What is tax?

Taxes are mandatory contributions levied on individuals or corporations by a government entity—whether local, regional, or national. Tax revenues finance government activities, including public works and services such as roads and schools, or programs such as Social Security and Medicare.

Direct and indirect taxes

Direct taxes are directly paid to the government and levied on one’s income and profits. The burden of direct tax can’t be shifted from one entity to another. Examples include income tax, property tax, wealth tax, fringe benefits tax, etc.

Indirect taxes are collected by an intermediary on the behalf of the entity facing the actual economic burden. Its burden can be shifted from one person to another. Examples include Value Added Tax (VAT), Goods and Service Tax (GST), etc.

Difference between Direct and Indirect Taxes

The difference between the two can be understood from the table below:

What does shifting of Burden mean?

Tax shift is a kind of economic phenomenon in which the taxpayer transfers the tax burden to the purchaser or supplier by increasing the sales price or depressing the purchase price during the process of commodity exchange. Direct taxes have to be paid by the entity levied on whereas indirect taxes have to be paid by the consumer on the consumption of goods and services to the retailer/ service provider.

Merits of Direct Taxes

Direct taxes are equitable and an important source of revenue for the government. It raises the civic sense of people and develops a consciousness towards the spending of their hard earned money towards societal welfare.

Demerits of Direct Taxes

It is liable to be evaded as many individuals portray false information of their wealth. The high rate also demotivates the desire to work and save.

Merits of Indirect Taxes

Indirect taxes are levied on everyone regardless of their income bracket and so are inclusive in nature. They can be conveniently paid as they are included in the selling price proposed by the shopkeeper. Indirect taxes are impossible to evade as they are paid at consumption and consumers don’t feel a burden paying them due to the low amount of rate.

Demerits of Indirect Taxes

Indirect taxes can be perceived as regressive as they are standard for rich and poor alike. While affluent people might not mind paying indirect taxes, the poor can feel the burden. They also increase the price of a commodity with retailers charging an extra margin to fill their pockets.