a) what is the difference between direct and indirect taxes

The government needs money to function and taxes are one of the most important sources of the
government’s income. The government levies taxes on various items ranging from consumer
goods and electronics to fuel and liquor. Every individual earning above a certain limit has to
pay income tax. But what is income tax? What is the difference between Income Tax and the
Goods and Services Tax? It is important to have the knowledge of the types of taxes of India. For
instance, income tax is a direct tax, while GST is an indirect tax. To understand the difference
between direct and indirect taxes, it is important to know both of them.
What is a direct tax?
Direct taxes are the taxes that are paid to the authority that imposes it without any intermediary.
These taxes cannot be transferred to any other entity and have to be paid directly. The Central
Board of Direct Taxes under the Department of Revenue is responsible for direct taxes in India.
It administers the collection of direct taxes and provides crucial inputs to the government.
Common direct taxes
Income tax: It is the tax imposed on the income of an individual in a financial year. The quantum
of the tax depends on the income tax slab of the taxpayer. The government provides a number of
tax incentives to individual employees.
Tax on capital gains: Whenever you sell an asset at a profit, you have to pay the capital gains tax.
The tax has been categorised into two forms-long term capital gains tax or short-term capital
gains tax.
What is indirect tax?
The differences between direct and indirect taxes are easily distinguishable. While direct tax is
levied on income, indirect tax is imposed on goods and services and are paid through an
intermediary. The Central Board of Indirect Taxes and Customs is tasked with monitoring
indirect taxes.
The Goods and Services Tax (GST) is one of the most common indirect taxes. When it was
rolled out in 2017, it had subsumed over 17 indirect taxes such as service tax, central excise tax
and state’s value-added tax. The GST council decides the rates at which different products and
services are taxed.
Difference between direct tax and indirect tax
There are several major points that distinguish between direct and indirect tax.
Imposition: Direct tax is imposed on income and profits, while indirect tax is levied on goods
and services.
Taxpayer: The individuals, companies and other taxable entities pay direct taxes, while indirect
taxes are paid by the end-consumer.
Tax burden: Direct taxes like income tax are filed by the individual and hence the tax burden
falls solely on them. In the case of indirect taxes like GST, the tax burden is transferred to
consumers by manufacturers and service providers.
Transferability: One of the biggest differences between direct and indirect taxesis the
transferability of the tax. Direct taxes cannot be transferred and have to be paid by self. Indirect
taxes like GST can be transferred from one taxpayer to another.
Coverage: The coverage of direct taxes is not widespread as only an individual or entity earning
above a certain limit is liable to pay direct taxes. On the other hand, indirect taxes have relatively
larger coverage as they are uniformly imposed.
Inflation: Inflation is a crucial factor that distinguishes between direct and indirect taxes. Direct
taxes can be used in controlling inflation. If the inflation rises beyond control, the government
can increase direct taxes which will reduce money for sending and curtail demand for goods and
services. Indirect taxes, on the other hand, lead to inflation. An increase in taxes leads to the rise
in the cost of goods and services.
Nature: Direct tax is a progressive tax since it is imposed as per the income of an individual and
not uniformly. A higher share of the burden of direct taxes is shared by affluent people. Indirect
taxes are regressive in nature as everyone has to pay them irrespective of their income.
b) highlight the advantages and disadvantages of direct and indirect taxes
Taxes may be classified as direct and indirect. Direct taxes are levied on a person’s or a firm’s
income or wealth and indirect taxes on spending on goods and services. Thus, direct taxes are
paid directly by the person or firm on whom the assessment is made, while indirect taxes are paid
indirectly by consumers in the form of higher prices. Direct taxes cannot be legally evaded but in
direct taxes can be avoided because people can reduce their purchases of the taxed goods and
services.
Direct Taxes:
Examples of direct taxation include income tax, corporation tax (on companies’ profits), capital
gains tax (a tax on the profits of sales of certain assets), wealth tax (which is a tax on ownership
of property or wealth) and a capital transfer tax (a tax on gifts to replace death duties). Direct
taxes are mainly collected by the central government.
Advantages:
(i) It is easy to determine the incidence of the tax – a person or institution who actually pays and
suffers the burden of tax.
(ii) Direct taxes tend to be progressive – people in the higher income group pay a greater
percentage than poorer people, e.g., income tax is graduated so that high income earners pay a
larger percentage; also a selective wealth tax would only apply to those owning more than a
certain level of wealth.
(iii) Direct taxes are easy to collect. Consider, for example, the PAYE system which is used to
collect income tax from most wage and salary earners.
(iv) Direct taxes are important to the government’s economic policy. If the government is
fighting inflation it can impose, for example, high levels of income tax to restrict consumer
demand. If the government is concerned about unemployment it can reduce the levels of income
tax to increase consumer demand and increase production.
Disadvantages:
ADVERTISEMENTS:
(i) Direct taxation may be a disincentive to hard work. High rates of income tax, for example,
may discourage people from working overtime or trying to gain promotion at work. Some
economists blame the ‘brain drain’ (i.e., the emigration of highly qualified persons, such as
scientists and doctors) on India’s high levels of taxation.
(ii) Direct taxation discourage savings because, after paying tax, individuals and companies have
less income available to save. This means that investment, which relies on the level of savings, is
low and this could cause less production and employment.
(iii) This type of taxation encourages tax evasion – to avoid paying so much tax.
(iv) There is no element of choice about paying the tax – it is unavoidable.
Indirect taxes:
Examples of indirect taxation include customs duties, motor vehicles tax, excise duty, octroi and
sales tax. Indirect taxes are collected both by the central and state governments but mainly by the
central government.
Advantages:
(i) Indirect tax is fairly easy to collect.
(ii) It is easy to determine the incidence of an indirect tax.
(iii) The government can use it to discourage certain types of consumption. A high rate of tax on
tobacco can, for example, affect smoking habits.
(iv) Indirect taxation is a good way of raising revenue when levied on goods with an inelastic
demand, such as necessities.
(v) Tourists do not pay income tax. But they spend money on goods and services. This adds to
the tax revenue of the government.
(vi) Consumers have a choice as to whether they pay the tax. They can avoid paying the tax by
not consuming the goods which are being taxed.
(vii) Indirect taxes do not have a discentive effect on work.
Disadvantages:
(i) Indirect taxes are regressive. A regressive tax is one which causes a poor person to pay a
higher percentage of his or her income as tax than a rich person. For instance, the tax ingredient
of the price of a new television set would be the same for the poor and the rich person, but as a
percentage of the poor person’s income, it is far greater.
(ii) These taxes are not impartial. In recent years, certain groups of consumers have complained
that they are being heavily penalised by taxation, e.g., drinkers, smokers and drivers.
(iii) Indirect taxes may contribute to inflation. The imposition of an indirect tax on an item like
petrol will increase its price. Since petrol is an essential input in a large number of industries, this
may set off an inflationary spiral. Moreover, trade unions demand higher wages to maintain the
real incomes of workers.
Conclusion
Both direct and indirect taxes are a crucial source of income for the government. In the long run,
taxation has tended to decrease, giving more room for businesses and individuals to invest into
the economy.
REFERENCES
 My taxes go where? How countries spend your money (17 February 2015), The BBC
 Minarik, Joseph J. (2008). "Taxation". In David R. Henderson (ed.). Concise Encyclopedia
of Economics (2nd ed.). Library of Economics and Liberty. ISBN 978-
0865976658. OCLC 237794267.
 Seelkopf, L., Bubek, M., Eihmanis, E. et al. The rise of modern taxation: A new
comprehensive dataset of tax introductions worldwide. Rev Int Organ (2019).