Economy
Public Finance, Budget and Taxation
Taxation: Direct and Indirect Taxes
Tax concepts for CGPSC: direct vs indirect, incidence, buoyancy, cess vs surcharge, Income-tax Act 2025, new regime slabs, corporate tax and state taxes.
Prerequisites
- Union Budget: Structure and Classification — taxes are revenue receipts; this page explains their kinds.
- Centre-State Financial Relations — which government may levy which tax (Union, State and Concurrent Lists; Arts 268–271).
The Hook: Who Really Pays?
Connect
When a cement plant near Baloda Bazar pays GST on a bag of cement, the company writes the cheque. But the price on the bag goes up, and the farmer in Bemetara building a pucca house finally bears the tax. A salaried officer in Raipur, on the other hand, cannot pass his income tax on to anyone.
Who writes the cheque and who bears the burden are different questions, and the answer decides whether a tax is direct or indirect, progressive or regressive. This page sorts out the concepts and India’s main taxes as of 2026.
Why it matters: Prelims tests concepts (incidence, buoyancy, cess vs surcharge), abolished taxes and current rates. Mains asks about the tax-GDP ratio, equity of the tax system and the need for tax reform.
1. Core Concepts
Direct and indirect taxes
| Direct tax (प्रत्यक्ष कर) | Indirect tax (अप्रत्यक्ष कर) | |
|---|---|---|
| Impact and incidence | On the same person; cannot be shifted | Impact on the seller, incidence shifted to the consumer |
| Base | Income, profit, wealth | Consumption, transactions, imports |
| Equity | Can be progressive | Tends to be regressive (poor spend a larger share of income) |
| Examples (Union) | Income tax, corporation tax, securities transaction tax | GST (CGST, IGST), customs duty, Union excise (petroleum, tobacco) |
| Examples (State) | Land revenue, agricultural income tax, profession tax | SGST, VAT on petrol/diesel and liquor, state excise on alcohol, stamp duty, electricity duty, motor vehicle tax |
Other key terms
| Term | Meaning |
|---|---|
| Impact | Who pays the tax to the government first |
| Incidence | Who finally bears the money burden |
| Progressive tax | Rate rises as income rises (income tax slabs) |
| Proportional tax | Same rate at all incomes (a flat tax) |
| Regressive tax | Takes a larger share of a poor person’s income (most consumption taxes in effect) |
| Ad valorem | Levied as a % of value (most GST) |
| Specific | Levied per unit of quantity (per litre, per tonne) |
| Tax buoyancy | % change in tax revenue ÷ % change in GDP, including the effect of rate and base changes |
| Tax elasticity | Response of revenue to GDP excluding discretionary changes in rates and base |
| Laffer curve | Beyond some point, higher tax rates reduce total revenue (Arthur Laffer) |
| Pigouvian tax | Tax on a harmful activity to correct an externality (carbon tax, “sin” taxes) |
| Tax expenditure | Revenue forgone through exemptions and deductions |
Buoyancy above 1 means tax revenue is growing faster than the economy.
Cess and surcharge (उपकर और अधिभार)
| Cess | Surcharge | |
|---|---|---|
| Nature | Tax for a specific purpose; proceeds are earmarked | Tax on a tax, levied on top of the main rate |
| Constitutional basis | Excluded from the divisible pool by Art 270(1) | Art 271: surcharge on taxes in Arts 269 and 270 goes wholly to the Union |
| Shared with states? | No | No |
| Example | Health and Education Cess of 4% on income tax | Surcharge on high incomes |
This is why states complain that a rising share of cesses and surcharges in Union tax revenue reduces their effective share, even though the Finance Commission share stays at 41% (see Finance Commission).
2. India’s Tax Structure (as of 2026)
The tax mix (Union Budget 2026-27, Budget Estimates)
- Gross tax revenue about ₹44.04 lakh crore, about 11.2% of GDP.
- Of every rupee received: income tax 21 paise, corporation tax 18, GST and other taxes 15, Union excise 6, customs 4 — so direct taxes (39 paise) exceed indirect taxes (25 paise).
Personal income tax
- Income-tax Act, 2025 replaces the Income-tax Act, 1961 from 1 April 2026. It cuts the law to about 536 sections, uses plain language and replaces “previous year / assessment year” with a single “tax year”. It simplifies drafting; it was not meant to change rates.
- The new tax regime has been the default since 2023-24; the old regime (with deductions such as 80C) remains optional.
- New-regime slabs (set in Budget 2025-26; unchanged in Budget 2026-27):
| Income (₹) | Rate |
|---|---|
| Up to 4 lakh | Nil |
| 4–8 lakh | 5% |
| 8–12 lakh | 10% |
| 12–16 lakh | 15% |
| 16–20 lakh | 20% |
| 20–24 lakh | 25% |
| Above 24 lakh | 30% |
- With the rebate, no tax is payable on income up to ₹12 lakh under the new regime (about ₹12.75 lakh for salaried taxpayers after the ₹75,000 standard deduction).
- The 4% Health and Education Cess and surcharges on high incomes apply on top.
Corporation tax
- September 2019 cut (Taxation Laws (Amendment) Ordinance, later an Act): domestic companies could opt for a 22% base rate without exemptions (about 25.17% with surcharge and cess), and new manufacturing companies for 15% (about 17.01% effective). The 15% option applied to units that began production by 31 March 2024.
- The government invoked the FRBM escape clause partly citing this cut as a structural reform — see Fiscal Deficit and FRBM.
Abolished taxes (classic Prelims list)
| Tax | Status |
|---|---|
| Estate duty | Abolished in 1985 |
| Gift tax | Abolished in 1998 (gifts are now taxed as income above limits) |
| Wealth tax | Abolished by Budget 2015-16, replaced by a surcharge on the super-rich |
| Fringe benefit tax | Abolished in 2009 |
| Dividend distribution tax | Abolished from 2020-21; dividends taxed in the hands of shareholders |
Non-tax revenue
Interest receipts, dividends and profits (including the RBI’s surplus transfer — a record of about ₹2.69 lakh crore was approved in May 2025), fees, spectrum charges and other receipts. For Chhattisgarh, mineral royalty (coal, iron ore, bauxite, limestone) is the big non-tax source — see Minerals, Energy and Industry.
Tax reform committees
| Committee | Year | Known for |
|---|---|---|
| Raja Chelliah Tax Reforms Committee | 1991–93 | Lower and fewer rates, wider base; blueprint of 1990s reform |
| Vijay Kelkar Task Forces | 2002 (direct and indirect taxes), 2004 (FRBM implementation) | Simplification; the 2004 report pushed for a comprehensive GST |
| Parthasarathi Shome — Tax Administration Reform Commission | 2013–14 | Taxpayer services, administration |
| Akhilesh Ranjan Task Force | 2019 | New direct tax law (draft Direct Taxes Code) |
3. Analysis for Mains: Is India’s Tax System Fair and Adequate?
| Strength | Weakness |
|---|---|
| Direct taxes now exceed indirect taxes in Union receipts (39 vs 25 paise in 2026-27 BE) | Tax-GDP ratio (Union gross about 11.2%) is low for India’s development needs |
| GST unified the indirect tax market; 2025 rate cuts reduced the burden on common goods | Narrow personal income tax base: a small share of people pay income tax |
| Faceless assessment, TDS/TCS and data analytics improve compliance | Heavy use of cesses and surcharges bypasses the divisible pool |
| Simpler Income-tax Act from April 2026 | Agriculture income is exempt from Union income tax (Union List entry 82 excludes it); large informal sector |
Chhattisgarh angle: the state’s own tax revenue rests on SGST, VAT on fuel and liquor, stamp duty and state excise, while mineral royalty gives it a strong non-tax base. Under destination-based GST, a producing state like Chhattisgarh gains less from goods it produces but other states consume, which makes mining royalty and central devolution more important. See Chhattisgarh Economy and Schemes.
Memory Tricks
Abolished taxes: E-G-F-W-D
“Every Good Father Wants Dividends” — Estate duty 1985, Gift tax 1998, Fringe benefit tax 2009, Wealth tax 2015-16, DDT 2020-21. In order of abolition.
New regime slabs: the 4-lakh staircase
Every step is ₹4 lakh wide and the rate climbs by 5: 0 / 5 / 10 / 15 / 20 / 25 / 30, with the top rate from ₹24 lakh. Rebate makes everything up to 12 tax-free.
Buoyancy vs elasticity
Buoyancy includes Budget changes (rate and base changes); Elasticity Excludes them.
Don’t Confuse
| This | vs | That |
|---|---|---|
| Impact — who pays the government | vs | Incidence — who finally bears the burden |
| Cess — earmarked purpose, outside divisible pool (Art 270) | vs | Surcharge — tax on tax, wholly Union (Art 271) |
| Tax buoyancy — includes discretionary changes | vs | Tax elasticity — excludes them |
| Income-tax Act, 2025 — in force 1 April 2026 | vs | Income-tax Act, 1961 — replaced |
| 22% corporate rate (existing companies, no exemptions) | vs | 15% (new manufacturing, production by 31 March 2024) |
Common Mistakes
MCQ traps
- “GST is a direct tax because it is collected from the seller directly.” False. Its incidence is shifted to the consumer, so it is indirect.
- “Surcharges are shared with states under Article 270.” False. Art 271 gives surcharges wholly to the Union.
- “Wealth tax was abolished in 1985.” That was estate duty. Wealth tax went in Budget 2015-16.
- “Budget 2026-27 raised the tax-free limit beyond ₹12 lakh.” False. Slabs were unchanged; the ₹12 lakh rebate dates from Budget 2025-26.
- “Agricultural income is taxed by the Union.” False. It is excluded from Union income tax; states may tax it (State List).
- “Tax buoyancy below 1 means revenue is falling.” False. It means revenue is growing slower than GDP.
Practice
All questions below are original practice questions written in CGPSC style. They are not previous-year questions.
Level 1: Foundation
- If tax revenue grows by 12% when nominal GDP grows by 10%, tax buoyancy is ______.
- The Income-tax Act, 2025 came into force on ______.
- Surcharges on Union taxes go wholly to the Union under Article ______.
Answers
- 12 ÷ 10 = 1.2.
- 1 April 2026.
- 271.
Level 2: Prelims MCQs
Q1. Consider the following statements:
- The incidence of a direct tax can be shifted to another person.
- Most consumption taxes tend to be regressive in effect.
- Tax elasticity excludes the effect of discretionary changes in tax rates.
Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 and 3 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Answer and explanation
(b) 2 and 3 only. The incidence of a direct tax stays on the payer; it is the indirect tax whose incidence is shifted. Consumption taxes take a larger share of poorer households’ income, so they are regressive in effect. Elasticity excludes discretionary changes; buoyancy includes them.
Q2. Match List I (Tax) with List II (Year of abolition):
| List I | List II |
|---|---|
| A. Estate duty | 1. 2020-21 |
| B. Gift tax | 2. 1985 |
| C. Wealth tax | 3. 1998 |
| D. Dividend distribution tax | 4. 2015-16 |
- (a) A-2, B-3, C-1, D-4
- (b) A-3, B-2, C-4, D-1
- (c) A-2, B-3, C-4, D-1
- (d) A-2, B-4, C-3, D-1
Answer and explanation
(c) A-2, B-3, C-4, D-1. Estate duty went in 1985, gift tax in 1998, wealth tax with Budget 2015-16 (replaced by a surcharge) and DDT from 2020-21, after which dividends were taxed in the hands of shareholders.
Q3. Under the new tax regime applicable in 2026-27, a resident individual with taxable income of ₹10 lakh (no other income):
- (a) pays tax at 10% on the entire ₹10 lakh
- (b) pays no tax because of the rebate
- (c) pays tax at 5% on ₹6 lakh
- (d) must use the old regime
Answer and explanation
(b). The rebate makes income up to ₹12 lakh tax-free under the new regime (slabs set in Budget 2025-26 and unchanged in 2026-27). The new regime is the default, so (d) is wrong.
Q4. Which of the following is not a part of the divisible pool of central taxes shared with the states?
- (a) Corporation tax
- (b) Personal income tax
- (c) Central GST
- (d) Health and Education Cess
Answer and explanation
(d). Cesses for specific purposes are excluded from the divisible pool by Article 270. Corporation tax, income tax and CGST are all shared on the Finance Commission’s recommendation.
Level 3: Mains Answer Writing
Q1. (60 words) Distinguish between a cess and a surcharge, and explain why states object to them.
Model answer outline
- Cess: earmarked tax for a purpose (Health and Education Cess 4%); excluded from the divisible pool (Art 270).
- Surcharge: tax on a tax; wholly Union (Art 271).
- States’ objection: a rising share of both shrinks the pool shared at 41%, so states’ effective share of gross Union taxes falls below the headline figure.
Q2. (150–200 words) “India’s tax system has become more progressive but remains narrow-based.” Examine.
Model answer outline
- Intro: Union gross tax about 11.2% of GDP (2026-27 BE).
- More progressive: direct taxes (39 paise) now exceed indirect (25 paise) in Union receipts; GST 2.0 lowered rates on common goods; high-income surcharges.
- Narrow base: few individual taxpayers; agricultural income exempt; large informal sector; many exemptions (tax expenditure); rebate up to ₹12 lakh narrows the base further.
- Reforms: Income-tax Act 2025 (from 1 April 2026), faceless assessment, TDS/TCS, GST data matching.
- Chhattisgarh angle: state relies on SGST, stamp duty, excise and mineral royalty; destination-based GST limits gains from production.
- Conclusion: broaden the base with fewer exemptions and better data, while keeping rates moderate (Laffer logic).
Quick Revision Table
| Fact | Detail |
|---|---|
| Direct vs indirect | Incidence stays vs incidence shifts |
| Buoyancy vs elasticity | Includes vs excludes discretionary changes |
| Cess / surcharge | Art 270 exclusion / Art 271 wholly Union |
| Income-tax Act, 2025 | In force 1 April 2026; “tax year”; about 536 sections |
| New regime | Default since 2023-24; zero tax up to ₹12 lakh (rebate); top 30% above ₹24 lakh |
| Corporate tax (2019) | 22% (25.17% effective); 15% new manufacturing (17.01% effective) |
| Abolished | Estate duty 1985, gift tax 1998, FBT 2009, wealth tax 2015-16, DDT 2020-21 |
| Tax mix 2026-27 BE | Income tax 21, corporation tax 18, GST 15, excise 6, customs 4 paise |
| RBI surplus | About ₹2.69 lakh crore approved in May 2025 (record) |
| Committees | Chelliah 1991, Kelkar 2002/2004, Shome 2013, Akhilesh Ranjan 2019 |
Key Takeaways
Key Takeaways
- Direct taxes cannot be shifted and can be progressive; indirect taxes are shifted and tend to be regressive.
- Cesses and surcharges stay with the Union (Arts 270, 271) — a core federal grievance.
- The Income-tax Act, 2025 replaced the 1961 Act from 1 April 2026; new-regime slabs were unchanged in Budget 2026-27, with no tax up to ₹12 lakh.
- Direct taxes (39 paise) exceed indirect taxes (25 paise) in Union receipts (2026-27 BE).
- India’s challenge is a narrow base, not high rates.
What’s Next
- GST and GST 2.0 — the largest indirect tax, reformed in 2025
- Fiscal Deficit and FRBM — why revenue buoyancy matters for consolidation
- Centre-State Financial Relations — tax powers in the Constitution
- Public Finance — Quick Revision
Advertisement