The Advantages of Direct & Indirect Taxes

by Craig Berman

While paying taxes is nobody's favorite activity, it's something everyone has to do in order to keep government programs rolling. Direct taxes are paid by individuals and businesses directly to the government based on income and earnings, while indirect taxes are based on transactions involving money or its equivalent for something of value. Each has its advantages and disadvantages, largely based on individual earnings and spending habits.

Direct Taxes

Direct taxes are those imposed directly by the government against an individual or organization, with that party being responsible for remitting the money owed. Taxes may be paid directly by the specific party or by others on their behalf, but ultimately it is the individual or organization responsible for them. You may have tax withheld by your company every payday, and the company may send that to the IRS, but on April 15 you are the one responsible for making sure your income tax is paid.

Indirect Taxes

Indirect taxes are collected as the result of financial or commercial activities. When you go to the store and buy groceries, or head to the dealership and purchase a new car, there are often taxes associated with those transactions. While you pay the tax at the point of sale, it is the business owner who is responsible for its collection and transmittal to the government.

Progressive vs. Regressive

The type of tax you favor depends largely on what kind of system you consider to be more equitable. In a system relying on direct taxation, those who earn the most pay the most in taxes, making it a progressive tax. Indirect taxes are classified as regressive, because they are not based on income levels, and, generally, lower-income households pay more in indirect taxes as a percentage of their income. Direct taxes are based on what you make, while indirect taxes are based on what you spend.

Direct Taxation Advantages

Direct taxes tend to be more predictable than indirect taxes. Everyone pay at rate commensurate with their earnings, and so both the taxpayer and the government can estimate what the bill will be. This makes it easier for both to budget. Theoretically, it serves as a mechanism to reduce income inequality by easing the tax burden on poorer households, which can help drive business by increasing the customer base. It’s also easier for the government to raise money relatively quickly through raising taxes, or encourage growth or an influx of capital by limiting them.

Indirect Taxation Advantages

Because indirect taxes are collected as the result of commercial activity, there is more discretion as to how much an individual pays. You can control the indirect taxes you owe by controlling what you spend. If you don’t buy anything or shop only in areas that don't levy sales taxes, you won’t pay indirect taxes. Indirect taxes can also be used as a policy tool by the government to encourage or discourage specific consumer behaviors. An increase in the gas tax, for example, will cause commuters to spend more money every time they fill up their car. Some states may use that as a way of funding transportation projects, or encouraging mass transit.

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