.

Lastly, special thanks to my parents for guiding me in giving the final touch to
this project and helping me out throughout this project.

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 Table of Contents

1. INTRODUCTION.........................................................................................................................5

2. HISTORICAL BACKGROUND........................................................................................................7

3. RESEARCH METHODOLOGY.......................................................................................................9

4. INDIRECT TAXES DO NOT HAVE NEGATIVE RELATIONSHIP WITH ECONOMIC GROWTH............11

5. INDIRECT TAXES HAVE NEGATIVE RELATIONSHIP WITH ECONOMIC GROWTH.........................13

6. CONCLUSIONS AND SUGGESTIONS..........................................................................................14

7. BIBLIOGRAPHY........................................................................................................................15

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 1. Introduction

Indirect taxes are those taxes whose burden can’t be shifted onto others, they are not mandatory
as they are only levied on goods and services which are being asked by the consumer. Since
indirect taxes burden falls directly on the consumer, it directly impacts the cost of goods and
services. So this means indirect taxes increases the efficiency of the producer, so the ultimate aim
of the producer in an economy of indirect taxes is to work in their full efficiency and improve
their cost cutting measures. Increase in efficiency of the producer further leads to fuller utilisation
of the resources and growth of healthy competition in the market and the consumers are left with
different choices of producers or we can say more freedom of choice to the consumers. The
collection of taxes by the government are a great source of income and helps to control public
expenditure. Taxes are generally levied so as to make the government fruitful and to use the
concerned tax amount in the welfare and development of the society, basic examples of indirect
taxes are- income tax, sales tax, corporate tax, service tax and so on
. In India, taxation has been used as a powerful instrument of fiscal policy. Taxation alone
constitutes more than one-half of total budget resources. 'In 1960-61, 52.2 percent of the total
resources came from taxation’ in 1970-71, it contributed 56.9 percent of total resources of the
government of India the corresponding figure were 55 9 and 51.9 per cent in 1980-81 and
1991-92 respectively. The tax revenue in India shows a tremendous and continuous increase
over the time period. Even in post reforms era more than half of the total expenditure of

central government was financed from tax revenue. 1

Economic Development is a process by which the economy well being and quality of a life
of a nation is improved to such an extent as there is an increase in living standards of the
people living in particular country is improved. Economic development is used as a synonym
of Economic Growth, where the economy of a country is at growth both in qualitative as well
as quantitative aspects. Economic growth of a developed country increases with slow rate as
compared to underdeveloped country as the developed country had reached a certain point
where growth is not related to per capita rise in the income, but rather developments in the
existing technological advancements, mechanised economic system, transparency in the

1 Rahul, Role of Direct and Indirect Tax in Development of Indian Economy, International Journal of
Research in Finance and Marketing (IMPACT FACTOR – 5.230), (August 22, 2019), http://euroasiapub.org/wp-
content/uploads/2017/05/9FMDec-4864-1.pdf.

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assessment of the utilisation of funds and many whereas in an underdeveloped economy it
increases with rapid growth or with a boost in starting years and the it increases with the
diminishing rate.

As of 2010, the list of developed nations included the United States, Canada, Japan, Republic
of Korea, Australia, New Zealand, Scandinavia, Singapore, Taiwan, Israel, countries of
Western Europe, and some Arab states. In 2012, the combined populations of these countries
accounted for around 1.3 billion people. The populations of developed countries are generally
more stable, and it is estimated that they will grow at a steady rate of around 7% over the next
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40 years.

Imposing taxes is a great source of revenue generation for the government both at central as
well as state level. Taxes are imposed so the government can generate funds which are then
used for the development and for the welfare of the people of the country. In India taxes are

imposed, set, commuted and carried by the Ministry of Finance.3

2
Margaret Cunningham Economic Inequality: Differences in Developed and Developing Nations ( Sep 3,
2019), https://www.britannica.com/topic/economic-development.

3 Rahul, ROLE OF DIRECT AND INDIRECT TAX IN DEVELOPMENT OF INDIAN ECONOMY,

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 2. Historical Background

Taxes are an obligation for all citizens. There are two types of taxes in India, namely direct

taxes and indirect taxes. Taxes in India are rooted in the Manu Smriti and Arthasastra periods.

The current Indian taxation system is based on the old taxation system based on the theory of

maximum social welfare.

By Kalidas in Raghuvansh eulogizing

The origin of the word "Tax" is from "Taxation" which means an estimate. In India, the

system of direct taxation as it is known today has been in force in one form or another even

from ancient times. Variety of tax measures are referred in both Manu Smriti and Arthasastra.

The wise sage advised that taxes should be related to the income and expenditure of the

subject. He, however, cautioned the king against excessive taxation; a king should neither

impose high rate of tax nor exempt all from tax.

According to Manu Smriti, The king should organize the tax collection in such a way that

the taxpayer does not deduct the tax deduction. He noted that traders and the army would pay

1/5 of their profits in silver and gold, while farmers had to pay 1/6, 1/8 and 1/10 of their crops

on their own terms.

Kautilya also described the system of taxation in Mauryan Empire. It is remarkable that the

present day tax system is somewhat similar to the system of taxation in 2300 years ago at the

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reign of Mauryan empire.

Economic Development/growth can be historically put forward with a view as early as that

th th
of feudalism in the medieval time period from 9 century A.D. to 15 century A.D. then it

shifts to Industrial growth at that time. Economic growth can be related with different regions

as every region has its own set of areas in which they want to grow economically.

4
Hemant Singh, History of Taxation in India, Jagran Josh, (OCT 11, 2017 05:29 IST),
https://www.jagranjosh.com/general-knowledge/history-of-taxation-in-india-1481028305-1

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The best economic growth in historical aspect can be analysed from simple agrarianism to

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mercantile agrarianism (1500-1750) . Simple Agrarian society was based on the settled

agricultural production with no involvement in other economic activities, like trade beyond

the local community, it is locally self-sufficient, whereas the mercantile agrarian society is

more complex more developed agriculture is not the prime activity of the society, there is

change and progress in the society, trading outside the local domain as well as internationally

can be seen, as the main aim of the producer in this society is to earn profit and increase its

capital change can be seen in both the societies as in simple and mercantile as earlier there

was no scope of economic or trading activities in simple agrarian societies, but now in

mercantile agrarianism trading for the maximisation of profits can be clearly seen. The

change from simple to mercantile agrarianism can be termed as economic development.

5 J.C.H. Fei et al, Economic Development in historical Perspective, econ Yale, Nov 12 1968, at 1, 8

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 3. Research Methodology

The researcher is limited to the doctrinal method of research which includes articles, journals,
books and reviews by different laurates of economics. The basic purpose behind doctrinal
research is that it shows correct facts of data and not of worldly opinion, the doctrinal
research is highly corroborative in nature and is accepted very readily. The research work is
related with the use of taxes and why is it necessary to pay taxes to the government bodies, or
why they are levied.

3.1 Aims and Objective

The aim of this study is to know the economic impact of taxes on the economy
of any country whether it is positive or negative. It is also to verify that how
much economic growth is influenced by the indirect taxes in long- period and in
short-period.

To provide policy recommendations that how the policies should be formulated

3.2 Literature Review

In the H.L. Ahuja book ‘Macroeconomics Theory and Policy’ 6 taxes are classified into three
categories which are proportional, progressive and regressive. The classification is basically
based on income but the researcher will use these taxes to show that they are also levied on
indirect taxes.

Proportional tax meant that same rate of tax is charged whatever be the magnitude of the
base it is levied, say in all sugar producing factories same rate of tax is charged on small
producers as well as on large scale producers like 5 per cent, if one producer produces sugar
equals to 1000 tons then 5 per cent is and each tons cost say 10,000 in monetary value so for
5 percent of 1000 tons is 50 tons so the producer had to pay 5 lakh as a tax whereas, on the
other hand if there is a large scale producer say if he produces 1 lakh tons of sugar he has to
pay 5000 tons equals to monetary value as tax which he can levy as it is indirect tax.

6 H.L. Ahuja, Macroeconomics Theory and Policy 663-664, (20th ed. S. CHAND 2018) (1986)

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These taxes are not beneficial for the economic growth as the high level producers are in a
position to pay more tax as compared to low level producers so the economic development
will be stable at that point only and for that purpose progressive taxes are imposed in
countries which are developed.

Progressive tax is the tax at which rate of tax increases as the amount of tax base which
means higher the level of production higher the level of tax, it is the in Indian Economy in
Income tax laws. In progressive tax equity of taxation is maintained rather than equality.

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The main drawback of this has been stated in ‘ Development as Freedom’ which states that
the country should not grow on the expense of the riches(Rich class) just because they are
capable to pay more, as the equality of good conscience one cannot treat other in a abusive
way just because he is capable to spend more. It is the duty of the government to implement
policies that best fits the interest of the people and not to harmonise any sector, it will make
the lower sectors more dependable on the government which will always leads to the
inadequate usage of resources in those hands who are not employed on their own skills and
talent, but rather a part of a set of order and living a life which is not that they asked for.
Employment generation is the duty of the government but if the government is forced to do
so when the people are able and willing to work and still are moving towards an easy option
(government employment policies) because they had an option to work but due to their
lethargic attitude they tend to collide to that choice which they had not asked for.

Regressive tax is the opposite of progressive tax, in regressive tax the rate is lowered as the
output rises. This is the clear cut example of the dominating sections controlling the political
structure of a country and they exploit the lower classes as the way they deems it fit. In
today’s modern economic structure no developing country follows this type of tax structure
as it will not improve the standard of life rather it will lead to the capitalist form of structure
in an economy.

7 Amartya Sen, Development as Freedom, Oxford University Press 1999, 1, 81-86.

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 4. Indirect taxes do not have negative relationship with economic
growth

In a democratic country indirect taxes are levied in such a manner that they are used for the
benefits of the people, like India. Taxes have the ability to generate higher yielding revenue
for government and on the other hand giving returns to the public sector at large, this does not
mean that any government should impose super high taxes on the people as it will lead to
exploitation of the general masses and would degrade the level of economy and the GDP of
the country will collapse.

India

Policies are formulated by the finance department of the country in the utilisation of funds
which are to be generated through tax receipts, and proper implementation of the budget
plans is checked by the Ministry of Finance and accordingly funds are allocated to each
sector. If there is any deficit on the part of the revenue generated then it needs to be balanced
by fiscal measures or by any measures that the Finance Department deemed fit.

India began its “liberalization” when Rao became our Prime Minister on 21st June 1991.
Essentially it was the undoing of some of the idiotic policies that Nehru and his family put in
place in our country .

1. We did away with many of the import restrictions. Until 1991, we imposed a 400%
customs duty on many products. Industries had to beg to get an essential ingredient
imported. By 1991, the duties on many products were reduced substantially. This
brought new growth in our industries.
2. Import licensing was abolished. Until 1991, you need a license to import anything and
this license was very hard to get.
3. Government did away with the production licensing in many industries. Until 1991,
you needed government’s permission in what to produce and how much to produce. In
one stroke, the restriction was removed in many industries.
4. Rao put domestic economic back on track with two stars — Montek Singh and
Manmohan Singh. Huge spur was given to our local industries. Stock market rules
were relaxed.

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 5. Manmohan abolished “gold smuggling” (remember 1980s Bollywood movies?) in
one go. He effectively allowed Indian expats to bring back 5 kilos of gold with them
with no duty. Now, nobody had a reason to smuggle gold & electronics.
6. Singh and Rao allowed foreign investors to come. Until then India was living in the
paranoia of East India company. Many sectors were opened for foreign investment
and collaboration. Now, companies like Coke and Nike could come in. Suddenly,
Bombay Stock Exchange found a life.
7. Government started selling some of its businesses to the private sector. This brought

cash and new round of efficiency.8

The above Indian crisis which was dealt somehow by the imports duty on the production at a
certain level gave rise to the Indian economy at the time of the Narsimha Rao’s leadership
clearly shows that indirect taxes do not have a negative relationship with economic growth
but rather it can boost the economic sector and the production sector of an economy to its full
extent.

8 Balaji Vishwanathan, What exactly happened to the Indian economy in 1991 in layman’s terms?, Aug
18,
2017.

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 5. Indirect taxes have negative relationship with economic growth

Indirect taxes are a great source of revenue in any economy, but these taxes need to be levied
on a fair basis, say if any country levying indirect taxes impose them to satisfy their own
needs and utilise them for their own benefit, or to restrict any sector to grow.

Indirect taxes related to import and export if impose on the production sector unfairly like in
the Indira Gandhi government the taxes were as high as 400% (excise duty), licensing
restrictions, rep tapeism and other corrupt practices taken up by the then Indira Gandhi
government to stop the private sector to indulge in any direct relation with the growth of an
economy

The measures taken up by the then Indira Gandhi government in India are

1. Excise duty was as high as 400% so producers were in a great deficit due to that,
which leads to slowdown in the economy.
2. Licensing restrictions on many things that the so called ‘License Raj’ was being the
initiative of the government. It was done to restrict the private sector to grow and
increase the per capita GDP of the country.

These measures lead to the decline of the economy in a very critical situation that at the time
of 1991, economic crisis was seen in all over the country, GDP of the country starts to decline
which leads to the drop in foreign reserves and India became the centre of attraction at that
time. But due to Narsimha Rao government economic structure was stabilised.

From the above facts and summarised description of the governmental policies implemented
at that time we can say that Indirect taxes have negative impact on economic development of
a country.

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 6. Conclusions and Suggestions

India is a country of various diversities and thus these diversities leads to differences in opinions,
these opinions are thus kept in mind while making new laws or amending the earlier ones. There
are differences in opinion are basically of rich and poor. Poor people don’t know about the
taxation whereas the rich people on the other hand are finding out the loopholes in the tax system
to evade different taxes. The poor people should be tried to be freed from indirect tax regime
while more indirect taxes should be imposed on rich class to reduce income inequality gap.
Economy of any country should work for its own people first and secondly work for the outside
relations. People evade taxes because they don’t want to pay their income to the concerned tax
department and it is because of lack of education and more emphasis laid on generating money
and keeping it. People need to be made aware of that why do they are duty bound to pay taxes for
the goods and services they have purchased, it is the governments duty to create awareness camps
for making people understand the concept of taxation. The government does not get money from
any outside sources as much it gets from taxation, taxes are the main source of income and helps
in financing public expenditure, because one way or the other government of any country work
for the development of a country so it needs financing and that is applicable through taxes which
is generating revenue to the government and that revenue is spend on the welfare and
development of an economy.

One need to keep in mind while imposing taxes that it does not reach beyond the limit of the
taxpayer that he may indulge in corrupt practices to evade the taxes imposed by the government.
However, taxes are mandatory payments made by the people at large and thus they are levied on
the people, if there are no taxes how will the government of any country will get funds in any
form, so the imposition of taxes are necessary instrument to generate funds for the government so
that the can use these taxes to develop the economy of the country.

Indirect taxes have both negative as well as positive impact on the economy of the country,
all depends upon the methods used to implement these taxes, if the method is progressive in
nature it will definitely leads to the development of the country, or if the procedure followed
is in the form of capitalist structure the taxes imposed will be very high and will make the
economy of the country decline.

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 7. Bibliography

Books-


H.L. Ahuja, Macroeconomics Theory and Policy 663-664, (20th ed. S. CHAND 2018)
(1986).

Amartya Sen, Development as Freedom, Oxford University Press 1999.

Articles & journals


Lumnije ThaçI, Januaray-April 2018, Tax Structure and Developing Countries, European
Journal of Economics and Business Studies, Vol 4 No 1, pg 214-218 .

C.A. (Dr.) Pramod Kumar Pandey, Volume 3 Issue 1, The Impact of Indian Taxation
system on its Economic Growth, 2-3.

Hla Myint, Economic Development, 3 vol. (1981–83).

Rahul, Role of Direct and Indirect Tax in Development of Indian Economy, International
Journal of Research in Finance and Marketing (IMPACT FACTOR – 5.230), (August 22,
2019).

Hemant Singh, History of Taxation in India, OCT 11, 2017

J.C.H Fei et al, Economic Development in Historical Perspective, Economic Growth
Centre Yale University, Nov 12 1960, 8-15

ILABOYA, O. J. , Vol 3, No.11, Indirect Tax & Economic Growth, 80-81

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