Indirect taxes have become an important source of development funds in developing countries.

Question

Read the extract and answer the following :

Post : Gaurav Akrani

Indirect taxes have become an important source of development funds in developing countries. Many developing economies that have adopted economic planning use indirect taxes as important source of funds. These taxes are found to be better suited in developing countries because they have much wider coverage as compared to direct taxes. Both rich and poor pay indirect taxes in the form of commodity price.

(i) What are indirect taxes ?

(ii) Mention three important differences between direct and indirect taxes.

(iii) Classify the following into direct and indirect taxes.

(i) Custom duty

(ii) Professional tax

(iii) Income tax

(iv) Entertainment tax

(iv) Give two reasons why indirect taxes are important in developing countries.

(v) Explain clearly how indirect taxes can be both regressive and progressive.

Answer 1

(i) An indirect tax is a tax that is paid to the government by one entity in the supply chain, but it is passed on to the consumer as part of the price of a good or service. The consumer is ultimately paying the tax by paying more for the product. An indirect tax is shifted from one taxpayer to another.

(ii) Three important differences between Direct and Indirect taxes :

Difference Between direct and indirect taxes

| Point difference | DIRECT TAX | INDIRECT TAX |
| Incidence and impact | A tax is said to the direct 'wen impact and Incidence of a tax are on one and same parson. | If impact of tax is on one person and incidence on the another, the tax is called 'indirect' |
| Burden | Direct tax is imposed on the individual organisation and burden of tax cannot be shifted to others | Indirect tax is imposed on commodities and allows the tax burden to shift. |
| Viability of payment | Direct taxes are lesser burden then indirect taxes to people as direct taxes are based income earning ability of people. | Indirect tax is are bome by the consumers of commodities and services irrespective of financial ability as the MRP includes all taxes. |

(iii) (i) Custom duty — Indirect tax

(ii) Professional Tax — Indirect

(iii) Income Tax — Direct

(iv) Entertainment Tax — Direct

(iv) Indirect Taxes are important because of the following reasons :

(a) Resource Mobilisation

(b) Reduction in inequalities in income

(c) Social *** and regional development

(v) Indirect taxes are regressive because like sales tax, excise duty, customs duty, etc., they are levied on all products/services without any differentiation i.e. without considering the consumer group’* income/fiscal status which consumes the product/service. So the poor or rich are equally impacted by this and hence considered regressive.

Progressive taxes refer to tax in which the rate of tax increases with the increase in tax payer income. Indirect taxes are also an example of progressive tax because the amount tax paid will increase at a higher rate than the increase in tax base for income.