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Indirect Tax Meaning - Merits and Demerits of Indirect Taxes

what are indirect taxes

Post: Gaurav Akrani. Date: 12/30/2010 09:01:00 AM IST. No Comments. Label: Economics .

What are the Indirect Taxes. Meaning ↓

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Hicks classifies direct & indirect taxes on the basis of administrative arrangements. In case of direct tax-there is a direct relationship between the taxpayer and the revenue authorities. A tax collecting agency directly collects the tax from the taxpayers, whereas in case of indirect taxes there is no direct relationship between the taxpayers and the revenue authorities. They are collected through traders and manufacturers.

Over the years the share of indirect tax has declined in India due to reduction in the rates of indirect taxes.

Advantages / Merits of Indirect Taxes ↓

The merits of indirect taxes are briefly explained as follows :-

1. Convenient

2. Difficult to evade

3. Wide Coverage

4. Elastic

Some of the indirect taxes are elastic in nature. When government feels it necessary to increase its revenues, it increases these taxes. In times of prosperity indirect taxes produce huge revenues to the government.

5. Universality

Indirect taxes are paid by all classes of people and so they are broad based. Poor people may be out of the net of the income tax, but they pay indirect taxes while buying goods.

6. Influence on Pattern of Production

By imposing taxes on certain commodities or sectors, the government can achieve better allocation of resources. For e.g. By Imposing taxes on luxury goods and making them more expensive, government can divert resources from these sectors to sector producing necessary goods.

7. May not affect motivation to work and save

The indirect taxes may not affect the motivation to work and to save. Since, most of the indirect taxes are not progressive in nature, individuals may not mind to pay them. In other words, indirect taxes are generally regressive in nature. Therefore, individuals would not be demotivated to work and to save, which may increase investment.

8. Social Welfare

The indirect taxes promote social welfare. The amount collected by way of taxes is utilized by the government for social welfare activities, including education, health and family welfare. Secondly, very high taxes are imposed on the consumption of harmful products such as alcoholic products, tobacco products, and such other products. So it is not only to check their consumption but also enables the state to collect substantial revenue in this manner.

9. Flexibility and Buoyancy

The indirect taxes are more flexible and buoyant. Flexibility is the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, and buoyancy is a wider concept, as it involves the ability of the tax system

to generate proportionately higher tax revenue with a change in tax base, as well as tax rates.

Disadvantages / Demerits of Indirect Taxes ↓

Although indirect taxes have become quite popular in both developed & Under developed countries alike, they suffer from various demerits, of which the following are important.

1. High Cost of Collection

Indirect tax fails to satisfy the principle of economy. The government has to set up elaborate machinery to administer indirect taxes. Therefore, cost of tax collection per unit of revenue raised is generally higher in the case of most of the indirect taxes.

2. Increase income inequalities

Generally, the indirect taxes are regressive in nature. The rich and the poor have to pay the same rate of indirect taxes on certain commodities of mass consumption. This may further increase income disparities among the rich and the poor.

3. Affects Consumption

Indirect taxes affects consumption of certain products. For instance, a high rate of duty on certain products such as consumer durables may restrict the use of such products. Consumers belonging to the middle class group may delay their purchases, or they may not buy at all. The reduction in consumption affects the investment and production activities, which in turn hampers economic growth.

4. Lack of Social Consciousness

5. Uncertainty

Indirect taxes are often rather uncertain. Taxes on commodities with elastic demand are particularly uncertain, since quantity demanded will greatly affect as prices go up due to the imposition of tax. In fact a higher rate of tax on a particular commodity may not bring in more revenue.

6. Inflationary

The indirect taxes are inflationary in nature. The tax charged on goods and services increase their prices. Therefore, to reduce inflationary pressure, the government may reduce the tax rates, especially, on essential items.

7. Possibility of tax evasion

There is a possibility of evasion of indirect taxes as some customers may not pay indirect taxes with the support of sellers. For instance, individuals may purchase items without a bill, and therefore, may not pay Sales tax or VAT (Value Added Tax), or may obtain the services without a bill, and therefore, may evade the service tax.

Conclusion ↓

Elaborate analysis of merits and demerits of direct and indirect taxes makes it clear that whereas the direct taxes are generally progressive, and the nature of most indirect taxes is regressive. The scope of raising revenue through direct taxation is however limited and there is no escape from indirect taxation in spite of attendant problems. There is common agreement amongst economists that direct & indirect taxes are complementary and therefore in any rational tax structure both types of taxes must find a place.

Category: Taxes

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