Understanding Taxation: Key Component of Public Resource Mobilisation in India

Every road built, every government school staffed, every subsidised meal served under a welfare scheme needs money. Where does the government get this money? The single largest answer is taxation. Taxes are the lifeblood of a modern state, and the way a country designs its tax system shapes everything from how wealthy it can become to how fairly that wealth is distributed. For a country like India, with its vast developmental needs and diverse population, taxation is not just an accounting exercise. It is the primary tool through which the government mobilises public resources to run the economy and deliver on its promises to citizens.

What taxation really means 🔗

At its core, a tax is a compulsory contribution that individuals and businesses make to the government, without any direct quid pro quo. The authority to levy a tax in India comes from the Constitution itself. Article 265 lays down a simple but powerful rule: no tax can be levied or collected except by the authority of law, meaning every tax must be backed by legislation passed by Parliament or a State Legislature.

Why does this matter? Because taxation is a coercive power. Without constitutional safeguards, governments could tax arbitrarily. The Constitution also distributes taxing powers between the Union and the States through the Seventh Schedule, ensuring that both levels of government have defined revenue sources. The Union collects income tax, customs, and central excise, while States levy items like stamp duty and state excise. Local bodies, meanwhile, collect property tax and fees for services like water supply.

Why governments tax: the logic of resource mobilisation 🔗

Resource mobilisation is the process of gathering financial resources to fund public expenditure. For a developing economy, this is especially critical because capital formation, the process of building productive assets, depends on how much the government and private sector can save and invest. A well-designed tax system raises the savings rate of a country, channels those savings into public investment, and simultaneously discourages wasteful consumption.

Taxation works as a fiscal policy instrument that mobilises resources for capital formation in the public sector. By imposing progressive taxes on high incomes and higher indirect taxes on luxury goods, the government can ensure that the marginal saving rate exceeds the average saving rate, pushing the economy towards higher growth.

Beyond growth, taxes also serve three other vital functions: redistributing wealth to reduce inequality, stabilising the economy by moderating demand during inflationary periods, and funding merit goods like education, healthcare, and defence that the private market would under-supply.

The Indian tax structure: a three-tier system 🔗

India’s taxation system operates across three levels of government. The tax system in India is mainly a three tier system based on the Central Government, State Governments, and local bodies such as municipalities and panchayats. Each tier has constitutionally defined taxing powers, which prevents overlap and ensures financial autonomy at every level.

Broadly, taxes in India fall into two categories: direct and indirect. This distinction is not just technical. It affects who actually bears the burden of the tax and how fair the overall system is.

Direct taxes 🔗

A direct tax is one where the person on whom the tax is levied is the same person who ultimately pays it. You cannot pass it on to someone else. Income tax is the most familiar example. The burden stays with the taxpayer.

India’s principal direct taxes include:

Income tax is levied on individuals and Hindu Undivided Families on their annual earnings. It follows a progressive structure, meaning rates rise as income rises. This aligns with the principle that people with greater ability to pay should contribute more.

Corporate tax is paid by companies on their net profits. The rate differs for domestic and foreign companies and has been reduced over the years to improve India’s competitiveness as an investment destination.

Capital gains tax applies to profits earned from selling assets like real estate, shares, or mutual funds. It is split into short-term and long-term categories depending on how long the asset was held.

Direct taxes are considered more equitable because they are tailored to individual ability to pay. They impose a lesser burden on the economically disadvantaged compared to indirect taxes, which tend to hit the poor harder proportionally. In 2023-24, direct tax collections were reported at around ₹19 lakh crore, reflecting the rising share of this category in the country’s tax revenue.

Indirect taxes 🔗

An indirect tax, by contrast, is collected from one person but ultimately borne by another. A shopkeeper collects GST on a product and hands it over to the government, but it is the consumer who actually pays it in the final price. Because indirect taxes are built into the price of goods and services, they are less visible to taxpayers and therefore easier to collect.

The major indirect taxes in India today include:

Goods and Services Tax (GST), introduced on 1 July 2017, subsumed a tangle of earlier indirect taxes such as service tax, VAT, and most central excise duties. Goods and services are divided into five tax slabs for GST collection, namely 0%, 5%, 12%, 18%, and 28%. However, petroleum products, alcoholic drinks, and electricity remain outside GST and are taxed separately by state governments.

Customs duty is charged on goods imported into or exported out of India. It also serves as a policy tool to protect domestic industry and regulate the movement of sensitive items.

Central excise, though largely absorbed into GST, continues to apply to specific items like petroleum and tobacco products.

The administrative machinery 🔗

Designing taxes is one thing. Collecting them is another challenge entirely. The responsibility for administering India’s taxes rests with the Department of Revenue under the Ministry of Finance.

According to the Department of Revenue, it is led by the Secretary (Revenue) under the overall direction and supervision of the Union Finance Minister. The Department exercises control over all direct and indirect Union taxes through two statutory boards, namely the Central Board of Direct Taxes (CBDT) and the Central Board of Indirect Taxes and Customs (CBIC). Both boards were constituted under the Central Board of Revenue Act, 1963, with each board having six Members.

Central Board of Direct Taxes (CBDT) 🔗

The CBDT handles the levy and collection of income tax, corporate tax, and other direct taxes through the Income Tax Department. It designs policy, drafts rules, supervises field formations, and handles everything from refunds to enforcement actions. When you file your income tax return on the e-filing portal, you are interacting with the machinery that CBDT oversees.

Central Board of Indirect Taxes and Customs (CBIC) 🔗

The CBIC is the counterpart for indirect taxes. According to the official description, it oversees the administration of indirect taxes including customs duties, excise duties, and GST, and its function also extends to the prevention of smuggling and the regulation of narcotics through its attached offices.

The principles behind a good tax system 🔗

How do we judge whether a tax system is good or bad? The classical answer comes from Adam Smith, the Scottish economist whose 1776 work The Wealth of Nations laid down four canons of taxation. These principles, though centuries old, remain the benchmark against which modern tax systems, including India’s, are evaluated.

Canon of equity 🔗

Taxes should be levied according to a person’s ability to pay. Those with more income should contribute a larger share. India’s income tax system is progressive, with higher income groups falling into higher tax brackets, which reflects this canon directly.

Canon of certainty 🔗

Taxpayers should know in advance how much they owe, when to pay, and how to pay. Uncertainty breeds evasion and undermines trust. India’s use of the annual Finance Budget, Tax Deducted at Source (TDS), and advance tax payments all reinforce this certainty.

Canon of convenience 🔗

Taxes should be collected in a way that is easy for the taxpayer. The move towards online filing, UPI-based tax payments, and pre-filled returns reflects this canon at work.

Canon of economy 🔗

The cost of collecting taxes should be low relative to what is collected. Digital infrastructure like the GSTN and the income tax e-filing portal have cut administrative costs dramatically.

Modern public finance has added further principles such as productivity (a tax should raise adequate revenue), elasticity (revenue should grow with the economy), and simplicity (the system should be easy to understand).

The ongoing tensions in India’s tax system 🔗

Despite reforms, India’s tax structure faces some persistent challenges. One is the heavy reliance on indirect taxes. Even though direct tax collections have grown, direct taxes account for less than 40 percent of India’s overall aggregate tax revenue when state and central tax collections are combined. Since indirect taxes fall more heavily on the poor relative to their income, a system tilted towards them is regressive.

Another issue is tax evasion and the resulting black money economy, which erodes revenue and distorts competition. A narrow tax base, where only a small fraction of the population pays income tax, compounds the problem. Widening the base and encouraging voluntary compliance through simpler laws and better enforcement remain priorities.

Digitisation has helped. The introduction of PAN-Aadhaar linkage, faceless assessments, and AI-based scrutiny have reduced human interface and plugged many leakages. GST, despite its initial teething troubles, has also broadened the formal economy by bringing more businesses into the tax net.

Why this matters beyond numbers 🔗

Taxation is more than a revenue-raising exercise. It is a statement of a nation’s social contract. When citizens pay taxes, they are funding schools, hospitals, roads, and the very institutions that protect their rights. When governments collect taxes fairly and spend them wisely, trust grows and compliance improves. When the system is perceived as unjust or wasteful, evasion rises and the entire fiscal architecture weakens.

For a country aspiring to reach upper-middle-income status, building a robust, fair, and efficient tax system is non-negotiable. It determines how much can be spent on health and education, how much public debt must be taken on, and how evenly the fruits of growth are shared.

What do you think? Should India rebalance its tax structure to rely more on direct taxes rather than indirect ones, even if it means stricter enforcement on high earners? And how can the government widen the tax base without overburdening the middle class, who already feel the pinch of both income tax and GST?

References

1. https://en.wikipedia.org/wiki/Taxation_in_India
2. https://www.economicsdiscussion.net/economic-development/taxation-economic-development/taxation-and-resource-mobilisation-for-economic-development-economics/30284
3. https://www.mospi.gov.in/sites/default/files/Statistical_year_book_india_chapters/DIRECT-INDIRECT%20TAX-WRITEUP.pdf
4. https://www.cbgaindia.org/opinion/direct-vs-indirect-taxes-whats-adding-to-centres-tax-revenue-and-states-woes/
5. https://dor.gov.in/about-department
6. https://en.wikipedia.org/wiki/Central_Board_of_Indirect_Taxes_and_Customs
7. https://vaquill.com/blog/canons-of-taxation/