CHAPTER TWO
CLASSIFICATION OF TAXES
OBJECTIVES
By the end of the topic, the student should be able to:
Differentiate between various types of taxes.
State the advantages and disadvantages of each type of tax.
Explain the meaning of the terms incidence and impact of taxation.
2.1 Introduction
Taxes may be classified based on:
Administrative collection arrangements: Direct taxes and indirect taxes.
Tax rates: Progressive, proportional, regressive and digressive taxes
Tax bases
2.2 Classification Based on Administrative Collection Arrangements
2.2.1 Direct Taxes
What are Direct Taxes ? Meaning
A direct tax is one, which is paid by a person on whom it is legally imposed and the burden of
which cannot be shifted to any other person. The person from whom it is collected cannot shift
its burden to anybody else.The tax-payer is the tax-bearer. The impact i.e. the initial burden and
its incidence i.e. the ultimate burden of direct tax is on the same person. For e.g. Income tax,
wealth tax, property tax, estate duties, capital gain tax, corporate / company tax, etc. are all direct
taxes.
Advantages / Merits of Direct Taxes
Following are the important advantages or merits of Direct Taxes :-
1. Equity
There is social justice in the allocation of tax burden in case of direct taxes as they are based on
the principle of ability to pay. Persons in a similar economic situation are taxed at the same rate.
, Persons with different economic standing are taxed at a different rate. Hence, there is both
horizontal and vertical equity under direct taxation. Progressive direct taxation can reduce
income inequalities and bring about adequate social & economic justice.
2. Certainty
As far as direct taxes are concerned, the tax payer is certain as to how much he is expected to
pay, as the tax rates are decided in advance. The Government can also estimate the tax revenue
from direct taxes with a fair accuracy. Accordingly, the Government can make adjustments in its
income and expenditure.
3. Relatively Elastic
The direct taxes are relatively elastic. With an increase in income and wealth of individuals and
companies, the yield from direct taxes will also increase. Elasticity also implies that the
government's revenue can be increased by raising the rates of taxation. An increase in tax rates
would increase the tax revenue.
4. Creates Public Consciousness
They have educative value. In the case of direct taxes, the taxpayers are made to feel directly the
burden of taxes and hence take keen interest in how public funds are spent. The taxpayers are
likely to be more aware about their rights and responsibilities as citizens of the state.
5. Economical
Direct taxes are generally economical to collect. For instances, in the case of personal income
tax, the tax can be deducted at source from the income or salaries of the individuals. Therefore,
the government does not have to spend much in tax collection as far as personal income tax is
concerned. However, in the case of indirect taxes, the government has to set up an elaborate
machinery to collect taxes.
6. Anti-inflationary
The direct taxes can help to control inflation. During inflationary periods, the government may
increase the tax rate. With an increase in tax rate, the consumption demand may decline, which
in turn may reduce inflation.
Disadvantages / Demerits of Direct Taxes
CLASSIFICATION OF TAXES
OBJECTIVES
By the end of the topic, the student should be able to:
Differentiate between various types of taxes.
State the advantages and disadvantages of each type of tax.
Explain the meaning of the terms incidence and impact of taxation.
2.1 Introduction
Taxes may be classified based on:
Administrative collection arrangements: Direct taxes and indirect taxes.
Tax rates: Progressive, proportional, regressive and digressive taxes
Tax bases
2.2 Classification Based on Administrative Collection Arrangements
2.2.1 Direct Taxes
What are Direct Taxes ? Meaning
A direct tax is one, which is paid by a person on whom it is legally imposed and the burden of
which cannot be shifted to any other person. The person from whom it is collected cannot shift
its burden to anybody else.The tax-payer is the tax-bearer. The impact i.e. the initial burden and
its incidence i.e. the ultimate burden of direct tax is on the same person. For e.g. Income tax,
wealth tax, property tax, estate duties, capital gain tax, corporate / company tax, etc. are all direct
taxes.
Advantages / Merits of Direct Taxes
Following are the important advantages or merits of Direct Taxes :-
1. Equity
There is social justice in the allocation of tax burden in case of direct taxes as they are based on
the principle of ability to pay. Persons in a similar economic situation are taxed at the same rate.
, Persons with different economic standing are taxed at a different rate. Hence, there is both
horizontal and vertical equity under direct taxation. Progressive direct taxation can reduce
income inequalities and bring about adequate social & economic justice.
2. Certainty
As far as direct taxes are concerned, the tax payer is certain as to how much he is expected to
pay, as the tax rates are decided in advance. The Government can also estimate the tax revenue
from direct taxes with a fair accuracy. Accordingly, the Government can make adjustments in its
income and expenditure.
3. Relatively Elastic
The direct taxes are relatively elastic. With an increase in income and wealth of individuals and
companies, the yield from direct taxes will also increase. Elasticity also implies that the
government's revenue can be increased by raising the rates of taxation. An increase in tax rates
would increase the tax revenue.
4. Creates Public Consciousness
They have educative value. In the case of direct taxes, the taxpayers are made to feel directly the
burden of taxes and hence take keen interest in how public funds are spent. The taxpayers are
likely to be more aware about their rights and responsibilities as citizens of the state.
5. Economical
Direct taxes are generally economical to collect. For instances, in the case of personal income
tax, the tax can be deducted at source from the income or salaries of the individuals. Therefore,
the government does not have to spend much in tax collection as far as personal income tax is
concerned. However, in the case of indirect taxes, the government has to set up an elaborate
machinery to collect taxes.
6. Anti-inflationary
The direct taxes can help to control inflation. During inflationary periods, the government may
increase the tax rate. With an increase in tax rate, the consumption demand may decline, which
in turn may reduce inflation.
Disadvantages / Demerits of Direct Taxes
