Tax Types: Types of Taxes (With Advantages and Limitations)

Taxes may be classified in various types on different basis, such as the form, nature, aim and method of taxation.

The most important classification are:

1. Direct and Indirect taxes.

2. Specific and Ad-valorem taxes.

3. Proportional, Progressive, Regressive and Degressive taxes.

1. Direct and Indirect Taxes:

Taxes are of two kinds- Direct and Indirect. The most and well known distinction between Direct and Indirect taxes was the one made by J. S. MILL, “A direct tax (which) is demanded from the persons who it is intended or desired should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another.”

Thus according to Mill, taxes were direct or indirect depending upon the fact, whether they were actually paid by the people on whom the burden fell or not.

BASTABLE defined direct taxes as those, “which are levied on permanent and recurring occasions, and indirect taxes as changes on occasional and particular events.” Prof. Bastables classification was vague and ambiguous and could lead to rather confusing conclusions.

According to DALTON, “A direct tax is really paid by the person on whom it is legally imposed, while an indirect tax is imposed on one person but paid partly or wholly by other, owing to a consequential change in the terms of some contract or bargain between them.” Therefore, income and property taxes are direct taxes while customs and excise duties are indirect taxes.

We may conclude from the above discussion that, a direct tax is one whose burden (or incidence) cannot be shifted. To put it in another way, in the case of direct taxes the impact and incidence are upon the same person. The person who pays the tax cannot transfer the burden to any other person.

The chief examples of direct taxes are-income tax, expenditure tax, wealth tax, gift tax, etc. The burden of these taxes falls upon the person on whom they are levied.

But there are certain other taxes whose incidence can be shifted. This is possible in the case of indirect taxes like the sales tax or the excise duty. The impact of sales tax is upon the seller of goods.

But the seller is not required to pay the amount of the tax from his own pocket. He can easily shift the tax on to the consumer from whom he gets the price of the article, and, therefore, the incidence is upon the ultimate consumer.

Thus it is the conjunction or separation of impact and incidence that makes a tax direct or indirect.

Advantages of Direct Taxes (Merits of Direct Taxes):

(Income Tax, Profit Tax, Capital Tax, Interest Tax, Wealth Tax, Gift Tax)

a. Equitable:

A direct tax is an equitable tax. It is equitable in the sense that, it is levied according to the taxable capacity of the people. The rates of direct taxes like the income tax, can be fixed in such a way that the higher income of a man, the greater is the rate at which he has to pay the tax. Such a system is known as progressive taxation.

b. Economical:

Direct taxes are economical in the sense that, the cost of collecting them is low. They are mostly collected “at the source”. For instance, the income tax is deducted from an officer’s pay every month. This saves expense. The employer acts as an honorary tax collector. This means great economy.

c. Certainty:

The tax-payers know how much they are going to pay and at what time they are going to pay the tax. The authorities also know the amount of revenue they can expect. There is certainty on both sides. This minimizes corruption on the part of collecting officials.

d. Elasticity:

A direct tax can be varied according to the needs of the government and changes in the income of the people. When the income of the people goes up, the rate of income tax can also be increased. If the income of the people falls, the rate of income tax can be lowered.

e. Productivity:

Direct taxes constitute an important source of government revenue. Their collection charges are low. Therefore, direct taxes are productive.

f. Increases Civic Sense:

As a person knows that he is paying a tax, he becomes conscious of his rights. He claims the right to know how the government uses his money. Civic sense is thus, developed. He behaves as a responsible citizen.

Disadvantages of Direct Taxes (Demerits of Direct Taxes):

a. Inconvenient:

The greatest drawback of direct taxes is that they put the tax-payer to a lot of botheration and inconvenience. Sometimes, the tax-payer is called to pay the entire tax in one installment.

Besides, the tax-payers have to maintain elaborate accounts for the satisfaction of the tax officials.

b. Evadable:

By submitting false returns of income, some people evade the tax. That is why a direct tax is “A Tax on Honesty”.

c. Disincentive:

Direct taxes reduce the desire to work and save. The rates of direct taxes in India are usually high. Many business ventures are not undertaken on the ground that a large part of the income earned will have to be given to the government in the form of taxes. Thus, direct taxes reduce incentives to work and save.

d. Uneconomical:

These are uneconomical to collect when the number of tax payer are large and the amount that they pay are a small amount of tax. For example, Land revenue is collected from millions of farmers in small amount of money.

Advantages of Indirect Taxes (Merits of Indirect Taxes):

(Central Excise Duty, Customs Duty, Commodity Tax, Sales Tax)

a. Convenient:

They are mostly levied on commodities and are paid by consumers when they buy them in the market. The amount of the tax is included in the price of the commodity and the consumer pays the tax without experiencing its pinch.

b. Equitable:

Indirect taxes are equitable in the sense that they are paid by all the sections of the community at the time of making purchases of goods in the market; in the form of sales tax or customs duty.

c. Productive and Elastic:

By increasing the rate of taxes, the government can secure an adequate income from such taxes. The income from such taxes goes on increasing with the increase in population and production in the country.

d. Socially Desirable:

Indirect taxes are levied on intoxicants, like wine or opium, etc., and serve a great social purpose because they limit the consumption of such harmful commodities by the public.

e. No Possibility of Evasion:

No person can evade the indirect taxes, because they are collected in the form of higher prices of goods sold to the consumers.

f. Wide Coverage:

Indirect taxes can be imposed on a large variety of goods so that most of the people contribute to the revenue of government i.e. the tax system gets broadened.

Disadvantages of Indirect Taxes (Demerits of Indirect Taxes):

a. Regressive:

Indirect taxes are not equitable as they are regressive in nature. It affects the poor more than the rich man. For example, a commodity tax imposed on foodstuffs will affect a poor family to a much greater degree than a rich family.

b. Uncertain:

As soon as the tax is levied on a commodity, its price rises in the market and, consequently, its demand declines. It cannot be said with certainty, that to what extent the demand of the commodity will decline as a consequence of the imposition of the tax. Hence, there is always uncertainty about the income incurred from the indirect taxes.

c. Absence of Civic Consciousness:

Since the tax payers do not feel that they are paying a tax at the time of purchasing a commodity, in a way they do not promote savings. Thus these taxes do not promote civic consciousness among the citizens.

d. Uneconomical:

The cost of collection is quite heavy. Every source of production has to be guarded. Large administrative staff is required to administer such taxes. This turns out to be a costly affair.

e. Inflationary:

Indirect taxes tend to be highly inflationary. The imposition of indirect taxes on commodities increases their market prices, this further tends to raise the cost of living, and a demand in the wages of the worker. Thus indirect taxes generate a spiral of higher price, higher costs, higher wages and again higher price.

2. Specific Taxes and Ad-Valorem Taxes:

a. Specific Taxes:

Taxes which are levied on some external measures of commodities are > called specific taxes. For example tax on rice on the basis of units of weight, on cloth on the basis of length and geysers on the basis of capacity are specific taxes.

b. Ad-Valorem Taxes:

When the taxes are levied on the basis of value of commodities, they are called ad-valorem taxes. For example import or export duties which are irrespective of their size, length and weight.

3. Proportional, Progressive, Regressive and Degressive Tax:

Considering the relation between the tax-rate and the base, there can be four types of taxation, viz.:

a. Proportional taxes,

b. Progressive taxes,

c. Regressive taxes, and

d. Degressive taxes.

a. Proportional Taxes:

Taxes in which the rate of tax remains constant, though the tax base changes, are called proportional taxes. Here, the tax base may be income, money value of property, wealth, or goods, etc. Income is, however, regarded as the main tax base, because it is the determinant of taxable capacity of a person.

Tax amount is calculated by multiplying tax rate with tax base.

In a proportional tax system, thus, taxes vary in direct proportion to the change in income. If income is doubled, the tax amount is also doubled.

Characteristics of Proportional Taxes:

1. Proportional taxation leaves the tax-payer in the same relative economic status.

2. Proportional taxation is simple to calculate and to administer. Since it is uniformly levied, it is very convenient to estimate.

3. Proportional taxation is not as repugnant to tax-payers as progressive taxation.

4. The effect on willingness to work hard and save is not adverse in the case of proportional taxes.

5. Proportional taxation is inequitable as it falls heavily on the poor incomes.

b. Progressive Taxes:

Taxes in which the rate of tax increases with the rise in tax payer’s income, are called progressive taxes. Thus, in a progressive tax, the amount of tax paid will increase at a higher rate than the increase in tax base or income, the taxation amount is the product of the base by the rate and both these increase in a progressive tax.

Thus, a progressive tax extracts an increasing ratio of rising income. The term “Progressive’ refers to the way the tax rate progresses from low to high with the result that a tax payers average tax rate is less than the person’s marginal tax rate.

Characteristics of Progressive Taxes:

1. A progressive tax is equitable, as a larger part is taxed on higher incomes. It is justifiable just as the law of diminishing marginal utility operates in the case of money. Hence, the disutility of paying a high tax by rich is not as much as that of poor in paying even a low tax. Therefore, the rich should be taxed at a higher rate than the poor.

2. Progressive taxes may be justified on the ground that higher incomes contain surpluses, which have cent percent capacity to bear taxes. Thus, progressive taxation fully complies with the principle of capacity to bear or ability to pay the tax.

3. Progressive taxes are more economical, as the cost of collection does not rise when the rate of tax increases.

4. Progressive taxation has greater revenue productivity than proportional taxation.

5. The progressive tax system also complies with the canon of elasticity. For a rise in income is automatically taxed at a higher rate under the system so that revenue increases with economic expansion.

6. Progressive tax is an engine of social improvement. The strong should assist the weak and the rich should aid the poor. This social morale is well sustained by progressive taxation.

c. Regressive Taxes:

When the rate of tax decreases as the tax base increases, such taxes are called regressive taxes. It is opposite of progressive taxes.

Characteristics of Regressive Taxes:

1. In regressive taxation, the total amount of tax increases on a higher income in absolute sense, but in relative sense, the tax rate declines on a higher income.

2. Regressive taxation extracts a decline in proportion of rising income. This causes a heavier burden on the poor than on the rich.

3. Taxes on necessities are regressive as they take away a greater percentage of lower incomes as compared to higher incomes.

4. Regressive taxation is unjust and inequitable. It is not compliant with the canon of equity.

5. Regressive taxation tends to accentuate inequalities of income in the community.

d. Degressive Taxes:

Under this system, rate of the tax increases up to a certain limit but after that a uniform rate is charged.

Characteristics of Degressive Taxes:

1. Degressive taxation is a mixture of proportional and progressive tax system.

2. It allows the higher income groups to make less sacrifice than the lower income groups.

3. Degressive tax finds its application in the practice of income tax in India. Indian Tax Structure

The structure of taxation in India contains the following three categories of taxes:

(i) Taxes on Income- Income tax, Capital gain tax.

(ii) Taxes on property and capital transition- Estate duty, Wealth tax, Corporate tax.

(iii) Taxes on commodities -Custom duties, Excise duties. VAT (Value Added Tax).

Now except customs duty, all indirect taxes have been incorporated in Goods And Services Tax (GST).