What is Tax?

Last Updated On -01 Sep 2025

Any economy depends on taxes. They symbolize the compulsory payments that citizens and companies make to their states, which help countries finance state services, infrastructure, and social welfare activities. Governments would not be able to sustain law and order, erect schools and hospitals, or offer basic services like defense, transport, and medical care without taxes. Tax, in plain words, is the cost of civilized living.

The tax system is one of the largest and most complicated in the world. It not only finances the government activities but also encourages economic growth, equity, and stability. Over the past two decades, India has implemented significant tax reforms that simplified the structures and promoted compliance. Now, we will explore the core of tax, its nature, and how it forms the future of a nation.

Understanding Tax in India

In India, the powers of imposing taxes are directly derived from the Constitution of India. Each Government is divided into the Central Government and the State Governments, and the local bodies. For example:

The Central Government levies taxation such as income tax, corporate tax, customs duty, and excise duty.
State Governments are also tax collectors, like the state GST, state excise duty on alcohol, and stamp duties.
Local governments impose taxes such as property tax, water tax, and municipal tax.

This common accountability makes sure that revenues are shared equally to suit both national and local demands.

Types of Taxes in India

A functioning state is built upon taxes, and it is where the citizens are connected with their government. Being taxpayers who pay their taxes sincerely, people make a contribution to the national growth and well-being. The balance of direct and indirect taxes, progressive reforms such as GST, and the choice between the new and old tax regimes in the taxation system of India are the result of attempts to balance the simplicity, fairness, and revenue needs in this country.

Tax compliance is not only a legal responsibility but also a civic responsibility, as a citizen, a means of actively working towards the development of a stronger, more equitable India.

Taxes are of two types in a broad way:

Direct Taxes

Paid by individuals and Companies themselves.

Direct taxes are imposed on wealth. These are progressive taxes, and this implies that the more an individual earns, the more tax he or she pays.
Income Tax: It is paid by individuals on the basis of their earnings. India offers two regimes to the taxpayer:
Old Tax Regime: Higher rates but many exemptions and deductions.
New Tax Regime: Simpler with lower rates with fewer deductions.
Corporate Tax: Businesses pay this tax. The government has come up with concessional rates to startups and manufacturing companies to promote investment.
Capital Gains Tax: It is levied on the sale of assets such as property, stocks, or bonds. Gains should be classified as short-term and long-term, and each has a specific tax rate.

Indirect Taxes

Paid Indirectly via Goods and Services

The taxes are indirectly collected by making purchases of goods or services. At the end, the end consumer gets burdened.
Goods and Services Tax (GST): GST, which is the largest tax reform in India, was introduced in 2017. It has substituted various indirect taxes (such as VAT and excise duty) with one common tax. There are four significant slabs of GST 5, 12, 18, and 28, depending on the nature of the product or service.
Customs Duty: An import or export duty. It safeguards the local industries and controls international trade.
Excise Duty: It is levied on the production of such commodities as petroleum, tobacco, and alcohol.

Old Tax Regime vs. New Tax Regime

The introduction of the New Tax Regime has been one of the greatest changes that have occurred in India.

Old Regime: Encourages savings and investments through deductions (like Section 80C for life insurance, mutual funds, or PPF).
New Regime: Has lower tax rates but eliminates the majority of exemptions, which makes it easier for taxpayers who do not make heavy investments in saving instruments.

For example:

With the Old Regime, a person with earnings of 12 lakh in a year could save taxable income by investing in tax-saving schemes.
The New Regime means that the same person can pay a lower rate that is flat, but one without deductions.

Why Do We Pay Taxes?

The role of taxes extends far beyond just funding government expenditure. Some key purposes include:

Revenue Collection: To fund infrastructure, such as highways, metro, airports, and railways.
Redistribution of Wealth: It would be better to tax the rich more so that resources are distributed more fairly.
Economic Stability: Taxes promote the control of inflation and the fiscal deficit.
Behavioral Change: Taxes like "sin tax" on cigarettes and alcohol discourage harmful consumption.
Stimulating Investments: Concessions and rebates are given to individuals to invest in particular industries (e.g., renewable energy).

Challenges in India's Tax System

Though the setup is now better, there are still obstacles:

Low Tax Base: It is also estimated that income tax is paid by only a small percentage of the Indian population, even though it has more than 140 crore people.
Tax Evasion: Underreporting of income and black money is still there.
Complexity: In spite of simplification, the system remains confusing to most citizens.
Excessive dependence on Indirect Taxes: Indirect taxes, such as GST, are capable of weakening the poor.

Tax and Nation-Building

The tax/GDP ratio in India is approximately 11-12 and less than the global average of 15-20. Advanced nations such as the US, UK, and Germany are paying higher taxes as a percentage of their GDP, which allows these countries to offer more robust welfare programs. In the case of India, there is a need to raise the levels of compliance and to enlarge the tax base to benefit the ambitious development efforts.

Taxes are not the issue of compliance; it is the issue of creating a stronger nation. The following are some of how tax money is spent:

Education: Taxes are used to finance schemes such as the Samagra Shiksha Abhiyan.
Healthcare: Programs such as Ayushman Bharat offer affordable health care.
Infrastructure: Public funds are used to construct roads, smart cities, and power grids.
Defense and Security: A large portion of the taxes provides the security of the country.

Did you know?

One of the most ancient taxes in India was the tax on salt, which was introduced by the British during colonial rule. So controversial was it that in 1930, Mahatma Gandhi undertook the Dandi March protesting against the same, and taxation was a significant issue within the independence movement of India.

Frequently Asked Questions (FAQs)

Are direct and indirect taxes different?

Direct taxes are paid directly to the government by individuals or businesses, such as income tax and corporate tax. Indirect taxes are collected at the time of purchasing goods and services, like GST or customs duty, where the consumer indirectly bears the tax burden.

Which tax regime should I choose: Old or New?

The choice depends on your income level and investments. If you claim significant deductions (like 80C, HRA, home loan interest), the old regime may be beneficial. If you prefer simplicity with lower rates and minimal exemptions, the new regime might be better.

Why is India’s tax-to-GDP ratio considered low?

India’s tax-to-GDP ratio is around 11–12%, which is lower than the global average. This is due to a narrow tax base, widespread tax evasion, and reliance on indirect taxes. Expanding compliance can help improve this ratio.

How is tax money used by the government?

Tax revenue is used to fund infrastructure, education, healthcare, defense, welfare schemes, and subsidies. It ensures the smooth functioning of the government and supports long-term development goals.