Direct vs indirect taxes: Key differences and how they impact taxpayers and prices in India

Tax is a mandatory, not voluntary, payment made by individuals and organisations to the government. Taxes are one of the largest sources of revenue for the government and are levied by both the Central and state governments to manage the country’s economy, fund development and spend on social welfare programmes. The expenses are incurred on building the country’s defence, developing infrastructure like roads and bridges, and spending on education and healthcare.

There are two ways to collect taxes— direct and indirect. The Department of Revenue, under the Ministry of Finance, oversees the administration of direct and indirect taxes in India.

DIRECT TAX

This tax is paid directly by the taxpayer, be it an individual or organisation, to the government. The tax liability has to be borne by the taxpayer and cannot be transferred to any other person or entity. Income tax, property tax, gift tax, corporation tax, capital gains tax are all examples of direct taxes. The Central Board of Direct Taxes (CBDT) administers most of the direct taxes through its subordinate organisation, the Income Tax Department.

Pros & cons

Direct taxes can help control inflation by increasing tax rates and reducing individuals’ disposable income. It is also a consistent source of revenue for the government. For taxpayers, it’s a transparent and predictable method of contributing a known amount to the government every year. It’s also considered progressive because the quantum of tax depends on the income, with high-income individuals paying more tax.

On the flip side, taxpayers may arrange their affairs with a view to minimising their tax liability. The method of filing tax returns is also considered cumbersome by many despite automation and pre-filled returns.

Direct vs Indirect taxes

INDIRECT TAX

Indirect tax is collected by an intermediary, such as a retailer or a manufacturer, on behalf of the government, from the person who finally bears the tax liability (end consumer). This liability can be transferred by the taxpayer to someone else, but ultimately it is borne by the end consumer. Indirect tax may lead to an increase in the price of goods or services. Some indirect taxes include customs duty, Central excise duty, goods and services tax, etc.

The Central Board of Indirect Taxes and Customs (CBIC) is responsible for the administration of indirect taxes.

Pros & cons

It’s a regular source of revenue for the government and is not open to evasion as tax is included in the prices of goods and services. However, it’s not too transparent as many consumers don’t realise how much tax they are paying. It’s also considered regressive as it’s not based on the income of the taxpayer.