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Difference between Direct Tax and Indirect Tax

Main Difference

Tax is the biggest source of revenue for government to meet public expenditures. There are mainly two kind of tax that are direct tax and indirect tax. The ultimate purpose of both is to arrange compulsory contribution from the general public, however, still the both are entirely different from each other. The main difference between these two is that in direct tax the effect of tax restricted to the person who is actually paying the tax while in indirect tax the effect of tax pass temporarily to the person paying the tax and after that shifted onward to the last end user or consumer.

Direct Tax

Direct tax is a tax whose impact is remain on the person who is actually paying the tax amount or on whose behalf tax liability is being paid. Its effect cannot be shifted onward. Common examples of direct tax are property tax, wealth tax, income tax, tax on wages or any other kind of personal property. Now the person who actually paid the tax, can’t forward its impact on other person. The fine line between direct and indirect tax was first drawn by Adam Smith in most popular book The Wealth if Nations in which he wrote, “It is thus that a tax upon the necessaries of life operates exactly in the same manner as a direct tax upon the wages of labour. … if he is a manufacturer, will charge upon the price of his goods this rise of wages, together with a profit; so that the final payment of the tax, together with this overcharge, will fall upon the consumer.” Tax rate doesn’t remain same in case of direct tax. Each individual who is liable to pay tax has to pay as per his income or revenue.

Indirect Tax

Indirect tax is a type of tax whose impact pass on the other person. In indirect tax, although a person is initially paying the tax but he will shift its burden on others. Common examples of direct tax are sales tax, customs tax, value added tax (VAT), specific/special tax, or goods and services tax (GST). In this taxation system the person who is selling the goods or products initially bears the burden of payment but the ultimate economic burden of tax is then shifted to the consumer by adding the paid amount of tax in the price of product. Indirect tax is the major source of government revenue in almost all of the countries of the world. Tax rate remains same for homogeneous products. It is based on the principle of equity, a person who will purchase or spend more will pay high. It is equally applied on the whole society whether rich or poor.

Key Differences

  • In direct tax the burden of payment can’t be shifted onward while in indirect tax is so called tax whose economic burden has to bear by the final consumer.
  • It is easy to avoid the direct tax by hiding the income. Indirect tax can’t be avoided as it is wrapped in the price of product or service and a person who will purchase it, will automatically pay the tax.
  • Indirect tax generates more revenue for government as compare to direct tax.
  • Property tax, income tax, tax on salaries and wages, and wealth tax or examples of direct tax. Sales tax, customs tax, value added tax (VAT), specific/special tax, or goods and services tax (GST) are examples of indirect tax.
  • Rate of tax for direct tax are progressive tax, tax rate will increases as the taxable amount increases. Rate of indirect tax are proportional tax, tax rate is fixed. It depends upon your purchasing or consumption power. Rate will remain fix but more items you will purchase, more the taxable amount instead of tax rate.
  • The indirect taxes are more easy and cost-effective to collect as compared to direct tax.
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