Types of Taxation  

Direct taxes
Taxes which are collected directly from income and wealth are known as direct taxes.

Types of Direct taxes

Income tax: Income tax is collected on all incomes received by private individuals after certain
allowances are made. In most of the economies Income tax is a major source of Government
revenue.
Corporation tax: This tax is levied on profits earned by companies. It is a proportional tax
which is levied at the constant rate.

Petroleum revenue tax: It is a tax levied on the profits of companies involved in drilling of oil
and gas. This tax may or may not exist in other countries.

Capital gains tax: Capital gains tax is charged on the profit realized on the sale of a non-
inventory asset that was purchased at a lower price. The most common capital gains are realized
from the sale of stocks, bonds, precious metals and property. Not all countries implement a
capital gains tax and most have different rates of taxation for individuals and corporations.

Property Tax
Many countries have Property tax, or millage tax. It is the tax which the owner pays on the value
of the property being taxed. The taxing authority requires and/or performs an appraisal of the
monetary value of the property, and tax is assessed in proportion to that value. Forms of property
tax used vary between countries and jurisdictions.

Stamp duty
Stamp duty is a form of tax that is levied on documents relating to immovable property, stocks
and shares. Apart from transfers of shares and securities, stamp duties are also charged on the
issue of bearer instruments and certain transactions involving partnerships.
Indirect taxes
It is imposed on expenditure. In simple terms, it is a tax which is imposed on goods and services
sold. It is usually added to the cost of the good or service and charged from the ultimate
consumer. The seller will then file a return to the government on all the taxes he has collected
from the consumer.

Examples are sales tax and excise duty

Reasons for imposing taxes: The main reasons for government imposing taxes can be

1. To generate Government revenues: excise duties on beers, wines and spirits are price
inelastic in demand, so tax price increases by levying specific alcohol and tobacco taxes
raise consumer expenditures as a whole on these categories and therefore taxation
revenues;
2. To discourage consumption: Government might use taxes to discourage consumption of
certain demerit goods such as cigarettes.
3. To alter the pattern of consumption: Government might use direct taxes a a mean to alter
the consumption patter of its population. Certain goods can be made more price attractive
through lower taxes while goods which have high marginal social cost can be made
expensive through taxation.
Distinction between specific and ad valorem taxes

1. Specific tax is a flat rate of tax whereas ad valorem tax is a percentage tax.
2. Ad valorem literally the term means “according to value.” It is imposed on the basis of
the monetary value of the taxed item.
3. A specific tax is when specific amount is imposed upon a good, for example $10 on each
mobile phone sold; whereas ad valorem tax is expressed as a percentage of the selling
price e.g. 12% of the sales.
4. The amount of specific tax changes in the same proportion as the quantity sold increase,
5. whereas, in ad valorem the tax collected is more at higher prices then at lower prices.

Consequences of imposing indirect tax: Imposition of tax results in three economic

observations.

1. Incidence: Incidence of tax means the party who actually pays the tax.
2. Government revenue: the amount of tax government will receive as revenue
3. Resource allocation: the amount of fall in quantity demanded and produced created by
the tax.

Incidence or tax burden: When a tax imposed on a good or service increase the price by the
amount of the tax, the burden of the tax falls on consumers.

If instead it lowers wages or lowers prices for some of the other factors of production used in
the production of the good or service taxed, the burden of the tax falls on owners of these factors.
If the tax does not change the product’s price or factor prices, the burden falls on the owner of
the firm—the owner of capital.

If prices adjust by a fraction of the tax, the burden is shared. The incidence of tax will be shared
between the consumers and producers, depending on the price elasticity of demand (PED) for
that product (which we will discuss later).

If we assume that the burden is equally shared by both the consumers and the producers then the
size of square CYZPe is equal to PeZXP1. This means the incidence of tax is equally distributed
by both the consumer and producer.

Government revenue: Putting taxes on goods and services generates revenue for the
government.

Figure below shows the shaded region as tax revenue for government i.e. CYXP1. The
implication will be a fall in output from Qe to Q1 and thus the consumption and production of
the commodity will fall.
Tax incidence and price elasticity of demand and supplyIncidence of indirect taxes on consumers
and firms differs, depending on the price elasticity of demand and on the price elasticity of
supply. Let’s study individual cases.

Scenario 1: When PED is greater than PESWhere PED is greater than PES, it implies that
consumers are more sensitive to price changes as compared to suppliers. Thus the incidence of
tax will be more on the suppliers because if too much burden of tax is passed on to the
consumers then the demand will fall drastically. Therefore, this time the price paid by buyers
barely rises; sellers bear most of the burden of the tax.
Scenario 2: When PES is greater than PEDWhen the supply curve is relatively elastic, the bulk
of the tax burden is borne by buyers. This is because PED as compared to PES is elastic, which
means; consumers are not that price sensitive and will not reduce their consumption even if the
prices rise. Because the PES is elastic, suppliers will stop the supply if the cost of production
goes up. Therefore, buyers end up getting higher burden of tax.
Scenario 3 : PED is equal to PESIn this case both the producer and consumer will share equal
burden of tax