Difference Between Direct Tax and Indirect Tax

Direct Tax vs Indirect Tax

Taxes are financial levies or burden imposed by governments upon its citizens to realize money for various purposes. The main purpose is to carry out administration and welfare activities for the population, and also to raise money for the defense of the country. Taxes are not voluntary contributions, but rather enforced upon people. There are two types of taxes called direct taxes and indirect taxes, and both are used in varying proportions by all governments of the world. Though the purpose of revenue generation is served by both direct as well as indirect taxes, they are different in nature. This article attempts to make this distinction clear and remove all doubts from the minds of the readers.

The tax that is realized directly from the individual upon whom it is levied is called a direct tax while the taxes that are collected from intermediaries rather than those who actually pay them are called indirect taxes. The example of a direct tax would be income tax which is also called a progressive kind of tax. On the other hand sales tax is an example of indirect tax as the tax is collected from the merchants who in turn collect it from the end consumers. Indirect taxes are also called regressive taxes as they lead to an increase in inequalities in the society. They can however be made progressive if rich are made to pay them while poor are exempted from paying these taxes.

What is the difference between Direct Tax and Indirect Tax?

• Indirect tax changes the preference of a consumer towards goods because of price changes. Thus indirect tax has an adverse effect on allocation of resources whereas there is no such effect in case of direct taxes and hence realization is more.

• One other difference is in the nature of direct taxes being progressive as they reduce inequalities whereas indirect taxes are regressive and lead to more inequalities.

• However, indirect taxes are easier to administer than direct taxes. Then there are no exemptions in case of indirect taxes whereas there are many kinds of exemptions in direct taxes.

• Indirect taxes, being wrapped up with retail prices are more efficient than direct taxes and more difficult to evade.

• Cost of collection is also less in case of direct taxes which is pretty high in direct taxes.

• Indirect taxes are inflationary in nature. On the other hand, direct taxes bring stability and reduce inflationary pressures as they take away excess purchasing power from the people.

• Direct taxes reduce savings and people are not able to make investments which affects growth. On the other hand, indirect taxes are growth oriented. Indirect taxes discourage people from spending too much and as such encourage savings.