Business Standard

Volume IconWhat are direct and indirect taxes?

There are two types of taxes which the government collects -- direct and indirect taxes. Get clarity on them ahead of the Union Budget for 2022-23, which may keep modest targets for tax collections

Tax collections, taxes, tax cut, revenue, spending, expenditure, growth

In its Annual Financial Statement -- also called Union Budget -- the Central government provides details of how much money it expects to garner from various sources and how it intends to spend the funds

India earns about 80% of its total revenue through taxes. While taxation is the primary source of income for the government, it also earns a recurring income, which is called non-tax revenue. This comes from dividends and profits of public sector enterprises, interest, fines, regulatory charges and user charges for publicly provided goods and services.

Click here to connect with us on WhatsApp

Tax revenue comes from two categories -- Direct taxes and indirect taxes. Let us first understand direct taxes. 

As the name suggests, it is levied directly on taxpayers. Direct taxes include income tax and corporation tax. Income tax is imposed on individuals and businesses other than companies. It is paid on the income earned during a particular financial year. 

Corporation tax is the money paid by companies on the profits made by them in a given financial year.

Direct tax also included inheritance tax and wealth tax, which were abolished in India in 1985 and 2015 respectively. 

On the other hand, indirect taxes are levied by the government on goods and services, and not on the income, profit or revenue of an individual.

India introduced Goods and Services Tax on July 1, 2017. It replaced several indirect taxes such as the excise duty, VAT, services tax, etc.

It is not paid directly by a person to the government but collected by an intermediary such as manufacturer, trader or service provider and passed on to the government. The consumer bears the final economic burden of the tax.

Indirect tax includes GST, central excise duty and customs. Central excise duty is an indirect tax levied on goods made in the country.

In Financial Year 2021, India’s direct tax collection stood at Rs 9.45 lakh crore while the indirect tax collection was at Rs 10.71 lakh crore. Direct taxes in India are overseen by the Central Board of Direct Taxes (CBDT) and indirect taxes by the Central Board of Indirect Tax and Customs.

Direct taxes are considered more equitable. In most developed countries, the share of direct taxes in the total taxes collection is far more than the indirect taxes.

According to the latest data, the OECD average for direct tax collection in 2018 was 67.3% of the total tax collection. While for India, it was 38.3% for Financial Year 2019.

Direct taxes are imposed on those individuals who can afford it. It is linked to the tax payer’s income level. Higher the income, the higher is the income tax liability.

While high indirect taxes are considered regressive. They are paid by everyone at the same rate, irrespective of their income or financial status. A poor man pays the same amount of tax on soap as the rich man. 

The shares of direct taxes and indirect taxes also indicate how the government has managed its public finance. In 1991, for instance, the share of direct taxes in GDP was about 2% and that of indirect taxes in GDP was over 8%. In 2007-08, just before the global financial crisis, the shares had changed to 6% of GDP each for direct and indirect taxes.

In 2020-21, direct taxes had a share of 4.7% of GDP, while indirect taxes’ share in GDP was about 5.4%. Low direct tax and low corporate tax suggest that the tax burden is shifting towards the poor.

Watch video

Don't miss the most important news and views of the day. Get them on our Telegram channel

First Published: Jan 25 2022 | 8:45 AM IST

Explore News