- Types of taxation
I hope you all are aware of what exactly is a tax. You must also of course know that a tax is levied on by the government. There are two main types of taxation. One is called the direct tax, while the other is known as the indirect tax. Direct taxes are taken directly from incomes and wealth while the indirect taxes are taxes on spending. Taxation can also be divided into two more categories i.e progressive taxation and regressive taxation. A progressive tax is a tax by which the tax rate increases as the base income increases, while a regressive tax is a tax by which the tax rate increase when the base income decreases.
- Types of Direct tax
(i) Income tax
(ii) Corporation tax
Just as individuals are taxed on their incomes, companies are taxed on their profits. The tax on company profits is called corporation tax.
(iii) Capital gains tax
It is possible to make profits by buying shares, property etc, at a low price and then selling at a higher price. Profits made in this way are called capital gains and are subject to tax by the Government. Profits made on an individual’s home, private cars, winnings from gambling and assurance policies are not subject to capital gains tax.
(iv) Inheritance tax
Inheritance tax is a tax on transfers of wealth made at death. When an individual dies and leaves property or money to somebody else, inheritance tax might be payable on the value inherited.
- Types of indirect tax
(i) Value added tax (VAT)
Value added tax is a tax on spending. This VAT money is then passed on buy the shopkeeper to the tax collection authorities.
VAT is regressive in nature because it takes a larger proportion of a poorer person’s income. For example a burger of Rs.100 with Rs.20 as tax, will remain the same for both the poor and the rich. The tax would make up 10% of the person with income Rs.200, while it would make up only 0.1% of a person with income Rs.20000
(ii) Customs duties
Some goods imported into Pakistan are taxed. These taxes are called customs duties and are used to discourage foreign companies from selling their goods in Pakistan.
(iii) Excise duties
Excise duties are taxes placed on certain goods and services. Examples include duties on fuel, tobacco, the air passenger duty, insurance premium tax etc.
- Pros and cons of Direct taxes
(a) Direct taxes are a source of income for the government. The total amount of taxes collected can be estimated with reasonable accuracy in advance, which of great help when planning on how much the Government can be spend on different areas.
(b) Redistribution of wealth takes place. The progressive nature of many direct taxes means that wealthier members of society are taxed more heavily than poorer groups. Many people think this is fair.
(c) Ability to pay is taken into account. Direct taxes are constructed so that they take into account of firms’ and people’s ability to pay tax. Family commitments, dependants, etc., are taken into consideration and a system of tax allowances are used to reflect these responsibilities.
(a) Workers get demotivated. A high rate of tax on income may cause people to work less hard because they know that the more they earn the greater the proportion of their income they will have to pay in tax.
(b) Entrepreneurs are discouraged. Corporation tax on firm’s profits reduces the incentive for entrepreneurs to start up firms to earn a profit.
(c) Tax evasion starts to take place. High tax rates increase the advantages of evading taxes and finding loop-holes in tax laws. As a result, revenues are lower and the trouble of trying to catch up with tax evaders increases costs.
- Pros and Cons of Indirect taxation
(a) Indirect taxes are cheap to collect. The burden of collecting taxes in this way lies, mainly with the manufacturers, wholesalers and retailers collecting VAT, and importers paying custom and excise duties.
(b) Indirect taxes have a wider tax base. Indirect taxes are paid by young, old, employed and unemployed alike when they buy goods and services, not just by people with earned incomes. As a result, the effects of indirect taxes are spread more widely throughout the community.
(c) Selective aims can be achieved. Indirect taxes can be used to achieve specific aims. For e.g taxes on cigarettes can discourage harmful consumption. Taxes on oil can reduce the demand of this limited resource and reduce air pollution.
(d) Indirect tax rates can be easily altered unlike direct taxation rates, therefore more flexible.
(a) Indirect taxes are regressive in nature. That is, they fall more heavily on people with low incomes. This may be thought as unfair.
(b) Indirect taxes add to the prices of goods and services and can therefore boost the rate of inflation if the tax is increased.
(c) Because the government can only guess how much people will spend on the goods and services, he or she will be uncertain of how much revenue indirect taxes will raise.