Direct Tax vs. Indirect TaxDr. Swati Gupta

Contents Introduction Define tax Concept of progressive, proportional, regressive

and digressive tax Define direct tax Pros and cons of direct tax Define indirect tax Pros and cons of indirect tax Conclusion

IntroductionMoney plays an important role in everybodys life. Without money even we can't imagine to run our life smoothly. If the importance of money is great for an individual, it is greater to the government. All the function of government depends on public finance. It is not only confined with the function of government but also the effect of these functions on the social and economic life of the nation. Public finance is now regarded as the powerful instrument to bridge the gulf between higher status and lower status of the society. The progressive tax system would impose maximum proportion of tax on rich and use this fund for the welfare of the poor.

What is taxA tax is a compulsory payment levied by the government on individuals or companies . According to Plehn-Taxes are general compulsory contribution of wealth levied upon persons or corporate, to defray the expenses incurred in conferring common benefit upon the residents of the state. According to Hugh Dalton, A tax is a compulsory contribution imposed by a public authority, irrespective of the exact amount of service rendered to the taxpayer in return, and not imposed as penalty for any legal offence.

Thus it is clear that1-Tax is a compulsory payment 2- It is levied by the public authority. 3- The individual cant expect for special service in return for the tax paid by him.

Concept of progressive, proportional, regressive and digressive taxProportional tax - A proportional tax is one in which same percentage is charged from all income group.Income in Rs % of Income paid in tax Amount of tax in Rs 2,000

A

10,000

20%

BC

40,00070,000

20%20%

8,00014,000

Progressive tax- A progressive tax is one in

which a larger percentage is charged from high income groups comparatively from low income group.Income in Rs A B C 10,000 40,000 70,000 % of income paid in tax 10% 20% 30% Amount of tax in Rs 1,000 8,000 21,000

Regressive tax Regressive tax is one in which

larger percentage is charged from low income groups than from high income groups.

Income in RsA B C 10,000 40,000 70,000

%of income Amount paid in tax of tax in Rs30% 20% 10% 3,000 8,000 7,000

Digressive tax- Digressive tax is one in which a tax

is charged initially at a progressive rate but after a certain limit , it may be charged at a flat rate. This tax is a mixture of proportional and progressive tax.Income in Rs % of Amount income of tax in paid in tax Rs 10% 1,000 20% 30% 30% 8,000 21,000 30,000

A B C D

10,000 40,000 70,000 1,00,000

Direct TaxA direct tax is paid by a person on whom it is legally imposed and he can not shift the burden of tax to any other person. The impact and the incidence (incidence means the final resting place of a tax) are on the same person in the direct tax. A tax-payer is the tax-bearer also. Income tax, wealth tax, property tax, corporate tax, etc. are the example of direct taxes.

Merits of direct tax Equitable -Direct taxes are based on the principle of

ability to pay as persons belonging with different economic status are taxed at a different rate. Economical - In direct tax, there is no intermediary between the tax- payer and the government. the tax can be deducted at source from the income or salaries of the individuals. Therefore, the cost of collection is small and economical. Certainty- The Government can estimate the yield collected from direct taxes with a fair accuracy. The tax payer is also certain of the amount that he has to pay. Elasticity- direct taxes are Elastic as government can increase the revenue by increasing the rates of taxation. If the income of the individual and company increases, the revenue from direct taxes will also increase.

Merits of direct tax contd..Social justice- Progressive direct taxes are helpful in

reducing income inequalities and in favour of social and economic justice. Public Consciousness - In the case of direct taxes, the taxpayers bear the burden of taxes so they takes the interest in how public funds are used by the government. It creates the civic consciousness among the tax payers. They take interest in government activities and civic affairs. Anti-inflationary -The direct taxes can help to control inflation. During inflation, the government may increase the tax rate to reduce the consumption income which may reduce the demand of commodity, thus reduce inflation.

Demerits of direct taxes Inconvenient - Direct taxes are inconvenient for the

person as he has to pay in a lump sum. Besides it has a lot of formalities and procedures in filing of returns. There is a psychological pain also in paying direct tax as the person has to pay a large amount of his income to the government so their propensity to evade tax remains high. Further a person who is paying a direct tax, has to provide appropriate evidence of his income & wealth and he has to maintain his accounts in proper form. Evasion - It is easier for the businessmen to evade direct taxes. They might hide the correct information about their incomes by manipulating their accounts and evade tax on it. Thats why it is said that a direct

Demerits of direct taxes contd.. Arbitrary Rates -The direct taxes are arbitrary as the

rates are not determined on any scientific principle. Therefore direct taxes may not always fulfil the canon of equity. Narrow Coverage - In India, the government does not get enough funds from direct tax because of low coverage in rural areas. Effect on working efficiency- High taxes rates discourage people from working harder in order to earn and save more. They might think if they will earn more ,they will have to pay more part of their income as tax. It might reduce people's ability and willingness to work

Indirect taxA Indirect tax is levied on one person but he can shift the burden of tax partially or impartially on other person. The impact and the incidence are on different person in the case of indirect tax. The tax payer is not the tax bearer. Commodity taxes or sales tax, excise duty, custom duties are the examples of indirect taxes.

Merits of Indirect taxes Convenient- Taxpayers do not feel the burden of

indirect taxes as persons pay the tax when they buy a commodity and the tax amount is actually hidden in the price of the commodity bought. It is paid in small dribbles rather than in lump sum. Indirect taxes are convenient for the government also as the tax amount is collected from manufacturers or traders generally in a lump sum amount. Elasticity-Some of the indirect taxes are elastic in nature when imposed on necessaries of life. If government wants to increase its revenues, it increases these taxes. Universality- Indirect taxes are paid by all classes of people as they have to pay a indirect tax if they are purchasing the goods. Poor people may be relax from the burden of the income tax, but they pay indirect

Merits of Indirect taxes contd.. No evasion- Indirect taxes are included in price of

commodity so it is very difficult to evade it. Social Welfare- Government impose higher tax on the consumption of harmful drugs such as alcoholic products, tobacco products etc to reduce the consumption of these goods. Wide Coverage- The indirect taxes have a wide coverage as it is levied on a large number of commodities. The consumers of such products have to pay them. Equitable- Indirect taxes are imposed at a high rate on luxuries goods which is used generally by the rich and at low rate on necessities.

Demerits of Indirect taxes Uncertainty- Indirect taxes are often rather uncertain

as it is imposed on commodities which is based on consumers demand. If demand is high , revenue will be more and vice versa. Inflationary- The indirect taxes are inflationary in nature. As it is imposed on goods and services which increase their prices and if prices are already rising, it increase inflation. Affects Consumption- Indirect taxes affects consumption of certain products. In the case of tax imposed at high rate, the price will also increase and it may restrict the use of such products. Consumers belonging to the middle class and lower class may delay their purchases, or they may not buy at all. It will effect the investment and production which may be a barrier in economic growth.

Demerits of Indirect taxes contd.. Lack of Social awareness- Indirect taxes do not

develop any social consciousness . The taxpayers do not feel the burden of the taxes as it is concealed in price. Regressive- Indirect taxes are regressive in nature. The rich and the poor have to pay the same rate of indirect taxes on the necessities of life therefore real burden of the tax is higher on the poor as they spend a maximum portion of their income on necessaries while the rich pay it on a small portion of their income. This may increase income inequality among the rich and the poor. Evasion -There is a possibility of evasion of indirect taxes if the customer is not taking a bill on their

ConclusionThus it is clear that direct and indirect tax, both have their pros and cons . As direct tax tries to make the bridge between the gulf of both rich and poor by imposing tax at higher rate on the rich and low rate on the poor. Thus direct tax is progressive and help to reduce inequalities but indirect tax increase the inequalities as tax imposed on necessaries put more burden on the poor . The poor spend the big amount of their income on necessities of life while the rich pay less, thus it widens the gap between rich and poor.

Conclusion contd..For certainty point of view, direct taxes are good comparatively indirect taxes. Revenue collected from direct tax is almost certain but in indirect taxes how much revenue government will get, it depends on demand of the goods. Direct tax helps to develop the civic consciousness among the tax-payers but in indirect tax, person does not realize the pain because tax is included in price itself so he is not curious to know about how the government is using that fund gained from indirect tax.

Conclusion contd..Direct tax helps to control the inflation as in inflation time government might increase the rate of tax and control the consumption while indirect tax increase the inflation as it is included in price. Indirect taxes are good from convenience point of view, as person pays the tax while purchasing the goods so he does not bear the pain but in the case of direct tax, person has to pay a part of his income directly to the government so it becomes painful for him. Indirect tax are universal as it is paid by all classes of people but direct tax is confined with the limited people. Both the taxes has its own pros and cons, so it is the responsibility of government to impose these taxes in proper and rational way as to generate maximum revenue