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Role of Tax in the Economic Development of a Country

Updated on June 28, 2011

Tax is a contribution exacted by the state. It is a non penal but compulsory and unrequited transfer of resources from the private to the public sector, levied on the basis of predetermined criteria.

The classical economic were in view that the only objective of taxation was to raise government revenue. But with the changes in circumstances and ideologies, the aim of taxes has also been changed. These days apart from the object of raising the public revenue, taxes is levied to affect consumption, production and distribution with a view to ensuring the social welfare through the economic development of a country. For economic development of a country, tax can be used as an important tool in the following manner:

1. Optimum allocation of available resources:

Taxis the most important source of public revenue. The imposition of tax leads to diversion of resources from the taxed to the non-taxed sector. The revenue is allocated on various productive sectors in the country with a view to increasing the overall growth of the country. Tax revenues may be used to encourage development activities in the less developments areas of the country where normal investors are not willing to invest.

2. Raising government revenue:

In modern times, the aim of public finance is not merely to raise sufficient financial resources for meeting administrative expense, for maintenance of low and order and to protect the country from foreign aggression. Now the main object is to ensure the social welfare. The increase in the collection of tax increases the government revenue. It is safer for the government to avoid borrowings by increasing tax revenue.

3. Encouraging savings and investment:

Since developing countries has mixed economy, care has also to be taken to promote capital formation and investment both in the private and public sectors. Taxation policy is to be directed to raising the ratio of savings to national income.

4. Reduction of inequalities in income and wealth:

Through reducing inequalities in income and wealth by using an efficient tax system, government can encourage people to save and invest in productive sectors.

5. Acceleration of Economic Growth:

Tax policy may be used to handle critical economic situation like depression and inflation. In depression, tax is set to increase the consumption and reduce the savings to increase the aggregate demand and vice verse. Thus the tax policy may be used to strengthen incentives to savings and investment.

6. Price Stability:

In underdeveloped countries, there is another role to maintain price stability to ensure growth with stability.

7. Control mechanism:

Tax policy is also used as a control mechanism to check inflation, consumption of liquor and luxury goods and to protect the local poor industries from the uneven competition. Taxation is the only effective weapon by which private consumption can be curbed and thus resources transferred to the state. Thus the economy can ensure sustainable development.

Thus it can be said that the economic development of a country depends various reasons one of them are on the presence of an effective and efficient taxation policy.


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