Direct and Indirect Taxes

Direct Taxes

In a simple word, it is known as individual tax. Direct tax is a tax which is imposed on the individual or property. It is a tax which is paid directly to the government of the country by the tax payer. Tax liability has to be paid by the person in question and it cannot be transferred to some another person. For example, Property Tax, Corporate Tax, Income Tax etc. It is based on ability to pay principle; it means that the tax increases with the increase in the income.

It cannot be passed on to another person or entity, only the person or organization upon which tax is levied is responsible for payment of tax.

Example- If a person is working in an organization and earns $1,00,000 in a year. Tax liability of that person is $1500 + 20% of taxable income. So, total tax payable in the year will be $21,500.

Advantages of Direct Taxes

1) Equal- Direct Tax’s burden cannot be shift to any other person or entity. So, person to whom tax is imposed is liable to pay the tax. And it is also progressive in nature which means that the tax will be increased in relation to the increase in the income. For example- if your taxable income in the year 2015-16 is 4,00,000 rupees and in 2016-17, 7,00,000 then in both the years, tax liability imposed on you will be different. Tax payable will be more in 2016-17 compared to 2016-16.

2) Economical- Direct Tax is economical in sense that it saves time and efforts on the side of the collection officer. Collection of tax is generally done at the organization an individual is working in.

3) Certainty- Both the parties i.e. tax payer and officer knows the amount of the tax. Tax payer knows what will be his tax expenses and collection officer also knows what will be his revenue. Due to this, it becomes difficult for an individual or corporate to save them from tax.

4) Flexible- Direct tax is flexible in nature. If government is in need of finance, they can increase the income tax rate and death duties. It will increase the revenue for the government. Thus, it can be used as a tool for sucking funds from public.

5) Productive- Another virtue of direct taxes is that they are very produc­tive. As a community grows in numbers and prosperity, the return from direct taxes expands automatically. The direct taxes yield large revenue to the State.

Disadvantages of Direct Taxes

1) Inconvenient- It acts as a de-motivating factor for the individual. As he pays a larger lump-sum amount, it pinches him to a great extent. And in future, he will try not to earn more as more income will mean more taxes.

2) Evadable- Individual or corporate can easily evade this tax. It can easily be done by presenting false information in front of the officers. Thus, it is a tax on honesty.

3) Heavy taxes mean less investment and savings. If individuals and business houses doesn’t invest and save, then the country would get into a financial crisis.

Various Direct Taxes-

  • Income Tax
  • Corporate Tax
  • Wealth Tax
  • Gift Tax
  • Estate Duty
  • Expenditure Tax
  • Fringe Benefit Tax

Indirect Taxes

It is the opposite of the direct tax. Indirect tax is a tax collected by a person on behalf of another. In other words, indirect tax is a tax where the burden of the tax can be shifted to another person. It is paid by one entity to the government of the country but it is combined in the prices of the goods and services of the customers. So, ultimately tax is paid by the customer to the retailers through price.

Prices of the product will also be increased as the element of the tax goes in. Examples- Liquor, Fuel etc. Excise duty on the car is first paid by the manufacturer; ultimately the burden is shifted to buyer of the car in the way of price. The degree to which the burden of a tax is shifted determines whether a tax is primarily direct or primarily indirect.

Indirect Taxes are also regressive in nature which means it remains same for the person with the income $1,000 and $10,000.

Advantages of Indirect Taxes

a) Convenient- It is also convenient method of tax collection for government and tax payers can also pay the taxes without involving them into much documentation work.

b) Easy Collection- Collection of the indirect taxes is easy. Individual do not need to file any return or submit any document to pay the taxes. Indirect taxes are included in the price, as and when he purchases a product, indirect tax is paid.

c) Non-Evadable- It cannot be evaded by the person as it is included in the price of the product. Whenever a person purchases a product, it will be paid.

d) Check on Harmful Consumptions- Government can keep tax rates of harmful products like alcohol, tobacco higher, so that the consumption of the product is discouraged.

e) Choice Available- Individual has a choice whether he wants to pay the tax or not. If he wishes not to pay the tax, he can simply avoid buying the goods.

Disadvantages of Indirect Taxes

a) Regressive in Nature- Indirect taxes are regressive in nature which means an individual having income of $2000 and $20,000 would have to pay the tax at the same rate. So, it can be said as not equitable tax.

b) Uncertain- Until indirect taxes are not imposed on the necessity goods, we cannot be sure about the revenue that it will yield. It is because tax will increase the price of the goods and will decrease the demand. Without purchasing a product or service, how tax would be paid.

c) Costly- Indirect taxes are proved to be costly for the government. It is because the collection cost is very heavy. It is because there are large numbers of firms in a country that manufacture a product. And every firm has to be guarded by the administration, so it becomes quite difficult for them.

d) Discourage firms to remain in the market- Every production unit requires raw materials to produce a final product. And if raw materials are taxed then it will increase the cost of the production of the company which will increase the price of the company. In comparison with the other firms, if price of a firm is higher, then competitive advantages cannot be taken by the firms.

Comparison of direct and indirect tax

Direct Tax Indirect Tax
1) It is a tax which is paid by an individual to the government. 1) It is a tax which is paid by the individual to the government indirectly.
2) Burden of the tax cannot be shifted to another person. 2) Burden of the tax can be shifted to another person.
3) Types- Wealth Tax, Income Tax, Corporate Tax. 3) Types- Sales Tax, Value Added Tax, Service Tax.
4) Evasion is possible. 4) Evasion is not possible.
5) It helps in reducing inflation. 5) Indirect tax helps in promoting inflation.
6) It is levied on individual, HUF, company. 6) It is levied on Goods and Services.
7) Nature- Progressive 7) Nature- Regressive