MODULE 3

Financial Market and Fiscal System

3.1 Indian Money Market and Capital Market
Q1. Explain the Structure of Indian Money Market
A1: The Money Market is a market for lending and borrowing of short-term
funds. It deals in funds and financial instruments having a maturity period of
one day to one year. It covers money and financial assets that are close
substitutes for money. The instruments in the money market are of short-term
nature and highly liquid.
The Indian money market consists of two segments, namely organized sector
and unorganized sector.
(A) ORGANIZED -SECTOR OF INDIAN MONEY MARKET
1. Treasury Bills (T-Bills): Treasury bills are short-term securities issued by
RBI on behalf of Government of India. They are the main instruments of short
term borrowing by the Government. They are useful in managing short-term
liquidity. At present, the Government of India issues three types of treasury bills
through auctions, namely – 91 days, 182-day and 364-day treasury bills.
2. Commercial Bills: Commercial bill is a short-term, negotiable, and self-
liquidating instrument with low risk. They are negotiable instruments drawn by
a seller on the buyer for the value of goods delivered by him. Such bills are
called trade bills. When trade bills are accepted by commercial banks, they are
called commercial bills.
3. Repos: Repo rate is the rate at which the central bank of a country (Reserve
Bank of India in case of India) lends money to commercial banks in the event of
any shortfall of funds. Reverse repo rate is said to be that rate of interest at
which the central bank (RBI in India) borrows money from the commercial
banks for a short term.
4. Discount and Finance House of India (DFHI): The Discount and Finance
House of India (DFHI) is a money market institution incorporated in March
1988 and it commenced operation in April 1988. The prime objective of DFHI
is to facilitate smoothening of the short-term liquidity imbalances by developing
an active secondary market for the money market instruments.
5. Money Market Mutual Funds (MMMFs): Money market funds* (MMF)
are a type of mutual fund that invest in highly liquid, short-term, fixed-income
debt securities such as cash and cash equivalents, Treasury bills, commercial
papers, certificate of deposits (CD), etc.
6. Certificates of Deposits (CDs): CDs are unsecured, negotiable promissory
notes issued at a discount to the face value. They are issued by commercial
banks and development financial institutions. CDs are marketable receipts of
funds deposited in a bank for a fixed period at a specified rate of interest. CDs
were introduced in India in June 1989. The main purpose of the scheme was to
enable commercial banks to raise funds from the market through CDs.
(B) UNORGANIZED SECTOR OF INDIAN MONEY MARKET
The main components of unorganized money market are:
1. Indigenous Bankers: They are financial intermediaries which operate as
banks, receive deposits and give loans and deals in hundies. The hundi is a short
term credit instrument. It is the indigenous bill of exchange. The rate of interest
differs from one market to another and from one bank to another. They do not
depend on deposits entirely, they may use their own funds.
2. Money Lenders: They are those whose primary business is money lending.
Money lenders predominate in villages. However, they are also found in urban
areas. Interest rates are generally high. Large amount of loans are given for
unproductive purposes. The borrowers are generally agricultural labourers,
marginal and small farmers, artisans, factory workers, small traders, etc.
4. Finance Brokers: They are found in all major urban markets specially in
cloth markets, grain markets and commodity markets. They are middlemen
between lenders and borrowers.
Q.2 What are the features of Indian Money Market?
OR
Examine the defects of Money Market in India.
A2: The features of the Indian Money Market are as follow:
1. Existence of Unorganized Money Market: This is one of the major defects
of Indian money market. It does not distinguish between short term and long
term finance, and also between the purposes of finance. Since it is outside the
control and supervision of RBI, it limits the RBI’s control of over money
market.
2. Multiplicity in Interest Rates: There exists too many rates of interest in the
Indian money market such as the borrowing rate of government, deposits and
lending rates of cooperative and commercial banks, lending rates of financial
institutions, etc. This is due to lack of mobility of funds from one section of the
money market to another. The rates differ for funds of same durations lent by
different institutions.
3. Inadequate Funds: Generally there is shortage of funds in Indian money
market on account of various factors like inadequate banking facilities, low
savings, lack of banking habits, existence of parallel economy, etc. However,
the banking development particularly branch expansion, has improved the
mobilization of funds to some extent in the recent years.
5. Seasonal Stringency of Money: The seasonal stringency of money and high
rate of interest during the busy season (November to June) is a striking feature
of Indian money market. There are wide fluctuations in the interest rates from
one season to another. RBI has been taking various measures to avoid such
fluctuations in the money market by adding money into the money market
during the busy season and withdrawing the funds during the slack season.
6. Absence of Bill Market: A well-organized bill market is necessary for
linking up various credit agencies effectively to RBI. The bill market is not yet
developed on account of many factors such as the practice of banks keeping a
large amount of cash for liquidity purposes, preference for borrowing rather
than discounting bills, dependence of indigenous bankers on one another,
widespread practice of using cash credit, high stamp duty on usance bill, etc.
7. Lack of Integration: The Indian money market is broadly divided into two
sectors, the organized money market and the unorganized market. The
organized market constitutes several institutions such as RBI, State Bank of
India, commercial banks, cooperative banks and financial institutions. RBI as an
apex body regulates their working. The unregulated sector is not homogenous in
itself. It constitutes indigenous bankers, loan companies, money lenders, etc.
There is no uniformity in their practices and there is multiplicity of
functionaries.
Q3. What are the recent trends in the Indian Money Market?
A3: The recent trends in Indian Money Market are as follows:
1. Deregulation of Interest Rates: From May 1989, the ceiling on interest rates
on the call money, inter-bank short-term deposits, bills rediscounting and inter-
bank participation was removed and the rates were permitted to be determined
by the market forces. Thus, the system of administered interest rates is being
gradually dismantled.
2. Discount and Finance House of India (DFHI): In order to impart liquidity
to money market instruments and help the development of secondary market in
such instruments, DFHI was set up in 1988 jointly by RBI, public sector banks
and financial institutions.
3. Regulation of NBFCs: The RBI Act was amended in 1997 to provide for a
comprehensive regulation of NBFC sector. According to the amendment, no
NFBC can carry on any business of a financial institution, including acceptance
of public deposit, without obtaining a Certificate of Registration (CoR) from
RBI.
4. The Clearing Corporation of India Limited (CCIL): The CCIL was
registered on April 30, 2001 under the Companies Act, 1956, with the State
Bank of India as the chief promoter. The CCIL clears all transactions in
government securities and repos reported on the Negotiated Dealing System
(NDS) of RBI.
5. Repurchase Agreements (Repos): RBI introduced repos in government
securities in December 1992 and reverse repos in November 1996. Repos and
reverse repos help to even out short-term fluctuations in liquidity in the money
market. They also provide a short-term avenue to banks to park their surplus
funds. Through changes in repo and reverse repo rates RBI transmits policy
objectives to entire money market.
6. Liquidity Adjustment Facility (LAF): RBI has introduced LAF from June
2000 as an important tool for adjusting liquidity through repos and reverse
repos. Thus, in the recent years RBI is using repos and reverse repos as a policy
to adjust liquidity in the money market and therefore, to stabilize the short-term
interest rates or call rates. LAF has, therefore, emerged as a major instrument of
monetary policy.
Q4. Explain the role of Indian Capital Market.
A4: Capital market is a place where buyers and sellers indulge in trade
(buying/selling) of financial securities like bonds, stocks, etc. The trading is
undertaken by participants such as individuals and institutions. Capital market
trades mostly in long-term securities.
The role of the Indian Capital Market as follows:
1. Modernization and Rehabilitation of Industries: Capital market can
contribute towards modernization, rationalization and rehabilitation of
industries. For example, the setting up of development financial institutions in
India such as IFCI, ICICI, IDBI and so on has helped the existing industries in
the country to adopt modernization and replacement of obsolete machinery by
providing adequate finance.
2. Technical Assistance: An important bottleneck faced by entrepreneurs in
developing countries is technical assistance. By offering advisory services
relating to the preparation of feasibility reports, identifying growth potential and
training entrepreneurs in project management, the financial intermediaries in the
capital market play an important role in stimulating industrial entrepreneurship.
This helps to stimulate industrial investment and thus promotes economic
development.
3. Encourage Investors to invest in Industrial Securities: Secondary market
in securities encourage investors to invest in industrial securities by making
them liquid. It provides facilities for continuous, regular and ready buying and
selling of securities. Thus, industries are able to raise substantial amount of
funds from various segments of the economy.
4. Reliable Guide to Performance: The capital market serves as a reliable
guide to the performance and financial position of corporate, and thereby
promotes efficiency. It values companies accurately and toes up manager
compensation to stock values. This gives incentives to managers to maximize
the value of companies. This stimulates efficient resource allocation and
growth.
5. Channelization of Funds into Investments: Capital market plays a crucial
role in the economic development by channelizing funds in accordance with
development priorities. The financial intermediaries in the capital market are
better placed than individuals to channel the funds into investments which are
more favourable for economic development.
6. Industrial Development: Capital market contributes to industrial
development in the following ways:
• It provides adequate, cheap and diversified finance to the industrial sector
for various purposes.
• It provides funds for diversified purposes such as for expansion,
modernization, upgradation of technology, establishment of new units
etc.
Q5. Explain the structure of Indian Capital Market.
A5: check Jason sir’s notes on the drive
Q6. State the reforms of capital market under
a) primary sector b) secondary sector
A6: Reforms under Primary sector:
1. Securities and Exchange Board of India (SEBI): SEBI was set up as a non-
statutory body in 1988 and was made a statutory body in January 1992. SEBI
has introduced various guidelines for capital issues in the primary market.
2. Disclosure Standards: Companies are required to disclose all material facts
and specific risk factors associated with their projects. SEBI has also introduced
a code of advertisement for public issues for ensuring fair and truthful
disclosures.
3. Freedom of Determine the Par Value of Shares: The requirement to issue
shares at a par value of Rs.10 and Rs.100 was withdrawn. SEBI has allowed the
companies to determine the par value of shares issued by them. SEBI has
allowed issues of IPOs through “book building” process.
4. Underwriting Optional: To reduce the cost of issue, underwriting by the
issuer is made optional. It is subject to the condition that if an issue was not
underwritten and was not able to collect 90% of the amount offered to the
public, the entire amount collected would be refunded to the investors.
5. FIIs Permitted to Operate in the Indian Market: Foreign institutional
investors such as mutual funds and pension funds are allowed to invest in equity
shares as well as in debt market, including dated government securities and
treasury bills.
6. Intermediaries under the Purview of SEBI: Merchant bankers, and other
intermediaries such as mutual funds including UTI, portfolio managers,
registrars to an issue, share transfer agents, underwriters, debenture trustees,
bankers to an issue, custodian of securities, and venture capital funds have been
brought under the purview of SEBI.
Reforms under Secondary sector:
1. Setting up of National Stock Exchange (NSE): NSE was set up in
November 1992 and started its operations in 1994. It is sponsored by the IDBI
and co-sponsored by other development finance institutions, LIC, GIC,
Commercial banks and other financial institutions.
2. Over the Counter Exchange of India (OTCEI): It was set in 1992. It was
promoted by a consortium of leading financial institutions of India including
UTI, ICICI, IDBI, IFCI, LIC and others. It is an electronic national stock
exchange listing an entirely new set of companies which will not be listed on
other stock exchanges.
3. Rolling Settlement: Rolling settlement is an important measure to enhance
the efficiency and integrity of the securities market. Under rolling settlement all
trades executed on a trading day are settled after certain days.
4. The National Securities Clearing Corporation Ltd. (NSCL): The NSCL
was set up in 1996. It has started guaranteeing all trades in NSE since July
1996. The NSCL is responsible for post-trade activities of the NSE. Clearing
and settlement of trades and risk management are its central functions.
5. Trading in Central Government Securities: In order to encourage wider
participation of all classes of investors, including retail investors, across the
country, trading in government securities has been introduced from January
2003. Trading in government securities can be carried out through a nationwide,
anonymous, order-driver, screen-based trading system of stock exchanges in the
same way in which trading takes place in equities.
6. Mutual Funds: Emergency of diversified mutual funds is one of the most
important development of Indian capital market. Their main function is to
mobilize the savings of general public and invest them in stock market
securities. Mutual funds are an important avenue through which households
participate in the securities market.
Q7. Explain the role/significance of SEBI.
A7: SEBI was established as a non-statutory board in 1988 and January 1992, it
was accorded statutory status. The regulatory powers of SEBI were increased in
January 1995. It has now become a very important constituent of the financial
regulatory framework in India. The SEBI is under the overall control of the
Finance Ministry.
1. Promotion and Development of Capital Market: It protects the rights and
interests of investors, especially the individual investors. It prevents trading
malpractices. Its regulatory measures are meant for the healthy development of
capital markets.
2. Regulatory Role: Another important role of SEBI is the regulation of the
security markets in India. The SEBI can frame or issue rules, regulations,
directives, guidelines, norms with respect to primary and secondary markets.
3. Protection of Interest of Investors: An important role of SEBI is the
protection interest of investors in securities. SEBI has introduced various
measures to protect the interests of investors. To ensure no malpractice takes
place in the allotment of share, a representative of SEBI supervises the
allotment process.
4. Investor’s Education: SEBI has a role of educating the investors about the
securities market. It issues advertisements from time to time to enlighten the
investors on various issues related to the securities market and of their rights
and remedies.
5. Investor’s Grievances Redressal: SEBI plays another role of redressing the
investor’s grievances. SEBI has introduced an automated complaints handling
system to deal with investor complaints. The Investor Grievances Redressal and
Guidance Division of SEBI assists investors who want to make complaints to
SEBI against listed companies.
6. Primary Market Policy: SEBI looks after all the policy matters and
regulatory issues with respect to primary market. It is responsible for vetting of
all the prospectuses and letters of offer for public and right issues, for co-
ordinating with the primary market policy, for registration, regulation and
monitoring of issue related intermediaries.
3.2 Measure of Money supply
Q8. Write a short note on the measure of Money supply in India.
A8: Supply of money refers to the stock of money held by the public for a given
period of time as a means of payment and store of value.
RBI uses the following 4 measures of money supply
M1 = Currency held by public + demand deposits with commercial banks +
other deposits with commercial bank
Narrow definition of money
M2 = M1 + Savings deposits with post office saving banks.
Also includes small time deposits which are less than 1 crore and money market
mutual funds.
Wider Definition of money
M3 = M2 + Time deposits with commercial banks (deposits of more than 1
crore)
M4 = M3 + Total deposits with post office saving organisation (NSC excluded)
The highest liquidity lies with the one having currency component followed by
demand deposit as it is easily converted to money on demand. Then is savings
deposit. Finally comes the time deposit and total deposit which can also be
converted to money without any loss of interest only upon maturity. If encashed
before, the depositor has to accept lower interest.
MO = currency in circulation + currency deposited by commercial banks with
RBI + other deposits with RBI.
High Powered Money
3.3 Public Revenue
Q9. Define Public revenue. Give the sources of public revenue.
A9: Public revenue refers to the income earned by the government from its
various sources.
Sources of public revenue:
1) Taxes: The government levies tax on the citizens of the country. This is a
vital source of public revenue because taxes are compulsory payment made by
the citizens on whom it is levied on, to the government without expecting any
goods or services in return for the welfare of the state.
2) Duties: The government imposes excise duties on the consumption of those
goods which proves to be harmful to the health and well being of the citizens.
For example: Duty on Consumption of wine, opium, etc.
3) Commercial Revenues: commercials revenues refer to the revenue received
by the government because of the payments made by the citizens for using
government provided public services. For example: City bus transport,
electricity and water supply, etc.
4) Fines and Penalties: The government imposes fines and penalties on those
citizens who break the law. For Example: Violating traffic rule, etc. the motive
behind this is not to ern income but to discourage the citizens from breaking the
law.
5) Government Properties: Another source of public revenue is income
generated from government owned properties like mines, forests, etc.
6) Gifts and Grants: Sometimes, voluntary contributions are made by the
citizens of the country, private sectors and foreign government to the
government. This is termed as gift and grants.
3.4 Public expenditure
Q10. What is public expenditure? Give its types.
A10: Public Expenditure refers to the expenses incurred by the public
authorities, viz. the central government, state government and local bodies for
the maintenance of law and order and satisfying the collective needs of the
citizens and/ or promoting their economic and social welfare.
Types of public expenditure
1) Direct and Indirect Expenditure
Direct Expenditure refers to expenses incurred by the government on the
purchase of goods and current services of factors of production. Also known as
Exhaustive and non- transfer expenditure. Ex: expenses incurred on defence,
civil services, etc.
Indirect Expenditure refers to the payments without any corresponding return of
any factor services for such expenditure. Also known as transfer payments. Ex:
old age pension, compensation, etc.
2) Developmental and Non- Developmental Expenditure
Developmental expenditure refers to expenses incurred on the development of
the public. Ex: Education, etc
Non- Developmental expenditure are expenses incurred on non- developmental
activities like administration, maintenance of law, etc.
3) Productive and Non- productive expenditure
Productive expenditures refer to expenses incurred on improving the productive
capacity of the economy and are in the nature of investment like machinery,
factories, etc.
Non- productive refers to expenses incurred on not improving the productive
capacity of the economy and are in the nature of consumption.
4) Capital and Revenue Expenditure
Capital expenditure are made only once and are not of recurring nature. Ex:
Expenses incurred on setting up plants, etc.
Revenue expenditure is that of a recurring nature and is made on administration
and maintenance.
Q11. State the cause for the rise in public expenditure.
A11: The following reasons are responsible for the rise in public expenditure:
1) Rise in population: one of the major reasons for rise in public expenditure is
the growing population. The government has to cater to the needs of all the
citizens and a rise in population leads to a rise in public expenditure.
2) Defence expenditure: Even without the war going on the Government has to
incur expenses on maintaining the army and manufacturing sophisticated arms.
This involves high public expenditure.
3) Developmental needs: A large part of public expenditure is made on
satisfying the developmental needs of the citizens like providing the citizens
with education, hygiene, etc.
4) Provision of utility services: The government provides its citizens with
utility services like electricity, water supply, public transport, etc. the expense
involved in providing this is too high.
5) Increase in subsidies: The government in order to motivate the workers to
stay employed and maintain their status in the society, makes transfer payments
to them like old age pension, compensation, etc.
6) Growing State Function: Earlier the state was only concerned with
maintenance of law and order but now since the state is a welfare state it incurs
expenses on promoting the social and economic welfare of its citizens.
3.5 Public Debt
Q12. Define Public debt.
A12. Public debt refers to the debt which the government owes to the citizens of
its own country or to the government of a foreign country. It refers to the
borrowing of money from the residents of domestic country or from the foreign
countries.
Q13. State the methods for public debt redemption
A13. Methods for public debt redemption:
1) Sinking Fund: a separate fund which Government may sometimes create by
depositing a certain amount of revenue in it every year for the repayment of
outstanding debt. This is then used to pay both interest and principal
components of loans.
2) Refunding: is the process by which Government raises fresh, new loans to
pay off old, maturing loans. This method is adopted if Government is unable to
repay the existing loan out of available resources. This method accumulates
debt and postpones the debt repayment to a future date.
3)Terminal Annuities: Government pays the debt in equal annual instalments
called annuities, comprising both interest and principal components of the loan.
The debt burden keeps reducing each year until it is fully paid off.
4) Debt Conversion: Government converts a high interest-bearing loan which it
had borrowed when interest rate was high, into a low interest-bearing loan when
interest rates fall. This reduces the interest burden for Government. This is
possible, if Government enjoys good credit- worthiness.
5) Budgetary Surplus: If Government has a surplus budget, it may use this to
pay off public debt and reduce its liabilities. However, surplus budget is a rare
phenomenon.
6) Purchase of government bonds: Government may buy its own bonds and
securities from the market. This leads in automatic liquidation of the debt
liability of the government.
3.6 Intergovernmental fiscal relation between the state and centre and the
financial commission
Q14. Comment on the Intergovernmental fiscal relation between the state
and centre and the financial commission
A14: In India, the intergovernmental fiscal relationship between the state and
the centre is governed by the Constitution of India and Various laws, rules and
regulation. The constitution of India has provided with a three- tier government:
• The union (central) government
• The state government
• Local bodies like panchayats, municipalities, etc
The intergovernmental fiscal relationship between the centre and state is a very
critical aspect of the Indian Government and the Finance commission plays an
important role in determining the distribution of resources between the centre
and the state. The finance commission is a constitution body appointed every 5
years to give recommendation on distribution of tax revenue between the centre
and the state.
The Finance commission is responsible for the following recommendation:
• The distribution of net proceeds of tax between the state and the centre
• The principles that should govern the grants-in-aid to the states by the
 Centre.
• The measures needed to augment the consolidated fund of a state to
supplement the resources of the panchayats and municipalities.
• The measures needed to maintain the financial stability of the states.
The Finance Commission also makes recommendations on other matters related
to fiscal management, such as the debt burden of the states, the financing of
disaster management, and the maintenance of fiscal discipline. The
recommendations of the Finance Commission are typically implemented
through legislation passed by the Parliament.
3.7 Indian Tax Structure
Q15. Define Tax. State its characteristics.
A15: Taxes are compulsory contribution from a person to the government to
defray the expenses incurred in the common interest of all, without reference to
special benefits conferred.
Nature/characteristics of taxes:
1. Compulsory Contribution: Tax is a compulsory contribution due to income
earned, ownership of property and certain economic activities by taxpayers. It is
compulsory to pay taxes and refusal to do so is liable to legal action and
punishment by Government.
2. Personal Obligation: It imposes a personal obligation on the taxpayer to pay
the required taxes and the taxpayer should not indulge in any malpractices like
hiding income or evasion of taxes.
3. General Benefit: Taxes received are used by Government for common and
general benefit of all the people and no individual taxpayer may expect to
receive individual benefits for taxes paid. Example- A property taxpayer should
not expect that the taxes paid by him would be used to repair the road outside
his property.
4. No Quid Pro Quo: (something given in return). A taxpayer does not receive
a definite, direct, proportionate benefit from the Government for taxes paid.
There is no direct give-and-take relationship between the Government and
taxpayer. Example- A taxpayer paying Rs One Lakh annually as taxes cannot
claim a benefit of Rs One Lakh from the Government.
Q16. State the classification of Taxes.
A16: Taxes are classified as follows:
Proportional Taxation: A tax is called Proportional when the rate of taxation
remains the same as the income of the taxpayer increases. All income is taxed at
a uniform rate whether the taxpayer’s income is high or low. The absolute
amount of tax increases with increase in income, but the proportion of tax
liability remains the same.
Progressive Taxation: A tax is called Progressive when the rate of taxation
increases as the income of the taxpayer increases. Here, lower income is taxed
at a lower rate and higher income is taxed at a higher rate. With an increase in
income, tax amount increases in absolute terms and also as a proportion of the
income.
Regressive Taxation: A tax is called Regressive when the rate of taxation
decreases as the taxpayer’s income increases and vice-versa. Here lower income
is taxed at a higher rate and higher income is taxed at a lower rate. However, the
absolute amount of tax may increase with increase in income.
Degressive Taxation: A tax is called Degressive when the rate of progression
in taxation does not increase in the same proportion as increase in income. It
may be mildly progressive. It may be a combination of Progressive and
Proportional Taxation. The tax rate increases up to a certain limit with increase
in income (Progressive) beyond which the tax rate remains uniform, irrespective
of increase in income (Proportional).
Q17. What are the essentials of a good tax system?
A17: the essentials of a good tax system are as follows:
1. Equity: the burden of the tax should be distributed among the different
sections of the society in a just and equitable manner. This implies that
the heaviest bird and should fall on the broader shoulder. The burden of
the tax should fall on the rich class more than the poor because they are in
a better position to pay the tax.
2. Productivity: the tax system should be able to generate enough revenue
to meet the expenditure of the government and also it has to be seen that
it does not discourage the productive capacity of the country.
3. Elasticity: it should be elastic so that when the government requires
increased revenue, the tax system should also yield more income with a
slight increase in the rate of taxes.
4. Convenience: why devising a tax system, the government should keep in
mind the convenience of the taxpayer. The timing in the mood of the tax
payment should be convenient to the taxpayer.
 5. Absence of tax evasion: a tax system should be so devised as to leave no
scope for tax evasion on the part of the taxpayers. For this purpose,
proper mix of direct and indirect taxes are required.
Q18. Differentiate between Direct Tax and Indirect Tax.
A18:
Direct Tax Indirect Tax
Direct tax Is that tax which is initially imposed
Is that tax whose money burden is on and paid by one person but the
borne by the same person on whom money burden is passed on to some
it is levied other person who ultimately bears
it.
Impact and Incidence of tax is on the Impact and Incidence of tax fall on
same person different persons.
Taxpayer has to pay it himself and Producers and sellers as taxpayers
cannot shift the money burden of can shift the money burden of tax to
tax on some other person the consumers
Is levied on the income and property Is levied on expenditure incurred
of a person
Example-Income tax, Property tax, Example- Excise duty, Sales Tax,
Capital gains tax, Wealth tax, VAT, Customs duty etc. Most of the
Corporation tax (tax on a company’s indirect taxes have now been
profits), Death duty replaced with Goods & Services Tax
(GST) levied on expenditure
incurred.

Q19. Write a short note on Direct Tax.

A19: direct tax is the tax whose Money burden is borne by the same person on
whom it is levied. Example: income tax, property tax, wealth tax, death duty,
etc.
Merits of direct tax:
1. Economical: the cost of collecting direct tax is relatively low as they are
usually collected from the source it self and are paid directly to the
government by the taxpayer.
2. Certain: taxpayers know how much they have to pay and on what basis
they have to pay. The government is also fairly aware about the amount
of tax we are going to receive.
3. Elasticity: elastic as the government revenue can be increased by raising
the tax rate in times of crisis.
Demerits of direct tax:
1. Unpopular: direct tax levies direct burden on individuals, thus not
popular among people
2. Inconvenient: direct tax causes a lot of inconvenience. For example:
sometimes businessmen or required to pay taxes in one instalment.
3. Tax evasion: many small businessmen escape the income tax by
presenting false account statement to the tax authority.
Q20. Write a short note Indirect Tax.
A20: indirect tax is the tax which is initially imposed on and paid by one person
but the money burden is passed on to some other person who ultimately bears it.
Example: goods and services tax.
Merits of indirect tax:
1. Wide coverage: indirect taxes can be imposed on the large variety of
goods so that most of the people can contribute something to the revenue
of the government
2. Socially desirable: indirect taxes helps to increase social welfare. Heavy
indirect taxes on articles which are undesirable and injurious to health,
such as wine, opium, et cetera. May restrict their consumption.
3. No evasion: the chances of tax evasion in case of indirect taxes are less
as they are included in the price of the commodities.
Demerits of indirect tax:
1. Inequality: generally, and direct taxes are imposed on consumers goods.
The poor people have to pay the same price for the good as a rich people.
This is understand and equitable.
2. An economical: the administrative cost of collecting indirect tax is
generally heavy as they have to be collected from a large number of
people.
3. Inflationary: indirect taxes feed the inflationary forces in the economy.
The increase the price of the commodity which is in itself inflationary.
This increase the cost of living and as a result of this, the trade unions,
my demand higher wages.
Q21. Explain the cannons of taxes.
A21: The canons of taxes are as follows:
Canon of productivity: this canon implies that a tax system should be able to
generate enough revenue to meet the requirements of the government and also it
should be imposed in such a manner as not to obstruct and discourage
production.
Canon of elasticity: this canon implies that the taxes should be levied that they
can be easily increased or decreased according to the requirements of the
economy. For example: in case of emergency, the tax should be capable of
yielding more revenue by an increase in the tax rate.
Canon of simplicity: the tax system should be simple so that the taxpayer can
understand its implications. A complex tax system will increase the chances of
corruption in the country.
Canon of coordination: according to this garden, there should be coordination
between different taxes that are imposed by various tax authorities that is
Central, state, and local government.
Canon of convenience: according to the scanning, the mood and timings of the
tax payment should be convenient to the taxpayer. For example: land revenue
should be collected at the harvest time.