Benjamin Franklin, one of the founding father of United Nations has rightly said “In this world nothing can be said to be certain, except death and taxes.” We can’t tackle the first one but let’s talk about dealing with the latter – Tax . The word “Tax” is originated from Latin word taxo, which mean, “I estimate.” We pay taxes of so many types in our daily lives, sometimes even without knowing that we are paying it. So it is important for us to know exactly what taxes we pay, both knowingly and unknowingly. While paying taxes is nobody’s favorite activity, it’s something everyone has to do in order to keep government programs rolling. Especially with the service tax rates increased to 14% one must try and understand how the scheme of things works with the direct and indirect taxes levy.
Taxes are classified in two major categories in India, direct taxes &indirect taxes. Direct Taxes, as the name suggests, are applied directly on individuals and organizations by the government. Every consumer pays Indirect Taxes indirectly when he buys any goods/service. These are applied on the manufacture or sale of goods and services. So in a way, the basis of classifying taxes into direct and indirect is “whether the burden of the tax can be shifted to others or not.” When the liability to pay the tax and the burden of that tax falls on the same person it is “Direct Tax” but when this same burden can be shifted to others is known as “Indirect Tax.” An example of direct taxation would be income taxes that are collected from the people who earn income. Indirect taxes are first paid to the government by an intermediary, who then adds the amount of the tax paid to the value of the goods/services and passes on the total amount to the customer.
A sales tax, for instance, would not be considered as direct tax because the money is collected from merchants, not from the people who actually pay the tax (the consumers). Hence ultimately even if the burden falls on the consumers they hardly realize it and hence it is easier to levy and collect. Each has its advantages and disadvantages, largely based on individual earnings and spending habits.
Few examples of direct taxes are – Income tax, corporate tax, wealth tax, estate duty.
Few examples of indirect taxes are – Sales tax, Octroi, service tax, VAT, excise duty, custom duty and so on.
Another important thing that can be noted is that direct taxes are considered to be progressive in nature while indirect taxes are considered to be regressive. Direct taxes have an element of certainty and can be collected economically, while indirect taxes are not equitable. For example, salt tax in India fell more heavily on the poor than on the rich, as it had to be paid at the same rate by all. Whether a rich man buys a commodity or a poor man, the price in the market is the same for all. The tax is wrapped in the price, hence, rich and poor pay the same amount. Both direct and indirect taxes are alternative methods of achieving any particular redistribution of income. Indirect taxes can be spread over a wide range. Very heavy direct taxation at just one point may produce harmful effects on social and economic life. As indirect taxes can be spread widely, they are more beneficial and suitable.
The administrative costs of direct taxes are also more than that of indirect taxes. This implies that the cost of collection and processing of direct taxes is more cumbersome and costly affair as the Income tax department has to calculate and process the payment for each tax payer. Direct taxes are narrow based, since it cannot be levied on one and all but only on a certain percentage of people and has many exemptions. Hence direct taxes are a cumbersome affair. Indirect taxes can be conveniently collected and cost of collection is constant overtime. From point of view of efficiency and productivity, indirect taxes are better. Indirect taxes are wrapped up in prices and hence they cannot be easily evaded. They are more productive as their cost of collection is the least. Thus, from point of view of administrative costs, indirect taxes are relatively superior.
The question whether direct taxes are better or indirect taxes, much can be said on both sides. Both types have to be mixed in a good system of taxation. Their relative importance depends on a number of factors, such as distribution of income, nature of the economic system, the stage of economic development, etc. The rich can be taxed best directly, but pockets of the poor have also to be tapped through indirect taxes. Nowadays, when the state functions are multiplying, substantial amounts are required for the discharge of its multifarious activities. Neither the direct nor the indirect taxes alone can raise adequate revenue. So both are necessary and the use of both direct and indirect taxes is indispensable in modern public finance.
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