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Taxes and National Income

Taxes and National Income

Taxes Matter in National Income: When we calculate national income, we must consider taxes collected by the government, both direct and indirect.

  • Direct Taxes: (Income Tax, Corporate Tax, etc.)
    • Examples in India: Individual Income Tax, Corporate Income Tax (Corporate Tax), Dividend Tax, Interest Tax.
    • No Adjustment Needed: Whether we calculate national income at Factor Cost or Market Cost, we don't need to adjust for direct taxes.
    • Why?
      1. Direct taxes are the same at both Factor Cost and Market Cost.
      2. They are collected directly from people's or companies' incomes.
  • Indirect Taxes: (Excise Duty, Sales Tax/VAT, Customs Duty, etc.)
    • Examples in India: Central Excise Duty (Cenvat), Customs Duty, Central Sales Tax (CST), Sales Tax/Value Added Tax (VAT), State Excise Duty.
    • Adjustment Needed for Factor Cost: If we calculate national income at Factor Cost, we must deduct the total amount of indirect taxes.
    • No Adjustment Needed for Market Cost: If we calculate at Market Cost, we do not deduct indirect taxes.
  • Why Deduct Indirect Taxes at Factor Cost? (Avoid Double Counting):
    • Indirect taxes get added twice if we don't deduct them when using Factor Cost:
      1. First Addition: People pay indirect taxes when they buy goods and services. They pay from their disposable income. So, indirect taxes are already included in the value of goods at market prices, which is derived from disposable income.
      2. Second Addition: Governments collect these indirect taxes as government revenue (income). If we simply add up all incomes in the economy (including government revenue from indirect taxes) without adjusting, we count the indirect tax amount again.
  • Source of Indirect Taxes: Indirect taxes come from people's and companies' disposable income when they buy things. The taxes then go to the government.


  • Formula for National Income at Factor Cost:
     National Income at Factor Cost = National Income at Market Cost – Indirect Taxes
     (In the text, it's written as: NNP at Factor Cost = NNP at Market Cost - Indirect Taxes. NNP stands for Net National Product, a measure of national income.)

  • Market Cost Calculation - No Deduction Needed: If we calculate national income directly at Market Cost, we don't deduct indirect taxes. Also, governments don't need to add their indirect tax income separately in this method.

  • Key Point: The confusion about taxes in national income calculation only happens when we are using Factor Cost, and it's specifically about indirect taxes.


In Simple Words:

  • Direct taxes (like income tax) are taken directly from income and don't cause double counting issues in national income.
  • Indirect taxes (like sales tax) are paid when you buy things. If we calculate national income at Factor Cost, we have to remove indirect taxes to avoid counting them twice (once when people pay them, and again when the government gets them as revenue).
  • If we calculate at Market Cost, we don't deduct indirect taxes because they are already included in market prices.

Basically, we adjust for indirect taxes when using Factor Cost to get a true picture of the factor incomes (wages, rent, interest, profit) earned in producing goods and services, without the distortion of indirect taxes

 

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