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Difference Between Income and Expenditure Tax
Expenditure Tax is a tax levied on various types of expenditures or consumption, rather than on income. It was originally designed to target luxury spending and conspicuous consumption, aiming to reduce income inequality and promote a more balanced economy. However, it can be extended to all spends, save and except that which one would want to specifically exempt, e.g. fruits & vegetables, milk and staples, etc. Expenditure Tax is typically implemented as a progressive tax, with higher rates applied to larger expenditures.
Income Tax, on the other hand, by definition, is a tax levied on an individual or entity's income during a specific tax year. However, the fallacy is that whereas it is levied on an individual’s income, thereby reducing her disposable surplus; it is levied on an entity’s profits after it has incurred all the expenses that it wants to. It is one of the most common types of taxes and is used by governments worldwide to fund public services and infrastructure. Income Tax can be progressive, proportional, or regressive, depending on the tax rates and brackets.
The primary difference between Expenditure Tax and Income Tax lies in their focus. Income Tax is imposed on income earned, while Expenditure Tax is imposed on expenditures or consumption. Expenditure Tax can serve as an excellent tool for governments to address income inequality by targeting the conspicuous consumption of high-income earners. However, implementing Expenditure Tax can be challenging, as it requires accurate tracking and reporting of individual expenditures, which may raise privacy concerns.
Brief History
India was one of the few countries to experiment with and implement Expenditure Tax. It was implemented in India on September 1, 1957, under the Additional Duties of Excise and Sales Tax Act, 1957. It was levied on specific luxury goods and services, such as high-value jewellery, cars, and entertainment.
The primary objective of implementing Expenditure Tax in India was to curb conspicuous consumption and address income inequality. It was also aimed at generating revenue for the government and financing public services and infrastructure.
However, Expenditure Tax faced several challenges during its implementation. It was difficult to accurately track and monitor individual expenditures, leading to issues with compliance and administration. Additionally, the tax was perceived as being regressive, as it disproportionately affected lower and middle-income individuals who also consumed luxury goods and services, albeit on a smaller scale.
Eventually, Expenditure Tax was withdrawn in India by the government on April 1, 1998. The government decided to focus on simplifying the tax system, improving compliance, and reducing the burden on taxpayers. Today, the Indian tax system primarily relies on Income Tax, Goods and Services Tax (GST), and other indirect taxes to fund public services and infrastructure.
Challenges faced in the 20th Century.
1. Accurate tracking and monitoring of expenditures: Expenditure Tax requires the accurate tracking and monitoring of individual expenditures, which can be difficult to enforce. This can lead to issues with compliance and result in a significant administrative burden for tax authorities.
2. Perceived regressivity: Expenditure Tax can disproportionately affect lower and middle-income individuals who also consume luxury goods and services, albeit on a smaller scale. This can lead to public perception that the tax is regressive, which can result in political opposition and resistance to its implementation.
3. Complexity in administration: Administering Expenditure Tax requires a sophisticated and robust system for tracking individual expenditures, which can be challenging to establish and maintain. This complexity can lead to administrative inefficiencies, errors, and increased costs.
4. Privacy concerns: Expenditure Tax requires the collection and monitoring of detailed information about individual expenditures, which can raise privacy concerns. This can lead to public resistance and opposition to the tax, as well as potential legal challenges.
5. Difficulty in defining luxury goods and services: Determining which goods and services should be subject to Expenditure Tax can be challenging, as there is often subjectivity and debate around what constitutes a luxury item. This can result in inconsistency and uncertainty in the application of the tax.
6. Resistance from businesses: Businesses that sell luxury goods and services may resist Expenditure Tax, as it can lead to reduced sales and profitability. This can result in political opposition and lobbying against the tax, making it difficult to implement and administer.
What has Changed now?
In a country that has managed to successfully implement one of the most complex indirect tax systems by way of a dual-GST together with digitization, automation, tracking, monitoring and auditing of spends, the challenges of the 20th century can easily be circumvented.
1. With smart tracking mechanisms, the administrative burden will stand significantly reduced. As expenditure tax will automatically result in a regular flow of income to the government, TDS (Tax Deduction at Source) may no longer be required, and this will further reduce the complexity and administrative burden. Also, advance tax will become redundant and can be eliminated.
2. The regressiveness or disproportionate impact on low and middle-income earners can be mitigated by exempting basic food and staples and medicines from such a tax. It is possible that low income earners may also occasionally consume luxury goods and services but it is certainly on a much smaller scale.
3. GST has proved that India is fully capable of a robust and sophisticated system for tracking and monitoring, if this wasn’t possible half a century ago, it is certainly possible now.
4. Digitization of all financial transactions and elimination of cash would further ease the burden of monitoring and administration. We, as a country, are already at a stage where a street vendor in cities too accepts payments by UPI. Once this is expanded to rural areas and the hinterlands, India would no longer need a currency note higher than INR 100 in value. This would also make it extremely difficult for black-money circulation.
5. One major area of inequity and imbalance is the fact that salaried taxpayers pay tax on their income, income from agriculture is not taxed at all and entities only pay tax on their profits, which can be subject to manipulation. An expenditure tax would also be levied on the rich farmers by default and entities would now be subject to the same tax that an individual would pay.
In the ongoing debate about tax reform, one idea that will soon gain traction among economists and policymakers is the concept of an expenditure tax, also known as a consumption-based tax. This system of taxation has the potential to be more equitable than the traditional income tax system, which has long been criticized for its inherent inequalities and disincentives.
Firstly, an expenditure tax is based on the principle that individuals should be taxed on what they consume rather than what they earn. This means that the tax burden is shifted from the point of earning to the point of spending. Under this system, individuals are only taxed on the money they spend on goods and services, while any income that is saved or invested is exempt from taxation. This approach encourages savings and investment, which are crucial for long-term economic growth and stability.
Moreover, an expenditure tax is inherently more progressive than an income tax. Under the current income tax system, high-income earners, professionals and corporate entities often have access to numerous deductions and loopholes that allow them to reduce their taxable income, resulting in a lower effective tax rate. In contrast, an expenditure tax ensures that those who consume more pay more in taxes, regardless of their income level. This means that the wealthy, who tend to have higher levels of consumption, would bear a greater share of the tax burden.
Another advantage of an expenditure tax is that it eliminates the double taxation of savings and investments. Under the current income tax system, individuals are taxed on their income when it is earned and then taxed again on the returns from their savings and investments. This creates a disincentive for people to save and invest, as they are effectively penalized for doing so. An expenditure tax, on the other hand, only taxes consumption, allowing individuals to save and invest without being subject to additional taxation.
Furthermore, an expenditure tax is simpler and more transparent than the current income tax system. The complexity of the income tax code, with its numerous deductions, credits, and exemptions, makes it difficult for individuals to understand and comply with. This complexity also creates opportunities for tax evasion and avoidance, as well as unintended consequences and distortions in economic behaviour. In contrast, an expenditure tax would be based on a single, straightforward principle: taxing consumption. This simplicity would make the tax system easier to understand and administer, reducing compliance costs and increasing transparency.
Critics of an expenditure tax argue that it could be regressive, as low-income individuals tend to spend a larger portion of their income on necessities compared to high-income individuals. However, this concern can be addressed through the implementation of a progressive expenditure tax structure, where the tax rate increases as consumption levels rise. Additionally, the government could provide targeted tax credits or rebates to low-income households to offset the impact of the tax on necessities.
Another potential concern is that an expenditure tax could discourage consumer spending, which is a key driver of economic growth. However, research suggests that the impact of an expenditure tax on consumer spending would be minimal, as individuals tend to base their spending decisions on their disposable income rather than their tax liability. Moreover, the increased savings and investment encouraged by an expenditure tax could lead to higher levels of economic growth in the long run.
In conclusion, an expenditure tax offers a more equitable alternative to the traditional income tax system for individual taxpayers. By taxing consumption rather than income, an expenditure tax encourages savings and investment, promotes economic growth, and ensures that the tax burden is distributed more fairly across income levels. While there are potential concerns about regressivity and the impact on consumer spending, these can be addressed through careful design and implementation. As policymakers continue to grapple with the challenges of tax reform, an expenditure tax deserves serious consideration as a means of creating a more equitable and efficient tax system.