Concept of Tax, its types and Features, Merits and Demerits of Direct and Indirect Taxes

Concept of Tax

The term tax refers to the compulsory monetary charge imposed by the government to its citizens and institutions for the service rendered in various sectors of the country. Nobody can deny it. The taxpayer does not expect a direct benefit in return. Hence, the amount collected by imposing a tax is spent for the welfare of the people. The main features of tax are as follows:

• Taxes are compulsory monetary payments and nobody can deny these payments.
• Direct benefits in return are not expected at the time of tax payment.
• The fund collected from taxes is spent for the welfare of the people.

Types of taxes

Taxes are imposed in various ways. According to the ways and the direction of the system of taxation, it is classified based on different aspects. The main classification of taxes is made on the basis of impact and incidence resting on taxpayers.

Tax is a compulsory payment and the burden of the tax falls on the taxpayer. The burden of tax at the time of payment is an initial burden which is called impact. In some taxes, the burden can be shifted to another person but in some others, it is not possible. When the burden of tax cannot be shifted to others, it is a real burden. The real burden is the final resting place of tax which is called incidence. On the basis of impact and incidence, taxes are classified into two types: direct and indirect.

a. Direct tax: 

When the impact and incidence of the tax fall on the same person on whom it is imposed legally, it is called direct tax. It means that direct tax is paid by the person on whom it is imposed. For example, income tax is the direct tax because the taxpayer cannot shift the amount of tax to another person.

b. Indirect tax: 

When the impact of the tax falls on one person and the incidence of tax is shifted to another, it is called an indirect tax. It means that indirect tax is imposed on one person but is paid by another. For example, value-added tax (VAT) is an indirect tax because it is paid by a producer or seller of a commodity and can be shifted to the final purchaser by adding the amount of tax with the price of that commodity.

Features of Direct Taxes

The features of direct taxes are as follows:

1. The burden of tax cannot be shifted: In a direct tax, the taxpayer is the bearer of tax. S/he cannot shift the burden of tax to another person. This tax is levied on that person who is desired to pay it.

2. Certainty: In a direct tax, the taxpayer is certain about the amount of tax and the time of payment. There is no uncertainty about how much and when the tax is to be paid. The tax authorities are also certain about the amount of revenue that is to be collected from the tax.

3. Elastic: Direct tax is elastic. The government can increase or decrease the amount of revenue by changing the rate of direct tax. The taxpayer cannot avoid such tax due to which it is easy to increase the amount of revenue.

4. Productive: Direct tax is productive. At the time of prosperity, the income of the people rises and they are paying a higher amount of tax to the government. It means the higher level of income yields the larger revenue to the government.

5. Educative: In a direct tax, the taxpayer is the bearer of tax. The actual taxpayer is conscious about his/her rights to know about the utilization of tax made by the tax authorities. S/he tries to be informed about whether the tax revenue is properly utilized or not. So, a direct tax is educational.

6. Anti-inflationary: The method of direct tax is a powerful instrument to control inflation. When the rate of tax is increased, the income of the people decreases. It reduces people's purchasing power, which results in the fall of aggregate demand in the economy leading to the fall in the price level.

Merits of Direct Taxes

The merits of direct taxes are as follows:

1. Ensures equity or equality: The burden of direct tax heavily falls on the richer section of the society than the poorer section because this tax is imposed on the basis of the level of income. The higher the level of income, the higher will be the rate of tax. Effective implementation of direct tax helps to achieve the goal of equal distribution of income and wealth in society.

2. Economy: The cost of collection of direct taxes is low. Direct taxes are collected mostly 'at the source'. For instance, the income tax is deducted from an officer's pay every month. Hence, it saves time and the cost of the tax collection of the government.

3. Certainty: In the case of direct tax, the payers know the amount of direct tax to be paid, time of tax payment, and place of tax payment. The authorities also know the amount of revenue they can expect. There is certainty on both sides. This minimizes corruption on the part of collecting officials

4. Elastic: The government may change the rate of direct tax according to the requirement of budget to meet the development and the regular expenses, In addition, the revenue of the government increases along with an increase in income and property of the taxpayers and vice versa.

5. Productive: Another virtue of direct taxes is that they are very productive. As the community grows in number, the return from direct taxes expands automatically. The direct taxes yield large revenue to the government.

6. Progressive in nature: The direct tax is regarded as a progressive tax in the sense that a higher tax rate is imposed on the rich and a lower tax rate on the poor.

Demerits of Direct Taxes

The direct tax has some demerits which are as follows:

1. Inconvenient: The direct tax is inconvenient to the taxpayer in the sense that the taxpayer has to maintain records of tax payment, and visit the tax office frequently. S/he 'squeaks', when a lump sum is taken out of his pocket in the form of tax.

2. Possibility of evasion: The taxpayer can submit a false return of income and thus can evade the tax. That is why a direct tax is "a tax on honesty". There is a lot of evasions. Many of those who should be paying taxes go scot-free by concealing their incomes.

3. Disincentive: If the taxes are too heavy, they discourage saving and investment. In that case, the country will suffer economically. A high level of taxation discourages investment and enterprises in the country. It inflicts a lot of damage on business and industry.

4. Arbitrary: If taxes are progressive, the rate of progression has to be fixed arbitrarily, and if proportional, they fall more heavily on the poor. Thus, both are bad. The rate of taxes depends upon the whim of the Finance Minister. This is arbitrary.

5. Limited scope: The direct tax holds a narrow base because it is collected only from rich people. The government would be unable to collect a substantial amount of tax in developing countries where the majority of people are poor.

Features of indirect taxes

The features of indirect taxes are as follows:

1. Shifting of tax burden: The burden of indirect tax can be shifted partly or wholly to another person. The producers or traders pay the tax imposed on commodities but the amount of tax is shifted to the final purchaser by including it with the price of such commodities.

2 . Broad-based: The area of indirect tax is broad. It covers most of the people, rich or poor because they have to purchase the commodities in which the tax is imposed. The amount of tax is included in the price of goods.

3. Difficulty of evasion: Indirect tax is paid with the price of goods. It is difficult to avoid such tax. People compulsorily pay the indirect tax at the time of purchasing goods and services.

4. Convenient: Indirect tax is convenient to pay. The final taxpayer pays this tax in small amounts at the time of purchasing goods. In fact, the real taxpayer does not feel the burden of tax because s/he thinks that s/he is paying only the price of goods.

5. Inflationary: Indirect tax is inflationary. When the rate of indirect tax is increased, it raises the price of goods. It means the increasing level of indirect tax will cause inflation in the economy.

6. Uncertain: The amount of government revenue collected from the indirect tax is not certain. When the rate of tax is increased, the price of goods will rise. The higher price will cause a decrease in demand. Thus, people purchase less quantity of goods, which will cause a reduction in the amount of revenue collected from indirect tax.

Merits of Indirect Taxes

The merits of indirect taxes are as follows:

1. Convenient: The indirect taxes are convenient to both the taxpayer and the government. It is because the taxpayers do not feel a burden as indirect tax is paid in small amounts. It is also partly because it is paid only at the time of purchase of goods and services. It is convenient to the government as well because it can be collected at the factory.

2. Broad-based: Since indirect tax is included in the price of goods and services, it is collected from all types of people, whether they are rich or poor. Therefore, it has a wider scope to collect government revenue.

3. Non-evadable: Indirect taxes cannot be evaded as they are part of the price because a consumer is compelled to pay this tax unknowingly during the purchase of goods and services.

4. Elastic: Indirect taxes are also very elastic in yield if imposed on necessaries of life that have inelastic demand. Indirect taxes on necessaries yield a large revenue because people must buy these things.

5. Equitable distribution of income: Indirect taxes help in the equal distribution of income and wealth. Government imposes a high rate of taxes on the goods consumed by the rich people and a low rate of taxes consumed by the poor people. 

    The revenue collected from these taxes can be spent on the welfare of poor people, i.e. free education, free health care, etc. This reduces the expenditure of the poor on education, health, etc. which increases their savings. This leads to an equal distribution of income.

6. Check harmful consumption: By being imposed on harmful products, indirect taxes can check the consumption of harmful commodities. That is why tobacco, wine, beer, cigarettes, and other intoxicants are heavily taxed. Thus, the revenue collected from such commodities is used for promoting the social welfare programs of the country.

Demerits of Indirect Taxes

The indirect tax has some demerits which are explained below:

1. Regressive: Indirect taxes are not equitable. The rich and the poor should pay the same amount of tax rate while purchasing the same goods. Its burden heavily falls on the poor rather than on the rich which is unfair.

2. Uncertain: Unless indirect taxes are imposed on necessaries, we cannot be sure of the revenue yield. In the case of goods with elastic demand, the tax might not bring in much revenue. The tax will raise the price and contract demand. When the thing is not purchased, the question of tax payment does not arise.

3. Uneconomical: The cost of collection is quite heavy. Every source of production has to be guarded. A large administrative staff is required to administer such taxes. This turns out to be a costly affair.

4. Unproductive: The indirect tax increases the prices of goods and services which limits the scope of saving and capital formation in the country.

5. Harmful to industries: Indirect taxes discourage industries if raw materials are taxed. This will raise the cost of production and impair their competitive capacity.

6. Un-educative: The indirect tax is uneducated in the sense that consumers don't feel that they are paying tax to the government while purchasing the goods and services. As a result, they do not sincerely respond to government expenditure as a sensitive citizen.