WHAT IS TAX?
A fee charged (levied) by a government on a product, income, or activity. If tax is levied directly on personal or corporate income. The purpose of taxation is to finance government expenditure. One of the most important uses of taxes is to finance public goods and services, such as street lighting and street cleaning.
There are two types of taxes.
* DIRECT TAX
* IN-DIRECT TAX.
Direct Taxes are the taxes that are levied on the income of individuals or organizations. Income tax, corporate tax, inheritance tax are some instances of direct taxation. Income tax is the tax levied on individual income from various sources like salaries, investments, interest etc. Corporate tax is the tax paid by companies or firms on the incomes they earn.
Indirect taxes are those paid by consumers when they buy goods and services. These include excise and customs duties. Customs duty is the charge levied when goods are imported into the country, and is paid by the importer or exporter. Excise duty is a levy paid by the manufacturer on items manufactured within the country. Usually, these charges are passed on to the consumer. Government started indirect tax because previously all people were not paying tax, Government. Started indirect tax. So the collection of tax will increase.
you buy any product like shampoo it includes all taxes that means suppose shampoo's price is Rs 20. All other tax, which is to be paid by manufacture or retailer, they are collecting from the consumer indirectly by raising the price.
One more example is if you go to watch a movie ticket prices are already include the tax. Finally if you spending that means you are paying indirect tax. Income tax which you paying directly to the government that is direct tax.
What are Direct Taxes? Meaning
A direct tax is one, which is paid by a person on whom it is legally imposed and the burden of which cannot be shifted to any other person. The person from whom it is collected cannot shift its burden to anybody else.
The taxpayer is the tax-bearer. The impact i.e. the initial burden and its incidence i.e. the ultimate burden of direct tax is on the same person. For e.g. Income tax, wealth tax, property tax, estate duties, capital gain tax, corporate / company tax, etc. are all direct taxes. Advantages / Merits of Direct Taxes.
Following are the important advantages or merits of Direct Taxes: - 1. Equity
There is social justice in the allocation of tax burden in case of direct taxes as they are based on the principle of ability to pay. Persons in a similar economic situation are taxed at the same rate. Persons with different economic standing are taxed at a different rate. Hence, there is both horizontal and vertical equity under direct taxation. Progressive direct taxation can reduce income inequalities and bring about adequate social & economic justice. For example, in the Indian Budget of 2007, individual with an income of up to Rs. 1,10,000 are exempted from payment of income tax and in the case of women taxpayer, the exemption limit is Rs. 1,45,000. 2. Certainty
As far as direct taxes are concerned, the taxpayer is certain as to how much he is expected to pay, as the tax rates are decided in advance. The Government can also estimate the tax revenue from direct taxes with a fair accuracy. Accordingly, the Government can make adjustments in its income and expenditure. 3. Relatively Elastic
The direct taxes are relatively elastic. With an increase in income and wealth of individuals and companies, the yield from direct taxes will also increase. Elasticity also implies that raising the rates of taxation can increase the government’s revenue. An increase in tax rates would increase the tax revenue. 4. Creates Public Consciousness
They have educative value. In the case of direct taxes, the taxpayers are made to feel directly the burden of taxes and hence take keen interest in how public funds are spent. The taxpayers are likely to be more aware about their rights and responsibilities as citizens of the state. 5. Economical
Direct taxes are generally economical to collect. For instances, in the case of personal income tax, the tax can be deducted at source from the income or salaries of the individuals. Therefore, the government does not have to spend much in tax collection as far as personal income tax is concerned. However, in the case of indirect taxes, the government has to set up elaborate machinery to collect taxes. 6. Anti-inflationary
The direct taxes can help to control inflation. During inflationary periods, the government may increase the tax rate. With an increase in tax rate, the consumption demand may decline, which in turn may reduce inflation.
Disadvantages / Demerits of Direct Taxes
Though direct taxes possess above-mentioned merits, the economist has criticized them on the following grounds: - 1. Tax Evasion
In India, there is good amount of tax evasion. The tax evasion is due to High tax rates, Documentation and formalities, Poor and corrupts tax administration. It is easier for the businessmen to evade direct taxes. They invariable suppress correct information about their incomes by manipulating their accounts and evade tax on it. In less developed countries like India, due to high rate of progressive tax evasion & avoidance are extensive and led to rise in black money. 2. Arbitrary Rates
The direct taxes tend to be arbitrary. Critics point out that there cannot be any objective basis for determining tax rates of direct taxes. Also, the exemption limits in the case of personal income tax, wealth tax, etc., are determined in an arbitrary manner. A precise degree of progression in taxation is also difficult to achieve. Therefore direct taxes may not always fulfill the canon of equity. 3. Inconvenient
Direct taxes are inconvenient in the sense that they involve several procedures and formalities in filing of returns. For most people payment of direct tax is not only inconvenient, it is psychological painful also. When people are required to pay a sizeable part of their income as a tax to the state, they feel very much hurt and their propensity to evade tax remains high. Further every one who is required to pay a direct tax has to furnish appropriate evidence in support of the statement of his income & wealth & for this he has to maintain his accounts in proper form. Direct tax is considered inconvenient by some people because they have to make few lump sum payments to the governments, whereas their income receipts are distributed over the whole year. 4. Narrow Coverage
In India, there is a narrow coverage of direct taxes. It is estimated that only three percent of the population pay personal income tax. Due to low coverage, the government does not get enough funds for public expenditure. Estate duty & wealth tax are equally narrow based and thus revenue proceeds from these taxes are invariably small. 5. Affects Capital Formation
The direct taxes can affect savings and investment. Due to taxes, the net income of the people gets reduced. This in turn reduces savings. Reduction in savings results in low investment. The low investment affects capital formation in the country. 6. Effect on Willingness and Ability to Work
Highly progressive direct taxes reduce people's ability and willingness to work and save. This in turn may have a negative impact on investment and productive capacity in the economy. If tax burden is high, people's consumption level gets adversely affected and this has an impact on their ability to work and save. High taxes also discourage people from working harder in order to earn and save more. 7. Sectorial Imbalance
In India, there is Sectorial imbalance as far as direct taxes are concerned. Certain sectors like the corporate sector is heavily taxed, whereas, the agriculture sector is 100% tax free. Even the large rich farmers are exempted from payment of personal income tax. Conclusion On Direct Taxes
In direct tax burden of tax cannot be shifted. The disadvantage of direct taxation is mainly due to administrative difficulties and inefficiencies. The extent of direct taxation should depend on the economic state of the country. A rich country has greater scope for direct taxation than a poor country. However direct taxation is an important aspect of the modern financial system.
What are the Indirect Taxes? Meaning
An indirect tax is one in which the burden can be shifted to others. The tax payer is not the tax bearer. The impact and incidence of indirect taxes are on different persons. An indirect tax is levied on and collected from a person who manages to pass it on to some other person or persons on whom the real burden of tax falls. For e.g. commodity taxes or sales tax, excise duty, custom duties, etc. are indirect taxes.
Hicks classify direct & indirect taxes on the basis of administrative arrangements. In case of direct tax-there is a direct relationship between the taxpayer and the revenue authorities. A tax-collecting agency directly collects the tax from the taxpayers, whereas in case of indirect taxes there is no direct relationship between the taxpayers and the revenue authorities. They are collected through traders and manufacturers. Advantages / Merits of Indirect Taxes.
The merits of indirect taxes are briefly explained as follows: - 1. Convenient
Indirect taxes are imposed on production, sale and movements of goods and services. These are imposed on manufacturers, sellers and traders, but their burden may be shifted to consumers of goods and services who are the final taxpayers. Such taxes, in the form of higher prices, are paid only on purchase of a commodity or the enjoyment of a service. So taxpayers do not feel the burden of these taxes. Besides, money burden of indirect taxes is not completely felt since the tax amount is actually hidden in the price of the commodity bought. They are also convenient because generally they are paid in small amounts and at intervals and are not in one lump sum. They are convenient from the point of view of the government also, since the tax amount is collected generally as a lump sum from manufacturers or traders. 2. Difficult to evade
Indirect taxes have in built safeguards against tax evasion. Customers pay the indirect taxes, and the sellers have to collect it and remit it to the Government. In the case of many products, the selling price is inclusive of indirect taxes. Therefore, the customer has no option to evade the indirect taxes. 3. Wide Coverage
Unlike direct taxes, the indirect taxes have a wide coverage. Majority of the products or services are subject to indirect taxes. The consumers or users of such products and services have to pay them. 4. Elastic
Some of the indirect taxes are elastic in nature. When government feels it necessary to increase its revenues, it increases these taxes. In times of prosperity indirect taxes produce huge revenues to the government. 5. Universality
All classes of people pay indirect taxes and so they are broad based. Poor people may be out of the net of the income tax, but they pay indirect taxes while buying goods. 6. Influence on Pattern of Production
By imposing taxes on certain commodities or sectors, the government can achieve better allocation of resources. For e.g. By Imposing taxes on luxury goods and making them more expensive, government can divert resources from these sectors to sector producing necessary goods. 7. May not affect motivation to work and save
The indirect taxes may not affect the motivation to work and to save. Since, most of the indirect taxes are not progressive in nature, individuals may not mind to pay them. In other words, indirect taxes are generally regressive in nature. Therefore, individuals would not be demotivated to work and to save, which may increase investment. 8. Social Welfare
The indirect taxes promote social welfare. The government for social welfare activities, including education, health and family welfare, utilizes the amount collected by way of taxes. Secondly, very high taxes are imposed on the consumption of harmful products such as alcoholic products, tobacco products, and such other products. So it is not only to check their consumption but also enables the state to collect substantial revenue in this manner. 9. Flexibility and Buoyancy
The indirect taxes are more flexible and buoyant. Flexibility is the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, and buoyancy is a wider concept, as it involves the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, as well as tax rates. Disadvantages / Demerits of Indirect Taxes
Although indirect taxes have become quite popular in both developed & under developed countries alike, they suffer from various demerits, of which the following are important. 1. High Cost of Collection
Indirect tax fails to satisfy the principle of economy. The government has to set up elaborate machinery to administer indirect taxes. Therefore, cost of tax collection per unit of revenue raised is generally higher in the case of most of the indirect taxes. 2. Increase income inequalities
Generally, the indirect taxes are regressive in nature. The rich and the poor have to pay the same rate of indirect taxes on certain commodities of mass consumption. This may further increase income disparities among the rich and the poor. 3. Affects Consumption
Indirect taxes affect consumption of certain products. For instance, a high rate of duty on certain products such as consumer durables may restrict the use of such products. Consumers belonging to the middle class group may delay their purchases, or they may not buy at all. The reduction in consumption affects the investment and production activities, which in turn hampers economic growth. 4. Lack of Social Consciousness
Indirect taxes do not create any social consciousness, as the taxpayers do not feel the burden of the taxes they pay. 5. Uncertainty
Indirect taxes are often rather uncertain. Taxes on commodities with elastic demand are particularly uncertain, since quantity demanded will greatly affect as prices go up due to the imposition of tax. In fact a higher rate of tax on a particular commodity may not bring in more revenue. 6. Inflationary
The indirect taxes are inflationary in nature. The tax charged on goods and services increase their prices. Therefore, to reduce inflationary pressure, the government may reduce the tax rates, especially, on essential items. 7. Possibility of tax evasion
There is a possibility of evasion of indirect taxes as some customers may not pay indirect taxes with the support of sellers. For instance, individuals may purchase items without a bill, and therefore, may not pay Sales tax or VAT (Value Added Tax), or may obtain the services without a bill, and therefore, may evade the service tax. Conclusion
Elaborate analysis of merits and demerits of direct and indirect taxes make it clear that whereas the direct taxes are generally progressive, and the nature of most indirect taxes is regressive. The scope of raising revenue through direct taxation is however limited and there is no escape from indirect taxation in spite of attendant problems. There is common agreement amongst economists that direct & indirect taxes are complementary and therefore in any rational tax structure both types of taxes must find a place.