Let us make an in-depth study of the merits and demerits of direct taxes.
(A) Merits:
1. Equity:
A direct tax is an equitable tax. Through it the rich can be made to pay more than the poor. In case of necessity, the poor people can be granted exemption from payment of such taxes.
A direct tax is equitable in the sense that it is levied according to the taxable capacity of the people. The rates of direct taxes, like the income tax, can be fixed in such a way that the higher the income of a man, the greater is the rate at which he has to pay the tax. Such a system is known as progressive taxation.
2. Certainty:
A direct tax satisfies the canon of certainty. For instance, a person liable to pay income tax knows how much he will be required to pay; for that purpose he can appropriate steps beforehand.
3. Elasticity:
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A direct tax has elasticity. It can be varied according to the needs of the government and changes in the income of the people. When the income of the people goes up, the rate of income tax can also be increased. If the income of the people falls, the rate of income tax can also be lowered.
4. Productivity:
Direct taxes constitute an important source of government revenue. Their collection charges are also low. Therefore, direct taxes are productive.
5. People’s Consciousness:
A direct tax increases the civic sense of the people. When the people are fully aware of the payment of taxes, they are also conscious of the way the government spends the money. They resent unproductive or wasteful expenditure. As a result, the government becomes careful in its expenditure.
(B) Demerits:
But direct taxes have certain demerits or defects, too.
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These are:
1. Lack of Popularity:
First, such taxes are not very popular, because the people have to bear the burden of such taxes directly. That is why, when the rate of a direct tax is raised, most people express their resentment against the government. For instance, when the rate of personal income tax or corporate profit tax is raised, criticism from those affected becomes very strong.
2. Evasion:
The second disadvantages of a direct tax is that it is liable to be evaded. By submitting false returns, many people try to evade income tax. Unless the civic sense of the people is well — developed and there is spread of education among them, the administration of direct taxes is very difficult.
3. People’s Indifference:
The third disadvantage of a direct tax is that it does not develop the civic sense of those who do not pay such taxes. In the case of income tax, people with incomes below a certain level are not liable to pay tax. In a low-income country like India, the majority of the people are not required to pay income tax. When a man directly bears the burden of a tax, he tries to know how the government spends that money. Those who are not directly affected by the burden of taxation remain indifferent as to the way the public expenditure is incurred.
4. Disincentive to Work and Save:
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Another disadvantage of direct taxes is that they reduce the desire to work and save. The rate of direct taxes are usually high. Many business ventures are not undertaken on the ground that a large part of the income earned will have to be given to the government in the form of taxes. Thus, direct taxes reduce incentives to work hard and save.
As the direct taxes have these defects, in a good tax system there should be indirect taxes, too.