Taxation

A Tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state.Taxes consist of direct tax or indirect tax.

A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government […] a payment exacted by legislative authority."

Purposes of Taxation

Financing government spending:

Taxes are justified as they fund government expenditure and activities that are necessary and beneficial to society.

Reduce gap between rich and poor

Progressive taxation can be used to reduce inequality in a society. According to this view, taxation in modern nation-states benefits the majority of the population and social development. Progressive tax system where higher income groups have to pay more tax is an effective way of reducing inequality of income.

Reduce consumption of demerit Goods

Taxes can be used as an effective tool to reduce the consumption of demerit goods like alcohol and tobacco. Higher taxes on these goods reduce the consumption. Examples include cigarette tax and excise duty.

Control Inflation

One of the causes of inflation is ‘too much money chasing too few goods’. Government can take away the extra disposable income of the people through higher taxes and thus reduce the aggregate demand in the economy and resulting in low inflation rate.

Balance of payments

Tariffs are taxes on imports. Government can correct an unfavourable balance of payment situation by increasing the tariffs. This will result in imports becoming expensive and will cause a fall in demand for the imported goods.

Protecting local industries

Government uses taxes as a mean to protect local/infant industries. Increasing tariffs on imports and charging lower taxes to local/infant industries may boost the demand for goods and services produced by domestic industry.