Lecture 4

Taxation

Classification of Tax
Tax can be classified into different types based on different angels, which
are described below:

A) On the basis of Incidence

On the basis of Incidence tax can be classified in to Two:
1. Direct Tax
2. Indirect Tax

Direct Tax: Direct tax is paid by the taxpayer directly to the government or tax-imposing authority.
The imposition and incidence of tax remain on the same person it is levied because the taxpayer cannot
shift the burden or amount of tax to another entity in any way. In other words, in the case of
direct taxes, impact and incidence are on the one and the same person. Examples of direct
taxes include income tax, corporate tax, and property tax.

Indirect Tax: Indirect taxes are taxes which are imposed upon persons, who are
expected to shift the burden of the tax to other persons. In other words, in the case of
indirect taxes, usually the impact and incidence will be on different persons. Sales and
Value-Added Taxes (VATs) are two examples of indirect taxes.

Differences between Direct and Indirect Tax

Here is a table pointing out the biggest direct vs. indirect tax differences-

Context Direct Tax Indirect Tax

1. Imposed on Income and profits All the goods and services
2. Who pays Individuals and businesses End-consumers
3. How much Depends on income and profits Same for everyone
4. Transferability Not transferable Transferable
5. Tax Evasion Possible Not possible
6. Nature Progressive Regressive
7. Collections Complex Convenient
8. Common examples Income tax and property tax Sales Tax and VAT

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Advantages of direct taxes include:

1. Equitability: They are based on the taxpayer's ability to pay, ensuring that wealthier
individuals pay more tax than those with less income.

2. Certainty: The taxpayer knows precisely how much they must pay and when reducing
uncertainty.

3. Elasticity: The government can adjust direct taxes according to the taxpayer's
income.

4. Progressive Nature: This means the tax rate increases as the taxable amount
increases. This system is designed to alleviate the tax burden on those less able to pay.
It is seen as a tool for wealth redistribution, enabling society to reduce economic
disparity.

However, direct taxes also have certain disadvantages:

1. Evasion: Due to the complexity of these taxes, individuals may try to evade payment,
leading to revenue loss for the government.

2. Time-consuming: Filing direct taxes can be lengthy and complex.

3. Inconvenient: They can be burdensome for individuals and businesses due to their
impact on personal income or profits.

4. Deterrent to Savings: These can sometimes act as a deterrent to savings. When

individuals or businesses are taxed a significant portion of their income or profits, they
might need more disposable income to save or invest.

Advantages of Indirect Taxes

Everyone can contribute in indirect taxes

Unlike Income Tax, which has to be paid by individuals in certain income brackets and
not others, Indirect Taxes have to be paid by each and everyone who purchases the
commodity. Persons not working in India like tourists and persons of lower economic
strata also have to pay it because they will in some form purchase commodities.

Indirect taxes are convenient

Indirect taxes are very convenient as far as charging them is concerned. Firstly, the
taxes can be very nominal and consumers do not feel burdened when paying such small

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amounts. Secondly, these indirect taxes are said to be ‘hidden in the price’, which
means that the consumer only effectively sees the price of the commodity itself.

Indirect taxes cannot be evaded

Indirect taxes cannot be evaded, because they are part of the price of the commodity.
So anyone who buys the commodity, will pay the tax.

Indirect taxes are spread over a wide range

Heavy taxation in any one aspect of a service or commodity will be highly noticeable as
well as a burden on the consumer. In this regard, indirect taxes can be beneficial since
they are spread out over a wide range of products in smaller amounts.

Disadvantages of Indirect Taxes

Indirect Tax can be regressive

Since indirect tax is the same for both the rich and the poor, it can be deemed unfair to
the poor. Indirect tax is applicable to anyone who makes a purchase, and while the rich
can afford to pay the tax, the poor will be burdened by the same amount of tax. Thus,
indirect taxes may be seen as regressive.

Indirect taxes raise price of commodities

Sellers cannot always calculate and collect the exact fraction of tax applicable on all
commodities that they sell. And hence they consciously charge more than the tax
amount so they can be sure that every buyer paid the indirect tax. But this has a
cumulative effect and increases the price of commodities.

Indirect taxes do not raise civic consciousness

Indirect taxes do not raise civic awareness because millions are not even aware that
they’re paying a tax because it is hidden in the price.

Conclusion
Thus, indirect taxes have both advantages and disadvantages, but no one can deny that
they are important to generate revenue. While direct taxes can be collected from the
rich, indirect taxes give an opportunity to the poor to contribute in their own small way.
So both have their own place in the economy.
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