Advantages & Disadvantages of Direct Taxes

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Direct taxes are those paid directly to the collection agency, such as the IRS or a state tax board. They differ from indirect taxes in that there isn't a third party passing the tax on (as is the case in sales taxes, for example). That makes them simpler than indirect taxes, since fewer entities are involved and the tax monies travel to fewer points before reaching their destination. Direct taxation provides tangible benefits, but some drawbacks as well.

Transparency

  • Direct taxes are transparent taxes, which means that the person paying the tax knows exactly how much is taken and to which specific agency it goes. This makes the taxing agency more accountable to the people whom it taxes, since the taxpayer doesn't have to follow a trail through any third parties. In addition, it allows the taxpayer to address discrepancies more readily, since he can spot them via his own records and point them out to the collecting agency.

Progressive

  • Direct taxes tend to be more progressive, in that the amounts are scaled to reflect a person's income. Someone working at the poverty level, for example, pays a smaller percentage of his income in taxes than a millionaire. Indirect taxes such as sales taxes charge everyone the same amount, which eats up a greater percentage of a poor person's income than a rich person's income. This is especially true in the case of essentials such as groceries or gasoline, which everybody needs to function in society.

Expense

  • A prominent disadvantage of direct taxes is that they cost more to administer than indirect taxes. With an indirect tax, the government need only charge the third party, such as a business in the case of sales taxes. A direct income tax, on the other hand, often means charging an entire populace, instead of just a percentage of them. That translates to more man hours required to collect the tax, more paperwork to keep track of it and more space (both computer and practical) to house it.

Disincentive

  • Direct taxes also tend to discourage taxpayers from saving and investing. When taxes are paid directly, the consumer has no reason not to use the remainder of his money for purchases. Indirect taxes, on the other hand, may be attached to consumer goods, and the higher price may encourage consumers to postpone their purchase and save their money. Governments can use this to encourage its citizens to adopt certain practices, and in the process, help keep the nation's economy healthy.

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