Direct Vs. Indirect Taxation - Research Paper Example

Direct Vs. Indirect Taxation Taxes are an important source of revenue for the government. A government thrives on collecting revenue from taxes and uses it for the developmental and welfare expenditure. The money received through taxes is also considered as a source of transfer payment, where money is collected from the rich and spent for the welfare of poor. However, it is very difficult for any government to decide on the optimal level of taxation and the medium used to collect these taxes. All the economies in the world are faced with a dilemma either to charge direct or indirect taxes. There’s no consensus yet, but both sides of the arguments have been able to muster some support (Bamford). Certain economists support the point of view that all taxes should be direct, whereas others are of the opinion that the large chunk of these taxes should be indirect. This would make avoidance of tax difficult for people who do not want to pay taxes. However, on the other hand many economist consider indirect taxation as an unfair as it is a regressive tax where the poor pay large chunk of their income as taxes as compared to the rich and wealth of the society. A good tax system is one that is fair and supports people at all levels in the society, hence many economists refute the support for indirect taxation. On the other hand many other economists consider that indirect taxation is good because it removes any leeway that people have to avoid taxes or to mislead their income and everyone has to pay this tax. So, they consider it as an optimal system of taxes and something that would lead to an increase in the collection of money as taxation. (Hotelling) In order to assess our argument it would be important for us to know the difference between direct and indirect taxation. Direct taxes are those taxes that are levied on one’s income. They are calculated annually and a certain percentage is levied on the earnings of a person. Similarly, indirect taxes or not levied on the people’s income. Instead, indirect taxes are paid on the purchase of goods and services. They are paid whenever a purchase is made. They are included in the selling price of a good and service and hence a person cannot escape indirect taxes since he is paying not only the price of the good or service, but also the portion of a tax. Hence it is unavoidable and is paid by everyone irrespective of his earning. (McConnell) We can use the above definitions to classify the federal income tax and federal sales tax into one of the two classes of taxation. This would help us in determining which is more useful in terms of revenue for the government and welfare of the society. Since we know that federal income tax is levied on people’s income and is calculated annually, we can classify it as a direct tax. This means that it is levied on the person’s income. It is a progressive tax where the rich person pays a higher amount than a person who is earning lesser than that person. On the other hand, federal sales tax is levied on the purchase of goods and services. People pay this type of tax only when they buy or sell something. It is not charged on the person’s income and it is a regressive tax meaning that both rich and poor pay equal amount of tax if the selling price of a good is same for their purchases. In other words, we can differentiate between these two types of taxes by using mathematic equation. Income tax is charged on one’s income. It is a percentage of one’s income. Let’s suppose that the prevalent income tax rate in the United States of America is 20%. The calculation of taxes for the income will be the following: Income Tax = Annual Income * 0.25 Similarly, in case of an indirect tax such as federal sales tax, the calculation for the income tax will be the following: Tax = Selling Price of Commodity * Percentage of the Tax These two equations tell us that federal sales tax has nothing to do with the income of a person. It is calculated just by looking at the value of the purchase that the person is making. Hence, even if a person with low income is buying an expensive good, he will have to pay the same amount of taxes as rich person would have paid. The debate regarding the system of taxation that the government of United States of America should follow is not very new. In fact different economists consider different systems to be perfect and there is no unanimous opinion. If we weigh the two options that we have argument by argument, that will be the only thing that would give us a fair picture of what kind of taxation policy government of the United States of America should follow. (Time) Many people also pointed out that Federal income tax is also not the ideal way of collecting revenue for the government. There have been cases that it has encouraged briber and window dressing of people’s income. Many people have been found to indulge in these practices in order to save the taxes. Hence, one must not rely on this alone and they also stated that federal sales tax is solution to this problem because this type of tax is equal for people with different income groups and does not incentivize understatement or window dressing of one’s income. Hence, the system of federal income tax should be immediately replaced by the system of federal sales tax. Many people rejected the idea of federal sales tax as the most efficient way of collecting taxes by the government. These people have gone to extremes where they asked the government to abandon the system of federal sales tax. They supported their premise by stating that not only the federal sales tax is unfair, but it also leads to the division of society by discouraging the purchase of highly priced good. This means that the standard of living for people in the lower segments of the society can never be as high as people in the elite classes. Hence, the society will remain divided at the two extreme and emergence of middle class will not be encouraged. This was a strong argument, but people who were against imposing this type of tax system countered this by stating that there is no way that the federal sales tax can be used as a progressive tax. There would be case of many people cheating or misleading their income in order to get the best deal of their purchase. Hence, trying to charge different sales tax for different people is impossible and would not be an efficient system for collecting high revenues for the government. (Mifflin) It therefore looked a better idea to run these systems side by side as it is happening in the United States of America today. However, many people argued by saying that running such a complex system is a problem in itself. It leads to high administration costs and thus this system can never be efficient. Hence, the government should first work towards improving the system federal sales tax and income tax before implementing it. This would make sure that any errors of risks are minimized before the system is imposed. (Metcalf) However, many economists argued that the government has already spent so much money in improving such a system, therefore, it would be a waste to spend more money on this system, hence the government should instead spend this money on improving the lives of people and not on the system that is already been in such a good shape. Therefore, it was claimed that this system can sustain itself in its current position and hence the government should need to improve supervision in order make it an efficient system of collection of revenue for the government. (Mirlees) Another main issue that was raised by the supporters of indirect taxation was that federal income tax was a system that requires a lot of supervision and if government employs a lot of people to supervise this system then the welfare money that is generated for the poor people of society. Hence this system can never be efficient because large chunk of the money is wasted in its implementation and only left over amount gets to the poor people of the society. It also violates the fundamental principle of taxation. A government does not charge taxes in order to take money from people, but it charges taxes because it wants to spend this money on the welfare of poor people, development expenditure and as a means of transfer payment. Hence, since most of this money gets washed away in supervision and implementation of the system this means that only very little reaches the people who deserve this money. Therefore, it can be recommended that the system of indirect taxation in the form of federal sales tax is more beneficial because the money reaches the government without much supervision or implementation costs and needy people enjoy the benefits of this money. In the light of above discussion, we can safely conclude that the best option for the government to streamline its operations is by implementing a system that is not only fair, but also leads to less implementation and supervision charges so that money reaches the people who deserve it. This means that a good tax system should be able to sustain itself and should be able close doors on people who want to avoid it without much interference by the government. An ideal situation is one where federal income tax and federal sales taxes are levied side by side each other. Federal income tax provides much needed fairness to the tax system, whereas federal sales tax is a system which is easy to manage without much administration charges. This system usually sustains itself; hence, it is a cheaper way of collecting taxes and spending it on the segments of the society which deserve it more than the other. The ideal situation for the United States of America, therefore, is one where both of these systems of taxation, federal income tax and federal sales tax are used. This would ensure that no one avoids tax and tax payments that fairer and used optimally to support the entire society. References: Bamford, C. Economics. Oxford University Press, 2003. Print Hotelling L. The General Problems in Relation to Taxation. JSTOR, 2003. Web McConnell and Brue, S. Economics. Prentice, 2003. Print Metcalf, G.E. VAT: A Tax Whose Time has Come. JSTOR, 1995. Web Mifflin, H. Fast Food Nation. New York Time, 2005. Web Mirlees, J A. Theory of Optimum of Taxation. JSTOR, 2000. Web Lipsey, R and Chrystal, A. Oxford University Press, 2003. Print Time. Taxation: Federal Sales Tax? Times Magazine, 2003. Web Read More