A tax is a financial charge or other levy imposed upon a taxpayer (an individual or legal entity) by a state or administrative division. Failure to pay tax is punishable by law.Tax is not a voluntary payment or donation.It is a contribution imposed by government, state or administrative division to enable them to meet the expenses.
So if anybody earns an income, he should share a portion of the same with the government. In India, taxes are divided in Direct Indirect Tax.
The way in which taxes are imposed, decides whether the tax is direct or indirect.
If a tax is levied directly on a person income then they are called direct taxes
Whereas the indirect taxes are levied on a product or a service the incidence of which is borne by the consumers who ultimately consume the product or the service.
For example I earn Rs. 12 Lac as salary. Suppose I need to pay Rs. 8000 as income tax on this salary income. Since the income tax of Rs. 8000 is directly levied on my salary income hence income tax is direct taxes.
Suppose in second case, I paid Rs. 950 (Rs. 900 basic amount + Rs. 50 as service tax) as my mobile bill to Airtel. Airtel will retain Rs. 900 and pay the Service tax Rs. 50 to the government.
Difference between Direct Tax and Indirect Tax:
There are different implications of direct and indirect taxes on the country. However, both types of taxes are important for the government as taxes include the major part of revenue for the government.
Key differences between Direct and Indirect Tax are:
- Direct tax is levied and paid for by individuals, Hindu undivided Families (HUF), firms, companies etc. whereas indirect tax is ultimately paid for by the end-consumer of goods and services.
- The burden of tax cannot be shifted in case of direct taxes while burden can be shifted for indirect taxes.
- Lack of administration in collection of direct taxes can make tax evasion possible, while indirect taxes cannot be evaded as the taxes are charged on goods and services.
- Direct tax can help in reducing inflation, whereas indirect tax may enhance inflation.
- Direct taxes have better allocative effects than indirect taxes as direct taxes put lesser burden over the collection of amount than indirect taxes, where collection is scattered across parties and consumers’ preferences of goods is distorted from the price variations due to indirect taxes.
- Direct taxes help in reducing inequalities and are considered to be progressive while indirect taxes enhance inequalities and are considered to be regressive.
- Indirect taxes involve lesser administrative costs due to convenient and stable collections, while direct taxes have many exemptions and involve higher administrative costs.
- Indirect taxes are oriented more towards growth as they discourage consumption and help enhance savings. Direct taxes, on the other hand, reduce savings and discourage investments.
- Indirect taxes have a wider coverage as all members of the society are taxed through the sale of goods and services, while direct taxes are collected only from people in respective tax brackets.
- Additional indirect taxes levied on harmful commodities such as cigarettes, alcohol etc. dissuades over-consumption, thereby helping the country in a social context.
Both direct and indirect taxes are important for the country as they are intricately linked with the overall economy. As such, collection of these taxes is important for the government as well as the well-being of the country. Both direct taxes and indirect taxes are collected by the central and respective state governments according to the type of tax levied.