Types of taxes in India and advantages and disadvantages of VAT and MODVAT

The article provides a complete detail on the various types of taxes in India. It also states the advantages of VAT and the disadvantages of VAT. It also states the advantages of MODVAT and the disadvantages of MODVAT. It also states the merits and demerits of progressive tax system. It also states the ways of saving taxes by investment.

Value-added tax

Value added tax is a fiscal innovation of the early 1960's. VAT has come out to be an important place in the fiscal economy of a nation and all the countries of th world at a large.
A value added tax is a tax that is levied not only on the total value of the commodity sold but on the value added to it by the producer or the trader. Value added is defined as the difference between the value of the output produced by the producer and the value of the intermediate goods purchased by the producer for producing that output. For example, if the manufacturer of a shirt purchase cloth worth Rs.10 crore to produce the clothes of Rs.15 crores, the value added by the producer is Rs.5 crore.
Thus, VAT can be looked upon as a multi-stage tax levied on the value added at each stage as a proportion of the value added. The value added at each stage of production and distribution is taxed.
For computing the value of the tax, normally two approaches are added. The first approach is to calculate the base of the tax by deducting the expenses on intermediate goods incurred by a firm form its sales. In the second approach, a firm is permitted to deduct the tax paid by it in its purchases from other units.

Advantages of VAT

  • VAT would simplify the existing tax system.The prevailing sales tax system is highly complex because of multiplication of rates, surcharge, turnover tax and additional sales tax. It has the cascading effects as the present system suffers form the incidence of tax as the tax passes form the producer to the consumer who has to bear all the burden.
  • The adoption of tax would help in reducing the amount of tax evasion since taxes are levied at each stage of production and distribution.The dealers would also have to maintain invoices in order to benefit from tax deductions. This is one of the most important characteristics of a good tax system.
  • VAT has a novel advantage of tax transparency. That is, the total burden of the tax on the particular commodity can be clearly seen. This shold be the primary objectives of taxation policy.
  • VAT also holds out great potentials of rising additional revenue by bringing withing its preview various services. It can also be broadened in due course of time.

Modified Value Added tax (MODVAT)

The year 1986 was a landmark in the history of excise taxation in India when the government introduced . MODVAT is different from the VAT system as it rakes into account the duty paid while calculating the taxes to be paid by the producers. MODVAT system permits the producers to obtain complete reimbursement of excise duty that is already paid on the components and raw materials purchased by them used in the manufacturer of the producers. It was passed in the Indian budget of that session.

Objectives of MODVAT

  • The objective of MODVAT scheme is to avoid repeated payment of duties from raw material stage to the final product stage.
  • The objective of MODVAT is to avoid payment of tax at different stages of excise duties.
  • It is to simplify and rationalize the tax procedure.

Advantages of MODVAT

  • MODVAT scheme benefits those producers who use indigenous raw materials and intermediate goods rather than the producers who use imported materials.
  • MODVAT also helps in shifting the effective burden of excise duties away from inputs and on to the final products.
  • MODVAT is expected to curb tax evasion. It will check the excise evasion as the credit of input cannot be claimed unless actual production of goods are displayed to the excise authorities.
  • Under the MODVAT system, a simplified procedure for obtaining tax concession has been laid down.
  • MODVAT is expected to reduce the cost of production, encourage ancillarization and help in increasing the exports.
  • MODVAT scheme is expected to encourage exports by removing the duty drawbacks and thereby making them more competitive.
  • MODVAT scheme makes excise levies transparent so that the effective rate of taxation on a particular commodity can be known. Let us hope that it will be much more transparent when the Jan Lokpal bill is passed.

Drawbacks of MODVAT

  • The implementation of MODVAT requires a sound administrative structure.
  • MODVAT may encourage unscrupulous traders to create false purchase invoices showing tax paid by other firms. It is perhaps the result of corruption in India that all the traders are able to evade taxes evry easily.
  • The problem of maintaining accounts, cross checking becomes complex when the series contains a lot of exemptions ad differential rates of taxation.
  • The system may not be effective in India since speculative hoarding and price hike resulting form the lack of competition and existence of anomaly.

Other types of taxes in India

  • Income tax: Income tax is levied on the income of the individuals as well as firms and Joint Hindu family by the government.Income tax in India is imped on the aggregate income form various income source like salaries, income form house property, capital gain, income form business etc.
  • Corporation tax: The corporation tax is the tax imposed on the income of the companies operating in India.
  • Interest tax: Interest tax is levied on the gross interest income of the financial institution such as commercial banks, financial companies and public financial companies.
  • Expenditure tax: Expenditure tax is imposed on the expenditure incurred in expensive hotels and restaurants.
  • Custom duties: Custom duties are taxes imposed on commodities imported in the country or exported from the country.
  • Service tax: Service tax is levied on services provided to the people such as services provided by the people of the hotels, telephones etc.

Central Value added tax (CENVAT)

Prior to 2001, there existed a number of ad-valorem rates of basic excise duty for different excisable items. An important step in the direction of reform of excise taxation was taken with the introduction of a single rate Central Value added tax by replacing the three ad-valorem ates with a single rate of 16%.
CENVAT scheme rationalized the excise duty by introducing only one ad-valorem rate in place of a number of rates.In addition, CENVAT scheme further rationalized and expanded the MODVAT scheme in the sense that now all,the inputs and capital goods are included in the eligible list of MODVAT.

Progressive taxation

A tax is called progressive when the rate of taxation increases by the increase in the rate of income. In other words, the lower income is taxes less as compared to the higher income. For example, up to Rs.50000 a year may b taxes at the rate of 20% and the higher income may be taxes at the rate of 22%.

Merits of progressive taxation

  • Equitable: An important advantages of progressive taxation is that it leads to equitable and just distribution of taxes as it is based on the principle of ability to pay.
  • Instrument for reducing inequalities: Progressive taxation serves as the instrument for reducing inequalities of income and wealth as the rich persons are requires to pay more taxes.
  • Elastic: Progressive taxes are elastic as the revenue of the government can increase substantially by increasing the tax rate marginally.
  • Productive: Progressive tax is productive as it brings in large revenue for the government.
  • Acting as the built-in stabilizer: Progressive taxation as an additional advantage of acting as the built-in-stabilizer. This is, the tax system acts as a cushion against the excessive upward or downward movement in prices and income.

Demerits of progressive taxation

  • Possibility of discouraging savings:Progressive taxation discourages savings and capital formation in the economy. It is argued that only the rich can save if they are taxes more heavily than the poor. However, one can also argue that this tax can be used by the government to increase the capital formation in the country.
  • Punishment to hard work:Sometimes, progressive taxation may have an adverse effect on he incentive to work.
  • Scope of tax evasion: Under the system of progressive taxation, the incentive for tax evasion is stronger than in the case of proportionment taxation. People may give a false declaration of their income so as to avoid heavy income.


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