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Canons of Taxation – Adam Smith's Principles

In 1776, economist Adam Smith laid down 4 golden rules for a good tax system in his book "The Wealth of Nations". These principles still guide tax policy today!

The Four Canons

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1. Canon of Equity (Fairness)

Principle: Taxes should be fair and just. Every person should pay according to their ability to pay.

"The rich should pay more than the poor"

Modern Application

Progressive Tax System:

Income ₹3L: 0% tax
Income ₹7L: 5% average
Income ₹20L: 17% average
Income ₹1 crore: 28% average

Higher income = Higher tax rate ✅ Equity achieved!

Examples

✅ Equitable:

  • Income tax with progressive slabs (0% to 30%)
  • Wealth tax on assets above ₹30 lakh (now abolished)
  • Higher GST on luxury goods (28%) vs essentials (0-5%)

❌ Not Equitable:

  • Flat tax rate for everyone (rich and poor pay same %)
  • Poll tax (same amount from everyone regardless of income)

Indian Context

Section 87A Rebate: No tax up to ₹7 lakh income

  • Rationale: Protect low-income earners ✅ Equity

Surcharge on Super Rich:

  • Income > ₹50 lakh: 10% surcharge
  • Income > ₹1 crore: 15% surcharge
  • Income > ₹2 crore: 25-37% surcharge

2. Canon of Certainty

Principle: Tax liability should be certain, not arbitrary. Taxpayer should know:

  • What to pay
  • When to pay
  • How to pay

"No surprises, no confusion"

Modern Application

Income Tax Act provides:

  • Clear tax slabs (published every budget)
  • Fixed due dates (July 31, October 31, December 31)
  • Defined procedures (e-filing, payment gateway)
  • Calculation formula (exact computation method)

Examples

✅ Certain:

  • Tax slab: ₹6L-9L taxed at 10% (clear!)
  • Due date: July 31 for individuals (fixed!)
  • TDS: Employer deducts tax monthly (known in advance!)

❌ Uncertain:

  • "Pay whatever officer decides" (arbitrary!)
  • "File return anytime within year" (vague!)
  • Frequent retrospective changes (2012 Vodafone case controversy)

Certainty vs Uncertainty

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3. Canon of Convenience

Principle: Tax payment should be easy and convenient for the taxpayer. Timing and method should suit the payer.

"Pay tax when you have money, not when you don't!"

Modern Application

TDS (Tax Deduction at Source):

  • Salaried: Tax deducted monthly (when salary received)
  • Not at year-end (when money already spent!)

Advance Tax:

  • Business owners pay quarterly (15%, 45%, 75%, 100%)
  • Aligned with cash flow

E-Filing:

  • File from home (no office visit!)
  • 24/7 availability
  • Pre-filled returns (95% data auto-populated)

Examples

✅ Convenient:

  • TDS on salary: Pay monthly, no lump sum shock
  • GST on purchases: Included in price, auto-paid
  • Self-assessment: You calculate, no officer harassment
  • Digital payments: UPI, net banking, credit card

❌ Inconvenient:

  • Pay all tax on March 31 (when poorest after year-long expenses!)
  • Visit tax office physically (waste time, travel cost)
  • Complex manual calculations (prone to errors)

Indian Convenience Features

Pre-filled Returns (AIS/TIS):

  • Salary auto-filled (from employer TDS)
  • Bank interest auto-filled
  • Capital gains auto-filled (from broker)
  • 95% data already there! Just verify and file

Faceless Assessment (2019):

  • No physical meeting with officer
  • All online communication
  • Reduces corruption, harassment

4. Canon of Economy

Principle: Cost of collection should be low compared to revenue. Don't spend ₹50 to collect ₹100 tax!

"Maximum revenue at minimum cost"

Efficiency Ratio

Formula: Collection Cost / Total Revenue × 100

India's Performance:

  • Direct Tax: ~0.5% collection cost
  • For every ₹100 collected, only ₹0.50 spent!
  • Efficient! ✅

Why India is Economical

1. TDS System:

  • Employer, bank, company deducts tax
  • No officers needed to chase individual taxpayers
  • Automated collection

2. Self-Assessment:

  • Taxpayer calculates own tax
  • No officer needed unless scrutiny
  • 95% returns auto-processed

3. E-Filing:

  • No paper, no post, no storage
  • Digital saves crores!

4. Data Integration:

  • PAN linked to bank, property, vehicle
  • Automatic cross-verification
  • Less manual audit needed

Examples

✅ Economical:

  • TDS: Automated, no chasing (cost ~0.3%)
  • E-filing: No physical infrastructure
  • Voluntary compliance: Self-assessment reduces officers

❌ Uneconomical:

  • Door-to-door tax collection (high manpower cost!)
  • Physical filing (paper, storage, sorting costs)
  • 100% audit (need crores of officers!)

Additional Modern Canons

Later economists added more canons:

5. Canon of Productivity

Tax should yield adequate revenue to government

India: ₹19 lakh crore income tax (2023-24) ✅ Productive

6. Canon of Elasticity

Tax should be flexible - increase/decrease easily as needed

Example: Budget changes tax rates yearly (elastic)

7. Canon of Simplicity

Tax laws should be simple to understand

Challenge: Income Tax Act 1961 has 298 sections! ❌ Not simple

Effort: New tax regime (2020) - simplified, fewer deductions

8. Canon of Diversity

Don't rely on single tax source - diversify

India: Income tax (55%) + GST (45%) ✅ Diversified

Application in Indian Tax System

CanonHow India Achieves It
EquityProgressive slabs 0-30%, rebate for ₹7L, surcharge on rich
CertaintyPublished slabs, fixed due dates, clear sections
ConvenienceTDS, e-filing, pre-filled returns, quarterly advance tax
Economy0.5% collection cost via TDS, self-assessment, automation

Real-World Example

Rajesh (₹10 lakh salary):

Equity: Pays ~₹1L tax (10% effective rate) vs rich person paying 25%+ ✅

Certainty: Knows exact tax in April itself (slab known) ✅

Convenience:

  • Employer deducts ₹8,000/month via TDS ✅
  • Files return online in July from home ✅

Economy:

  • No tax officer visits Rajesh ✅
  • Self-calculated tax ✅
  • Government's cost: ~₹500 to collect his ₹1L ✅

All 4 canons satisfied!

Summary

  • Canon of Equity: Fair distribution, rich pay more (progressive 0-30% slabs)
  • Canon of Certainty: Clear tax rules, fixed dates (July 31), known slabs
  • Canon of Convenience: TDS monthly, e-filing 24/7, pre-filled returns
  • Canon of Economy: Low collection cost (0.5%), TDS automated, self-assessment
  • Additional canons: Productivity (₹19L cr revenue), Elasticity (budget changes), Simplicity (challenge!), Diversity (direct + indirect mix)
  • India's performance: Meets most canons well, especially economy (0.5% cost)

Quiz Time! 🎯

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Next Chapter: Basic Definitions – Assessee, Deemed Assessee & Assessee-in-Default! 📚

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