Difference between Direct and Indirect tax

A tax is a compulsory payment imposed on persons or companies by the government to meet the expenditure incurred on providing common benefits to the people. Taxes are very significant to generate revenue for financing developmental programs. There are two types of taxes: Direct Tax and Indirect Tax

Difference between Direct and Indirect tax

Direct TaxesIndirect Taxes
Direct taxes refer to taxes that are really paid by those on whom they are legally imposed.Indirect taxes refer to taxes that are imposed on an individual but are paid by another person either partly or wholly.
The tax burden cannot be shifted to any other individual or firm by the taxpayer.The tax burden can be shifted by the taxpayer.
It is progressive because the tax rate increases with an increase in the income slabs.It is regressive because the common people bear this tax burden.
The impact and incidence of tax fall on the same person.The producer bears the impact and incidence of
tax on the consumer.

Merits of Direct Tax

  • Equity: Direct tax is imposed on the income of a person based on the principle of ability to pay. The income tax burden is equitably distributed on different people and institutions; thereby the tax burden falls more on the rich than on the poor.
  • Certainty: An individual knows how much of tax is due and when it is due. The government knows with certainty how much tax revenue is to be collected from direct tax. Accordingly, the government can adjust its income and expenditure.
  • Elasticity: Direct tax is more elastic. During the period of crisis, the government can yield more revenue by increasing the tax rates.

Demerits of Direct Tax

  • Tax evasion: There is a greater possibility of tax evasion of direct taxes as these taxes are collected based on honesty of the taxpayers. Business groups try to evade direct tax by misrepresenting their income statements to the income tax authorities.
  • Narrow in scope: Direct taxes are imposed heavily on rich people. The government cannot approach the low income group through these taxes. Hence, they have limited scope in collecting tax.

Merits of Indirect Tax

  • Broad coverage: In the tax on commodity, all the buyers of the commodity have to pay the indirect tax irrespective of the income level whether they belong to the high income group or the low income group. By widening the tax net, the government can yield more revenue for public expenditure.
  • Convenient: Indirect taxes are paid in small portion at regular intervals. It is not a burden to the taxpayer as it is included in the price of the commodity.

Demerits of Indirect Tax

  • Uncertain: Taxes on goods with elastic demands are very uncertain. When the commodity is taxed, prices of the commodity increase which reduces the demand for the commodity in the market. Hence, the revenue from indirect tax is uncertain.
  • Discourage savings: Most of the income is spent on consumption of goods where the price of goods includes indirect tax, thus making savings impossible.

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