Difference Between Direct and Indirect Tax

Collecting tax from citizens of the country are one of the biggest source of income to the government. The revenue collected is then used by the government in building the economy of the country. However, many of the residents are unaware of the type of tax they pay to the government. In this regard, we have brought you a detailed study of difference between direct tax and indirect tax.

What is the Meaning of Direct Tax?

Direct tax is a tax you pay the government directly under your name based on your financial criteria. The government has a tax rate for you based on your income, capital gains, and relaxations. It is not transferable to any other person as this tax is under your name in the tax records. The perfect example of direct tax is the Income Tax.

What is the Meaning of Indirect Tax?

Indirect tax is a tax with a mediator organization that levies the tax and then forwards the tax to the government. These taxes are meant for services provided and applicable to the person paying. These are also called transferable tax, as you can pay the indirect tax under someone else’s name too. GST is an apt example of indirect tax.

Comparison of Direct Taxes and Indirect Taxes

Based on the definition and the types, you must have a basic idea of the difference between direct tax and indirect tax. To further distinguish between direct tax and indirect tax, let’s focus on some significant differences.

Taxpayer: Individuals and businesses pay direct tax and end-customers pay indirect tax.

Taxed Item: The difference between direct tax and indirect tax in terms of the taxed item is that direct tax is applicable for income and capital gains. In comparison, indirect tax is applicable while purchasing goods or services.

Tax Exemption: Tax exemption is possible in direct tax by proving income and expenses through documents, whereas it is not possible in indirect tax.

Tax Collection: The direct tax collection is complex due to the framework and extensive documentation. However, indirect taxes don’t have such intricate frameworks.

Inflation: One significant direct and indirect tax difference is that direct tax helps reduce inflation while indirect tax increases it.

Inequalities: The taxation system of direct taxes is the same for everyone, thus promoting equality. But indirect tax promotes inequalities due to charging excess amounts based on the luxury or daily use items.

Administrative Costs: The administrative costs of direct tax are also very high as it has a vast network of officers to regulate and manage accounts. The administrative costs for indirect taxes are comparatively low.

Major Flaw: The major flaw in direct taxes is that it discourages people from investment schemes, as the capital gains have high taxes. The indirect tax discourages people from consumption of products and services.

Usage: Direct taxes are only limited to people and businesses who earn taxable income. And the number of people in this category is very few, almost below ten crores. But everyone comes in contact with indirect taxes at least once, through consumerism, and thus its usage is far more widespread.

Difference Between Direct Tax and Indirect Tax in Table Form

To further simplify the perfect difference between Direct Tax and Indirect Tax, here’s the table pointing out the quick comparison between the both taxes:

Benefits of Direct vs Indirect Tax

Direct Tax:

Direct pay encourages equality as tax is levied on the capacity of the individual to pay. There is no uncertainty in direct taxes, as they are already clear to the tax payer. It saves money and time of the payer as full transparency is present.

Indirect Tax:

All individuals are expected to contribute in indirect tax as they are convenient and can’t be avoided. Though indirect taxes increase the cost of basic commodities, it helps in the larger picture for the country.

Limitations of Direct Tax vs Indirect Tax

Direct Tax:

• Since the direct taxes are supposed to be paid at once, it can cause trouble to the tax payer.
• The tax is levied according to the income shown by the tax payer, in many cases, the numbers shown are false to save money. Direct taxes can cause corruption.
• Direct taxes have a narrow base, which means, every section and community are not covered properly, making the tax out of reach for many.
• As the direct taxes are based on the income of the tax payer, a large sum of the income is gone into tax which causes distress to the payers and their savings.

Indirect Tax:

• Indirect taxes are fixed for everyone, without any consideration of the buyers financial status. This is one of the reasons which makes indirect tax regressive and partial to the rich.
• The taxes keep increasing/decreasing by the government, which leads to the the cost of raw material going up, causing inflation in the system.

Difference Between Direct and Indirect Taxes: FAQs