Economics Note : Tax
Direct Tax
A direct tax is that tax whose burden is borne by the person on whom it is levied. He Can’t transfer the burden of tax to other person. Income tax, wealth/property tax, profit tax, etc. are some examples of direct tax.
According to prof. Dalton, “A direct tax is really paid by the person on whom it is legally imposed.”
Merits of Direct Tax:
1. Equality: A direct tax seeks to bring an economic equality in the society. It is imposed on the basis of ability-to-pay principle of taxation i.e. higher rate of tax to higher income earner and lower rate of tax to the lower income earner. It helps to maintain the economic equality.
2. Economical: Direct tax is directly imposed on the source of income of people. So the administrative cost of collection of direct is minimum and collected revenue is maximum.
3. Certainty: The rate of direct tax is fixed. The taxpayer knows the amount to be paid, time of payment, method of payment, etc. Therefore, the government can always be sure to receive the certain revenues from such taxes.
4. Elastic: Direct tax is more elastic in nature. The government can easily increase or decrease the rate of direct tax as per the need of government revenue.
5. Creates civic consciousness: Direct taxes 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. They are more likely to be more aware about their rights and responsibilities.
6. Convenience: Direct taxes are collected from the people at the time when they get income from different sources. So, it is convenient to pay.
7. Anti-inflationary: The direct is an important to control the inflation. During the inflationary periods, the government may increase the rate of tax. It results, fall in demand which in turn helps to reduce inflation.
Demerits of Direct Tax:
1. Unpopular: The direct tax is directly imposed on the source of income, against that taxpayer do not get any direct benefit. It becomes quite painful. So, it is unpopular.
2. Evasion of taxes: The collection of tax revenue depends upon the information provided by the taxpayer. Generally, tax payers do not show their actual income from various sources. In this situation, there is high possibility of tax evasion.
3. Inconvenience: Direct tax is inconvenient to the tax payer. Because, payment of direct tax needs to maintain proper record of all incomes, calculation of amount and later on amount should be deposited. For this purpose, he has to visit tax office many times.
4. Narrow Base/Scope: Direct taxes are generally imposed on a certain group of people. Generally, in most of the developing countries, majority of people are low income earner and they are free from burden of tax. And only few high income earners are included under the boundary of tax. So, it has narrow base.
5. Discourage capital formation: The imposition of higher rate of direct tax reduces the disposable income and saving of people. The low level of saving results low level of investment or low levelof capital formation.
6. Discourage the inflow of capital formation: Foreign in investors always calculate the burden of direct taxes before investing in a particular country. The higher rate of direct tax discourages the Foreign Direct Investment (FDI).
Indirect Tax
A tax levied by government on goods and services in order to raise the revenue as an instrument of fiscal policy is called indirect tax. The indirect tax is paid by an individual or institution but its burden can be shifted to others. VAT, Customs duty, Excise duty, etc. are examples of indirect tax.
According to Prof. Dalton, “Indirect taxes are those which are imposed on one person but he is able to shift them partially or wholly to another person.”
Merits/Advantages of Indirect Taxes:
1. Convenient: The amount of indirect tax is included in the price of commodity. While purchasing a commodity a consumer has to pay tax with price of the commodity. But he does not feel paying of tax. So, it is considered to be more convenient.
2. Difficult of Evade: Indirect tax is already included in the price of commodity. So, taxpayers have no chance to avoid tax. A consumer should sacrifice to consume in order to evade this tax.
3. Variety: Indirect taxes can be imposed in a variety of ways. These are Excise duty, Customs duty, VAT, etc. The rate of the indirect tax can be varied according the nature of commodity.
4. Broad Scope: It covers every class of the society according to the purchasing capacity. Different rate indirect tax is imposed on basic goods, normal goods and luxurious goods. As a result, every consumer compelled to pay tax as per their purchasing capacity.
5. Equity: It helps to maintain the economic equality in the society. The government can impose higher rate of tax on luxurious goods which are consumed by high income earner and very lower rate of tax on essential goods, which are basically consumed by poor people.
6. Reduce Harmful Consumption: The government can use indirect tax as an import tool to reduce the consumption of harmful goods like tobacco, alcohol, etc. As government increases the rate of tax, it increases the price of such goods and reduction of consumption level. It increases the social benefits.
7. Instrument of Protection: It is one of the best instruments to protect the domestic infant industries. In this regard, govt. can increase the rate of customs duty on imported goods, which helps to promote the market of domestic product.
Demerits/Disadvantages of Indirect Taxes:
1. Regressive: Generally, indirect taxes are regressive in nature. Every individual i.e. rich and poor has to pay same rate of tax on their consumption. So, the burden of tax is high to the tax payer and less burden to the rich.
2. Uncertain: The imposition of indirect increases the prices of commodities. A rise in price of commodity causes a fall in demand. Therefore, government may not collect targeted amount of revenue or collection of revenue is uncertain.
3. Lack of civic consciousness: Indirect tax is included in the price of commodity. So, the taxpayers are unknown about their contribution. Hence, they may not conscious about government activities.
4. Uneconomical: While collecting the indirect tax, every source of production should be monitored. It requires large number of administrative government staffs. Therefore, administrative cost of collection of indirect tax is higher in comparison to collected revenue.
5. Discourage Production: Indirect tax is imposed also on the capital goods. It leads to increase in the cost of production. As a result, profit margin of producer is less. It discourages producer to produce more.
6. Smuggling: The indirect tax is included in the price of goods. It makes the goods expensive. Therefore, both the consumers and businessmen try to adopt the means of smuggling to get goods at cheaper prices.
Characteristics (Canons) of Good Tax System:
Tax is an effective fiscal tool to influence economy. The state is called welfare state which imposes lower rate of tax or less burden to the tax payer and collects more amount of tax revenue. On the other hand, good tax should be effective and able to establish fair income distribution and socio-economic equality.
Adam Smith has given comprehensive concept of good tax system, which is known as canon of taxation.
1. Canon of Equality: A good tax should be based on the ability-to-pay principle of taxation. It means higher rate of tax should be imposed on higher income earner and lower rate of tax should be imposed on lower income earner. It ensures the socio-economic equality.
2. Canon of Certainty: Every taxpayer must know the time of payment, amount to be paid, method of payment, where and whom to be paid. These certainties build up the confidence of taxpayer. On the other hand, government can receive targeted amount of revenue in a time.
3. Canon of Economy: A good tax system should able to collect maximum revenue at minimum cost. It means government has to collect more amount of tax revenue by spending minimum administrative cost.
4. Canon of Convenience: In a good tax system tax should be levied in such a manner and at such a time in which it is convenient to the tax payer. For example; if the taxes are to be collected from the farmers after the harvesting of crops.
5. Canon of Elasticity: A tax system is good if it is elastic in nature. It means, government should be able to increase or decrease the rate of tax as per the need of government revenue.
6. Canon of Productivity: The principle of taxation must be based on the productive lines. Tax should be imposed in a systematic way by which it may not discourage the productive capacity of the tax payer. It means, tax should not reduce the ability to work, desire to work, saving and investment capacity of people.
7. Canon of Variety: The tax should be scattered among the different groups of people as well as commodities. By which there is the less chance of tax evasion.
8. Canon of Simplicity: Every tax should be simple. So that, the tax payer can understand its implications without the help of experts. The tax payment process also should be simple.
Concept of Proportional, Progressive, Regressive and Digressive Taxes
1. Proportional tax: If the rate of remains same after every level of taxable income, it is called proportional tax. In other words, if equal rate of tax is imposed to higher income earner and lower income earner after the taxable income limit, it is called proportional tax. In this system of tax, the rate of tax is same but amount of tax to be paid is different as per the taxable income. We can explain it by the help of given table and figure.
Taxable Income (In Rs.)
|
Rate of Tax (in %)
|
Total Amount
|
10000
|
10
|
1000
|
20000
|
10
|
2000
|
30000
|
10
|
3000
|
2. Progressive Tax: It is a system of tax in which rate of tax increase as per the increase in taxable income. It means higher rate of tax is imposed to the higher income earner and low rate of tax is imposed to the lower income earner. We can explain it by the help of given table and figure:
Taxable Income (In Rs.)
|
Rate of Tax (in %)
|
Total Amount
|
10000
|
5
|
500
|
20000
|
15
|
3000
|
30000
|
25
|
7500
|
3. Regressive Tax: It is a system of tax in which rate of tax decreases as per the increase in income and vice-versa. It means, higher rate of tax is imposed to lower income earner and lower rate of tax is imposed to higher income earner. We can explain it by the help of given table and figure:
Taxable Income (In Rs.)
|
Rate of Tax (in %)
|
Total Amount
|
10000
|
10
|
1000
|
20000
|
9
|
1800
|
30000
|
8
|
2400
|
4. Digressive Tax: It is a system of tax in which rate of tax increases as per the increase in taxable income up to a certain limit but beyond that limit the tax rate become constant. In most of the countries such kind of tax system is adopted. We can explain it by the help of given table and figure.
Taxable Income (In Rs.)
|
Rate of Tax (in %)
|
Total Amount
|
10000
|
10
|
1000
|
20000
|
15
|
3000
|
30000
|
20
|
6000
|
40000
|
20
|
8000
|
