Advantages and Disadvantages of Direct Taxes
Definition of Direct Taxes:
Direct taxes refer to the type of tax which is directly imposed on a person. A direct tax has to be paid by the person on whom the tax was legally imposed in the first place. In other words, unlike indirect taxes, the burden of a direct tax cannot be shifted to someone else.
Like any other type of tax, direct taxes have their own advantages and disadvantages. In this article, we will be discussing some of the most notable advantages and disadvantages of direct taxes, which may also be referred as the merits and demerits of direct taxes.
Advantages of Direct Taxes:
First, we will have a look at some of the advantages and merits of direct taxes:
If you do not know about the 'Canons of Taxation', read the following article.
1. In Accordance with the Canon of Equality:
As the canon of equality states that the taxes should be implied on the basis of equality. It is important to note that equality here does not mean that everyone should pay the same amount of tax. What it means is that the broader shoulders should carry the greater burden. The rich should pay more taxes, while the poor shouldn’t.
A direct tax is concretely in accordance with the canon of equality. Since it is imposed specifically to persons, belong to certain categories and income-groups, it serves the purpose of justice and equality.
2. In Accordance with the Canon of Certainty:
Direct taxes are also in accordance with the canon of certainty, which is an important to consider. The canon of certainty states that the amount of tax should be certain and definite to the taxpayer. There should not be any ambiguity regarding the amount of tax to be paid. As the amount of direct tax is decided well-before the submission date, the taxpayer has a fair bit of idea of the tax amount that he will be paying.
3. Creates Social Awareness:
Another advantage of a direct tax is that it creates social awareness among the general public. Since you have to pay a certain sum of money to the government, you expect something back as well. Moreover, you tend to feel more socially aware and responsible, as it is your money that is spent all around you. Direct tax has been proven to be a positive contributing factor in lesser crimes, littering and damaging public goods.
4. Creates Equal Distribution of Wealth:
Having equal distribution of wealth is one of the biggest primary objectives for any economy and government. A great advantage of direct tax is that it helps the economy to achieve that. As the government charges more taxes from the people who can afford them and spend that money on the poor, a step in the right direction is made. Furthermore, it also positively affects the social binding of different groups of people that are divided on the basis of income and wealth. Last, but not the least, equal distribution of wealth has a significant and positive impact on the crime rate.
5. Elastic and Anti-Inflationary in Nature:
Another advantage of direct taxes is that they might be used as an anti-inflationary measure. Although not as powerful and effective as the indirect taxes, direct taxes are also used to control the consumption and demand of products. If the government wants to decrease the inflation rate by decreasing the demand of the product, direct taxes are increased. As a result, the rich class of people that usually spend a lot of their money on buying different products and services will now have constrained spending capacity. This, in turn, reduces the consumption of products and services, and hence, the inflation rate.
6. Affects Savings and Investments:
Direct taxes directly affect the level of savings and investment – for an individual and for the overall economy as well. These direct taxes, therefore, can be used to affect the overall ratio of savings in an economy – by decreasing or increasing the tax rate. When a direct tax is decreased, the person has been left with more money to save, and hence, the investment level of the economy is increased and vice versa. This technique is used to create more investment opportunities and employment in an economy.
Disadvantages of Direct Taxes:
The disadvantages of direct taxes, when compared with the indirect taxes, can be summed up as follows:
1. Tax Evasion:
Probably the biggest disadvantage of direct taxes is that it leads to tax evasion and corruption in a society. If the system is not water-tight, there is always a chance of tax evasion by manipulating the law and using subtle techniques. Moreover, the more blatant way is to suppress the profits by showing wrong statements of profits, which reduces the tax rate imposed on the person. Unlike indirect taxes, there is always a chance of tax evasion in direct taxes.
2. Creates Social Conflict:
Since not everybody has to pay direct taxes, it is often responsible for creating social conflict amongst societies. It also leads to crimes, social injustice and a sense of inferiority among different groups of people.
Another great disadvantage of the direct taxes is that they are usually not in accordance with the canon of convenience. In order to submit the tax, a person has to undergo several formalities and procedures. Such inconvenience is also one of the important contributions factors in evasion of direct taxes.
4. Limits Capital Formations and Investment Opportunities:
It is usually the elite class that invests their money and form capital within an economy. Since direct taxes – in accordance with the canon of equality – are specifically applied on the elite class of people, it significantly limits the capital formation and investment opportunities in an economy. This, in turn, leads to higher unemployment and lower growth of economy.
5. Affects The Ability to Work and Motivation Level:
As a tax payer, you know that the harder you work and generate more income, the more you will have to pay in direct taxes – usually, at an exponential rate, as it is in certain countries. This goes with the canon of equality that people with more money should be paying more taxes. Therefore, it dramatically affects your ability to work and motivation to excel. Direct taxes have been a chief cause of hurting the job performances.
In direct taxes, the burden of tax cannot be shifted to someone else. There are several advantages and disadvantages of direct taxes – which we also know as the merits and demerits of direct taxes. However, like indirect taxes, direct tax forms a significant part of an economy’s taxation system. It is crucial to bring social equality and justice within an economy, without putting additional burdens on the poor. But in direct taxes, there is always a high risk of tax evasion and corruption.