Guide To Proportional Tax And How It Affects Your Wallet

Taxes are something that everyone is aware of in a general way. However, understanding taxes' intricacies and applicability are fundamental in real life. It is essential to look at different categories of taxes and how they impact organizations and individuals. While we shall be getting into the concept of Proportional Tax, we shall also be delving into other categories of Taxes so that the whole picture gets clear to you. Proportional taxation intends to create greater equality between marginal tax rates and average tax rates paid. 

Did You Know? Supporters of a proportional tax system propose that it provides taxpayers incentive to earn more because they are not penalized with a higher tax bracket.

What are Proportional Taxes?

Proportional tax is a tax that is levied at a single rate on the income, regardless of level or kind. This concept ensures equality between the super rich and poor in terms of tax. There are many other taxes that also do not differentiate between classes, but they are based on several criteria like age, source of income, business or profession and so on.

Also Read: Guide on Paying Self Assessment Tax - Learn About Self Assessment Tax Meaning & How to Calculate It

Importance of Taxes

Government imposes a tax on its citizens and businesses as an act of raising revenue that is used to meet budgetary demands. It also includes financing government and public projects along with the business environment in the country favourable for economic growth.

 Almost all levied taxes can be broadly classified into three specific categories.

• Progressive Tax
• Proportional tax
• Regressive Tax

Progressive Tax

Progressive Tax is the tax structure where the Tax levied varies in proportion to the income of an individual or organization. Those who earn higher incomes will be taxed more than those who make less. It is based on the principle of reducing wide gaps between the super-rich and the inferior segment of society. Almost every country in the world follows this concept.

Personal Income Tax is a clear example of Progressive Tax. The Tax is designed in multiple income slabs. Greater the income, the higher the Tax. The Table below shows the various levels of Tax paid depending on the income earned.

A prominent example of progressive tax comprise investment income taxes, tax on interest earned, rental earning, estate taxes and credit taxes

Regressive Tax

Regressive Tax is a system where the tax is levied without reference to the income of the tax payee. As its name implies, this tax is often levied to discourage the consumption of a certain range of products or services.

Certain taxes, which are said to be Sin tax, are regressive because the policy to implement those to certain specific product or service categories is based on the Government’s attempt to discourage consumption of those products. These products or services are considered harmful to society and hence the attempt to make it more difficult for these businesses to grow or attract fresh investments. Examples are a tax on alcohol, tobacco, gambling ventures, carbonated drinks, pan masala, bars, and pubs. 

The World Health Organization has recommended that tobacco products must bear a tax of not less than 75% of the retail price. In India, tax on tobacco products ranges from 52% to 204% for different categories. Only tax on Beedis is lower at 22%. Tobacco is considered one of the reasons for people getting cancer. Many citizens feel such high taxes are justified. State Governments are a bit hesitant as revenue from these products generates a lot of tax income. To offset this loss, the Central Government compensates suitably through a Cess.

Also Read: Tax Audits in India - Learn About Income Tax Auditing And It's Types

The Cess, in addition to the GST Rate of 28% on some of the tobacco products in this category during the year FY 21-22, are as follows:

Some experts believe taxes like GST and Property Tax should also be considered regressive as they are levied based on the income earned. However, other experts say that Regressive taxes are meant to deter consumption, which GST and Property Taxes are not.

For instance, Manoj, a coconut seller who earns ₹1,00,000 Lakh p.a. and requires to pay a tax of 15%, whereas Nitish, earning five times more than Manoj, pays a tax of 10%.

Proportional Tax

Proportional Tax is a concept where the Tax paid is independent of the income earned. It is a flat rate applied. Thus, irrespective of whether it is the wealthy, middle class, or poor, the amount of Tax paid is the same. This system is used in taxes like GST, Property Tax, Lifetime Tax on vehicles, Toll on roads, Tax on travel fares, Driving Licence fees, and so on.

Let us see a specific case example to understand the effect of Proportional Tax on a bike purchase.

Sunil Kumar was both anxious and excited. After working for years in his first job, he bought his first bike. Coming from a middle-class family with an annual salary of ₹6 lakhs, investing ₹1.8 lakhs on a bike was no small matter. He planned to take it up on EMI payable over three years. He knew he had to work hard and improve his income. Sunil had to wait as another customer was transacting at the counter. Gopichand was a very successful senior professional in an MNC. Sunil has seen him in the lift in his office building. Interestingly, both were buying the same bike model. After a few minutes, Gopichand took out his mobile, scanned the QR Code image, and transferred the entire money in one lot. ₹2 lakhs plus in one go. Sunil gasped. Sunil quickly scribbled a few figures on his notepad as an Accounts professional. What he saw shocked him. Here is what Sunil had jotted down while watching Gopichand complete his transaction.

Also Read: All You Need To Know About Section 143(1) of Income Tax Act

Sunil realized he was paying nearly 10% of his income towards Taxes on this purchase. Gopichand, who is so rich, was paying less than 1% of his income towards the same taxes. While Sunil has to struggle to save to meet EMIs, Gopichand will hardly feel the pinch of this purchase. "How unfair life is", Sunil sulked. But there wasn't any choice.

Now, let us observe the advantages and disadvantages of using Proportional Tax.

Advantages of Proportional Tax

1. One of the most important factors for strengthening a nation’s economy is its industrial and commercial growth. Heavy taxes discourage investments. If the tax is lower, it will attract more investment encouraging economic growth. As an additional effect, this will generate employment and improve the purchasing power of society as a whole. For example, Corporate Tax on profits is pegged at 25-30% plus surcharges if applicable. This is irrespective of the quantum of profits earned by the company. This will compel business owners to reinvest in expansion and diversification projects.
2. Proportional tax plan promotes higher income earners to work harder and earn more money. Second of all, the duty burden is normally distributed evenly among people so that lower-income earners are likely to invest more in their businesses. Third, a proportionate tax program encourages business owners to invest more cash and develop more jobs. As a result, the economy in general will grow, and the proportional approach encourages more businesses to operate.
3. A simple tax structure is easier for the government to implement it and the taxpayer. Those making huge profits will not be urged to find devious ways to evade tax as they know that the extra income earned stays with them. 

Disadvantages of Proportional Tax

1. Lower and middle-class families constitute the large majority of the population. The rich are a tiny fraction. Because of this disparity, the uniform Proportional Tax levied cannot be very high. At the same time, it should be sufficient to fund the requirements of the Government. 
2. Since the Proportional Tax cannot be indiscriminately kept high, the revenue of the Government is hit and creates budgetary constraints affecting economic growth.

Governments should, therefore, be cautious and implement Proportional Tax only in areas where the advantages outweigh its disadvantages. The four GST categories prevalent are shown below:

1. CGST (Central Goods and Services Tax): This is levied on the intra-state supply of products and services.
2. SGST (State Goods and Services Tax): SGST, like CGST, is levied on selling products or services within the State.
3. IGST (Integrated Goods and Services Tax): IGST is levied on state transactions of products and services across different States.
4. UTGST (Union Territory Goods and Services Tax): This is levied on the supply of products and services in the Union Territories in the country. UTGST is set along with CGST.

Conclusion

Taxation has always been a subject matter of experts. While a general idea can be obtained from published literature and data, every organization should use professional advice for their tax planning. The costs incurred for such advice would be a necessary and productive investment compared to the risk of ignoring them.

Tax structures and patterns vary from one country to another. A deep study of the country in which the organization is operating is a must if informed decisions are to be taken while implementing taxation plans.
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