CLASSIFICATION OF TAX

Tax can be defined as a compulsory contribution to state revenue, levied by the government on
workers' income and business profits, or added to the cost of some goods, services, and
transactions.

Classification of Tax

1. Direct and Indirect Taxes: On the basis of assessment, rather than on the point of
assessment, taxes are classified into direct and indirect.
Direct taxes are imposed by the state upon persons who are expected to bear the burden
of these taxes and who are not expected to be able to shift the tax burden to other persons.
In other words, in the case of direct taxes, impact and incidence are on the one and the
same person.
Indirect taxes are taxes which are imposed upon persons, who are expected to shift the
burden of the tax to other persons. In other words, in the case of indirect taxes, usually
the impact and incidence will be on different persons.

Advantages of Direct Taxes:

(i) Equity: Direct taxes are imposed according to the ability of a person to bear tax
burden. Hence, it is more equitable than indirect taxes. This tax is based on the
principle of progression.
(ii) Certainty: The taxpayer knows definitely what he has to pay and when and why.
This enables the taxpayer to make the requisite provision for payment without
causing hardship to his business.
Likewise, the state obtains correct information about the revenue yield from direct
taxes, so that it can accordingly plan the financial programmer.
(iii) Economy: The mode of collection is simple. Tax is collected at source. The cost of
collection is lower. There is no wastage. Since each person knows the exact amount
paid by him, government is compelled to be economical and careful. Prof. Gladstone
observes “if you had only direct taxes, you would have economical government”.
(iv) Elasticity: Direct taxes are more elastic and hence more productive. A slight increase
in the rate of taxation will mean a considerable addition to the revenue yield.
Moreover, the yield from direct taxes increases with increase in wealth and income.
(v) Another advantage of direct taxes is that, since it is collected at the source, there is
less chance of evasion.
(vi) Social Impact: The taxpayer is directly contributing to the government. So he will be
very keen to see that the tax money is not wasted and spend unnecessarily. Hence,
taxpayers take intelligent and keen interest in the financial operations of the state.
(vii) Distributive Justice: Direct taxes are based on the canon of ability. It is basically
tuned as per the principle of progression. Hence, it can be utilized as an important and

1
 effective tool to reduce the glaring inequality in the distribution of income and wealth
in the society.

Disadvantages of Direct Taxes:

(i) Unpopular: Direct taxes are paid directly by the people. Generally it cannot be
shifted. Hence it is painful to the taxpayers. It is more felt by the people and they are
more unpopular.
(ii) Possibility of Evasion: It is usually said that direct tax is a tax on honesty. It is not
evaded only when the taxpayer is honest and tax collecting machinery is incorrupt.
Otherwise, it can be evaded through fraudulent practices and by furnishing false
assessment of income returns.
(iii) Another difficulty is the necessity of assessment, in all direct taxes. Tax taxpayers
have the difficulty in producing the necessary returns and maintaining the proper
accounts.
(iv) Direct Taxes tend to be Arbitrary: It is difficult to arrive at an objective or just base
of taxation. If imposed on income, property or any other produce, there must be a
valuation of the object charged. This creates opportunities for arbitrary official action.
Moreover, there is every chance for change in the valuation method and rate of
taxation, depending upon the political color of the government.
(v) Narrow Base: A direct tax touches only a section of the community. It is not having
wider coverage. The tax belt is very narrow in the case of direct taxes. The major
drawback of direct taxes emerges out of administrative inefficiencies. Direct taxation
ought to be a part of every modern financial system and the extent to which it can be
applied will depend on the particular condition of the country.

Merits of Indirect Taxes:

(i) Convenience: Indirect taxes are paid indirectly by the taxpayer. They are not felt in
the same degree as direct taxes. It is imposed at the time of purchase of a community,
or at the enjoyment of a service. The tax is hidden in the price of the commodity
transacted. Moreover, they are paid in small amount. Hence indirect taxes cause less
inconvenience to taxpayers.
(ii) Elasticity: In times of prosperity, indirect taxes are elastic. The revenue yield from
this tax can be increased, when necessity arises. But the principle of elasticity and
equity conflict with each other in the case of indirect taxes.
(iii) No Evasion: Indirect taxes are generally difficult to evade. They are hidden in the
price of the commodity purchased. When a person buys a commodity, he will have to
pay the tax element. Hence, scope for evasion is very little.
(iv) Wide Coverage: Indirect taxes fall upon the goods and services. It is possible to tax
every member of the community in one way or another. All citizens contribute to the

2
 revenue source something. Hence, with the help of indirect taxes, tax system can be
made broad based.
(v) It is More Popular than Direct Taxes: Indirect taxes are paid indirectly. Its incidence is
felt by all, who purchase the commodity. Its incidence is felt through an increase in
price. Hence, the burden will not be felt heavily as in the case of direct taxes.
(vi) Productivity: If needed indirect taxes can be made productive. Merely by imposing a
few taxes, the government can increase its revenue yield.
(vii) It can Promote Social Welfare: Indirect taxes can perform a social and economic
service to the community. For example, the government can impose stiff rate on
articles and drugs which are harmful to the society. Thereby its consumption can be
restricted.
(viii) It can be made Progressive: Indirect taxes can be made progressive by imposing high
rates of taxation on luxury goods and comparatively lower rates on comforts and
semi-luxury goods. To make it more equitable, articles of mass consumption should
be exempted from taxation.

Demerits of Indirect Taxes:

(i) Regressive in Nature: Indirect taxes on articles of general consumption press more
heavily upon the working classes, than on the richer classes. Such articles are used in
larger proportion by the poor. Hence this tax in reality is not equitable.
(ii) Uneconomical: Indirect taxes are difficult to administer. The cost of collection of
indirect taxes is very high. They are to be collected from a large number of people in
small amounts.
(iii) They are Extremely Uncertain: The income from indirect taxes is said to be
uncertain. The taxing authority cannot accurately estimate the total yield from
different taxes. This is so because demand supply conditions for different goods are
influenced by different factors. If the demands for taxed commodities are elastic, the
income yield may be less and vice versa.
(iv) Social Significance: Indirect taxes do not promote any civic consciousness. It is
collected in small amount through middle men and traders. They are not felt very
much by the taxpayers. Hence nobody takes much interest in the affairs of the
government.
(v) Inflationary in Nature: Another demerit of indirect taxes is that they generate inflation
in the economy. It leads to sharp rise in prices of commodities. Direct and indirect
taxes are complementary to each other and a modern government relies on both for its
revenue. Both can be made use of depending on its suitability and efficiency in
particular circumstances

3
2. Proportional, Progressive, Regressive and degressive Taxation:
On the basis of method, that is the rate of taxation; taxes are classified and compared into
proportional, progressive, regressive and degressive.
(a) Proportional Taxation:
“A schedule of proportional tax system is one at which the rate of taxation remains
constant as the tax base changes”. In other words when the rate of taxation remains
the same for all incomes (or property) large or small, then we have proportional
taxation. The tax is fixed as certain percentage of the income or the price or value of
an item.
In this system amount of tax payable is calculated by multiplying the tax base with
tax rate. For example, the rate of income tax may be 20% on all in comes, or rate of
wealth tax may be 10% for all incomes

(b) Progressive Taxation:

“A schedule of progressive tax system is one in which, the rate of taxation increases
as the tax base increases”. That is if the rate of taxation increases as the income (or
property) increases, then we have progressive or graduated taxation. Moreover, a tax
is progressive, if it is graduated in such a way that the rate of tax rises, more sharply
than the increase in income or capital. The amount of tax payable is calculated by
multiplying the tax base, with the tax rate.

4
(c) Regressive Taxation:
“A schedule of regressive tax rate is one in which the rate of taxation decreases as tax
base increases”. In other words, if the rate of taxation diminishes as the income or
property increases, we have regressive taxation. Taxes that are unrelated to the
taxpayer’s ability to pay are regressive. The amount of tax payable is calculated by
multiplying tax base with tax rate.

(d) Degressive Taxation:

If the rate of taxes increases, faster than income or property but towards a fixed
maximum rate, which it can never exceed, it is known as degressive taxation.
Degression is a special case of progression where the acceleration of the tax rate
decrease as the tax base increases. These types of taxes are mildly progressive, but
not very steep.
5
 Hence high income do not make due sacrifice. In degressive taxation a tax may be
slightly progressive up to certain limit, after that it may be charged at a flat rate. Here
also the amount of tax payable is calculated by multiplying the tax base with tax rate.
The hypothetical table and graph makes the definition clear and understandable.

3. Ad-Valorem and Specific duty

(a) Ad-Valorem duty
When a tax is levied on the basis of the value of a commodity or property it is known
as Ad-valorem duty. This duty is expressed as a percentage of the value of a
commodity. In this case irrespective of the weight and size of the commodity, tax is
charged purely according to its value.
Ad-valorem duties impose greater burden on the richer income group. Hence in the
case of distribution of tax burden, it satisfies the canon of equity. Ad-valorem duty
encourages the production of low priced goods.

(b) Specific duty

When a tax is imposed on a commodity as per its weight, it is called
specific duty. Specific duties are expressed as definite sums to be
paid for the definite weight of a commodity.
The most important advantage of specific duty is that it is easy to levy and very
convenient to collect. However, specific duties result in higher revenue, only when
there is an increase in the physical volume of output.

4. Value Added Tax (Vat):

Value added tax (VAT) belongs to the family of sales tax. It is of recent origin. This tax
has been adopted as an important tool to impart greater flexibility to the revenue base of
an economy. VAT is not a tax on the total value of goods being sold. It is a tax on the

6
value added to the good by the last seller. The seller therefore is liable to pay a tax not on
the gross value, but on net value. Net value means gross value minus value of material
purchased from other firms. The salient feature of VAT is that it falls on the value added
at each stage from the stage of production to retail stage.