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Sujai Adithya
Human Resource and Banking & Finance Expert
Asked a question last year

Difference between direct tax and indirect tax?

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Sujai Adithya
Human Resource and Banking & Finance Expert

Direct taxes are the taxes levied on income and wealth, whereas indirect taxes are levied while spending on goods and services. Direct taxes are supposed to be paid by everyone who has a job. There's no choice of opting out. On the other hand, indirect taxes are collected in the form of higher product prices. This can be controlled by spending less while purchasing.

Direct taxes are generally collected by the central government. It serves as the main source of fund to run the government. Direct taxes are progressive, i.e., people who earn more have to pay a higher percentage of tax compared to people who earn lesser than them. Direct tax is an important tool for the government to control inflation. When there is an inflation, the government can impose high levels of income tax to restrict consumer demand. Common examples of direct taxes are income tax, corporation tax, wealth tax, capital gains tax and capital transfer tax. 

1.) Corporation tax is the tax levied on a company's profits.

2.) Wealth tax is the tax on ownership of property and wealth.

3.) Capital gains tax is the tax on the profits of sales of certain assets.

4.) Capital transfer tax is the tax on gifts to replace death duties.

5.) Income tax is the tax levied on a person's earnings.

Indirect taxes are the taxes levied on goods and services. A popular example in India is the Goods and Services Tax (GST) which was introduced recently. Other common indirect taxes include custom duties, excise duty, sales tax, etc. Indirect taxes are not progressive. Everyone, regardless of their economic status, has to pay the same amount as tax for the goods and services purchased. This can affect the poor people, as they have to pay a higher amount as tax while buying an expensive product.

The government has the power to control the consumption of certain products by imposing higher indirect taxes on them. A higher rate of tax on tobacco can affect the consumption of tobacco by the citizens. The main disadvantage of indirect taxation is that, it can cause inflation. So the government has to be very careful while making economic policies. Indirect taxes are easier to collect than direct taxes. It also helps to gain revenue from tourists.

The balance between direct tax and indirect tax should be proper, in order to maintain a good economy.