Direct vs Indirect Taxes
Notes
- Direct taxes are paid directly to the Government by the person on whom they are levied; the impact and incidence fall on the same person and the burden cannot be shifted. Examples: income tax, corporation tax, capital gains tax and Securities Transaction Tax (STT). Wealth tax was abolished in 2015.
- Indirect taxes are levied on goods and services; the impact falls on the seller, but the incidence falls on the consumer (the burden is shifted). Examples: GST, customs duty, central excise (now mainly on petroleum products and tobacco) and State VAT on petrol and diesel.
Basis | Direct taxes | Indirect taxes |
|---|---|---|
Incidence | On the person who pays | Shifted to the consumer |
Nature | Progressive (rises with income) | Regressive (the same rate for rich and poor) |
Equity | High | Low |
Evasion | Easier to evade | Harder to evade |
Inflation | Not inflationary | Can raise prices |
Collection | Costly and complex | Easy, wide base |
Examples | Income tax, corporation tax | GST, customs duty |
Other points
- Merits of direct taxes: equitable (based on ability to pay), progressive, a stabiliser, certain. Demerits: evasion, disincentive to work and save, narrow base.
- Merits of indirect taxes: wide coverage, convenient collection, hard to evade. Demerits: regressive, inflationary, can distort consumption.
- Shares in India: the share of direct taxes in the Centre's gross tax revenue has risen to more than half (about 55-58% in recent years), compared with the 1990s when indirect taxes dominated.
- Customs duty components: Basic Customs Duty, IGST on imports, Social Welfare Surcharge, anti-dumping and safeguard duties.
- Collection at source: advance tax, TDS (tax deducted at source) and TCS (tax collected at source).
- Cascading effect (tax on tax) was a problem under pre-GST taxes; GST removes it by input tax credit.
- A Pigouvian tax (such as a carbon tax) corrects negative externalities.
Key Points
- Direct: incidence and impact on the same person; progressive.
- Indirect: burden shifted to the consumer; regressive.
- Examples: income tax and corporation tax (direct); GST and customs (indirect).
- Direct taxes now form over half of India's tax revenue.
- TDS and advance tax are collection mechanisms.
MCQs
Q1. Which of the following is a direct tax? (a) GST (b) Customs duty (c) Corporation tax (d) Excise duty Ans: (c).
Q2. Indirect taxes are generally: (a) Progressive (b) Regressive (c) Proportional to income only (d) Not shifted Ans: (b).
Q3. In a direct tax, the impact and incidence fall on: (a) Different persons (b) The same person (c) Only companies (d) Only consumers Ans: (b).