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What Is the Importance of Taxes in India?

Taxes play a vital role in India’s economic development by funding infrastructure, public services, and long-term national growt

Written by : Knowledge Centre Team

2026-01-15

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7 minutes read

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Wondering why is taxation important or what is the importance of taxation in an economy? Well, taxation has been the primary source of revenue for states across the world for centuries, and India is no exception to this. The nation has a structured tax system that employs both progressive and proportional taxation based on income and other factors, and is determined by the central and state governments. The money received by the government is known as tax revenue and may be utilised for a broad spectrum of purposes such as infrastructure development in the form of roads, railways, bridges, dams ,etc, public healthcare and education, defence and civil services, to name a few. Helping the government fulfil its development goals is the main importance of taxation and highlights why tax is important for the economy. 

India’s tax-to-GDP ratio as of 2018-19 was 10.9%, a relatively low figure compared to the average ratio for OECD member states, which is around 34%. A high tax-to-GDP ratio signifies the government’s ability to manage its spending effectively, without relying on excess borrowing. High ratios are also generally associated with developed nations. India’s relatively low figures could be indicative of the reduced collection of service taxes, comparatively high GDP growth, as well as income tax evasion prevalent among large corporations and the upper strata of society. This further explains the importance of taxes in India and the importance of paying taxes responsibly.

    Key Takeaways

    • Taxes are a major source of revenue for India’s central and state governments

    • Tax revenue supports infrastructure, healthcare, education, and defence, underlining the importance of taxes

    • India follows a mix of direct and indirect taxation systems

    • Efficient taxation promotes economic stability and growth, emphasising the importance of taxation

    • Tax-saving investments can also provide financial security

    Types of Taxes

    Direct Taxes:

    • These direct taxes are levied on individuals or organisations and include income tax (corporate and individual), wealth tax, capital gains tax, perquisite tax, agricultural tax, as well as property tax, among others. They are directly paid to the governments and represent a significant portion of revenue collected, which explains the importance of income tax and direct taxation.  All entities with incomes higher than the limits exempt from taxation are required to pay income tax. The rates of taxation are also determined based on the relative wealth and incomes of taxpayers.

    • Income tax liability and applicable rates are determined as per the prevailing income tax laws notified by the Government of India.

    Importance of Direct Taxation :

    • Direct taxation is one of the main sources of income for the government.
    • It also affects inflation, demand, and supply within the economy by regulating disposable incomes across the board.
    • Luxury goods and services are the most affected by this regulation, and so, the tax rates have to strike a balance between providing administrative funds, limiting inflation, and leaving enough disposable income to encourage consumption.
    • Deductions on certain services, such as insurance or some types of loans, will attract individuals and organisations to invest, reinforcing the income tax importance.
    • This can allow for greater stability in the economy while also providing stakeholders with a greater degree of financial security.
    • More capital flowing into the country will increase revenue and, in turn, affect tax collection, providing the government with a higher budget for expenditure on developing the nation’s infrastructure, as well as its natural, man-made, and human resources, reinforcing the importance of taxation in India.

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    Indirect Taxes:

    These taxes are collected indirectly by the government and are charged on availing or purchasing goods and services. They are paid by consumers to service providers, who then have to pay the same amount to the government or local bodies. The system previously included a wide array of taxes, including the Value Added Tax, excise duty, customs charges, service tax, and sales tax. With the introduction of the Goods and Services Tax Bill in July 2017, many of these were consolidated into a single system of taxation with five slabs of tax rates, namely - 0%, 5%, 12%, 18% and 28%.

    Although they may vary in their method of collection, the importance of these taxes lies in the manner in which local bodies or governments collect and utilise them, and this can have a massive impact on a nation’s development.

    Importance of Indirect Taxation :

    • Indirect taxes have been put in place to ensure that resources are used efficiently by individuals and organisations as lower expenditure on raw materials will mean lower margins lost on taxes.
    • In turn, lowered costs of production will raise profits and foster healthy competition among rival organiSations, thereby developing the economy.
    • This also provides consumers with a wider variety of options catered to their needs, facilitating improvements in standards of living. However, the actual impact may vary based on market conditions and consumer behaviour.
    • The burden of taxation falls on the consumers in the end, as most retailers, manufacturers and service providers will attempt to recover taxes on initial expenses in the sales price itself.
    • Hence, the importance of taxation of this kind lies in how they incentivises organisations to make their operations as efficient as possible.
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    Did You Know?

    India’s Goods and Services Tax (GST) replaced more than 17 indirect taxes and 13 cesses, creating one of the largest unified tax systems in the world


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    Conclusion 

    The importance of taxes can be witnessed in the plethora of ways in which their regulation affects the drop and flow of economic activity. Proper regulation of the tax system and the efficient collection of payments will provide governments with adequate funds to invest in improving the overall quality of life within their borders. The provision of tax deductions on certain investments and services, such as life insurance, allows individuals as well as organisations to operate with more freedom and financial security. Certain investments may be eligible for tax benefits under Section 80C of the Income Tax Act, 1961, subject to applicable provisions and conditions, reinforcing the use of tax and the broader conclusion of taxation.

    Glossary

    1. Taxation: The process by which the government collects money from individuals and businesses to fund public expenditure
    2. Tax Revenue: Income collected by the government through taxes to support public services and development activities
    3. Direct Tax: A tax paid directly to the government by individuals or organisations, such as income tax
    4. Indirect Tax: A tax levied on goods and services and collected indirectly from consumers, such as GST
    5. Tax-to-GDP Ratio: The share of a country’s GDP collected as tax revenue, indicating fiscal capacity
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    FAQ’s

    Taxation is important because it provides the government with funds to invest in infrastructure, public services, and welfare programmes. It supports economic growth by enabling planned development and reducing reliance on borrowing.

    For the government, income tax is a key source of revenue for public expenditure. For individuals, it promotes financial discipline and allows access to tax benefits through eligible investments, subject to applicable laws.

    Income tax helps regulate disposable income, control inflation, and support equitable wealth distribution. It ensures a steady revenue flow, enabling consistent government spending on development initiatives.

    Paying taxes enables the government to fund infrastructure, healthcare, education, and defence. Responsible tax compliance strengthens public finances and contributes to long-term national growth.

    Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.

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