TYPES OF TAX
There are two major types of tax. These are direct tax and indirect tax.
- Direct Tax
Direct tax as the name implies refers to the type of tax imposed directly on income of individuals or organisations by the government or its agency. Such income would include wages, salaries, profits, rents and interests. The burden of direct tax is borne by the payers. The tax payers are usually aware of the payment of such tax.
Types of direct tax
- Personal income tax: This is the type of tax levied on the income of an individual, usually during a period of one year. In this type of tax system, individuals are granted certain rebates such as whether married, number of children, etc. and the balance of the income is then taxed. In Nigeria, personal income tax is based on pay as you earn [P.AY.E]. In this system, individuals are made to pay according to their income and ability to pay. Personal income tax is usually progressive, i.e. the rate of tax increases as income of the individual increases.
- Company tax: Company tax, also called corporate tax, is the tax levied on the profits made by the company. Allowance is also given to companies in the area of expenditure and the balance, called net profit, is taxed.
- Poll tax: This is the type of tax operated on flat rate basis usually imposed on the income of some individuals. The tax is said to be regressive of his income.
- Capital tax: This is the type of tax levied on property or on capital assets. Such properties may include land, cars, personal houses, etc. When tax is levied on the property or assets of a dead person, such capital tax is called death duty. It is levied on the person who inherits such property.
- Capital gains tax: A capital gains tax is the type of tax levied on the gains or profits derived from the sale of land and capital assets. An increase in the value of capital assets is referred to as capital gain.
- Expenditure tax: This is the type of tax levied on the part of a person’s income which is actually spent. It is not a very common tax in developing countries but it is used to encourage savings.
Advantages or Merits of Direct Taxes
- They are progressive in nature: Income tax is usually administered with a graded scale, i.e. the more or higher an income, the more tax the person has to pay.
- They are non-inflationary: They do not increase prices and, therefore, are not inflationary because money is taken from consumers and their purchasing power is thereby reduced.
- Reduce inequality of income: Direct taxes are used to ensure the redistribution of income as the poor pays less while the rich pay more. By so doing, it ensures redistribution of income.
- Easy estimation of revenue: Revenue accruing from direct taxes can easily be estimated by the government or its agency.
- Certainty in tax liability: In direct tax the payer knows what to pay while the government knows what is expected to be collected as tax.
- They are cheap to collect: Under the P.A. Y.E system, the cost of collecting direct tax is usually very small.
- They are convenient to payers: Direct tax is imposed on individuals’ or firms’ income based on their ability to pay. Such payments are usually at the convenience of the payer, e.g. personal income tax is deducted from the salaries of workers by the end of the month and the remaining amount, referred to as disposable income, is free for the owner to use or spend.
Disadvantages or Demerits of Direct Taxes
- They reduce savings: When tax is removed from one’s income, savings may become very difficult.
- They discourage investment: High tax on individuals and corporate bodies discourages potential investors from investments.
- They are prone to evasion: Direct taxes are usually prone to evasion by many income earners.
- They are inconvenient: Tax payers always feel the pains any time certain amount of money is deducted from their salaries.
- Disincentive to hard work: High incidence of tax can discourage people from working hard as they always believe that the more one works hard, the higher the tax one has to pay.
- They reduce purchasing power: When tax is imposed on the income of a worker, the balance may be small thereby reducing the purchasing power of such income earner.
- Difficulties in proper assessment: Direct tax may be difficult to assess, especially when many companies declare false profits.
- Indirect Taxes
Indirect taxes refer to taxes which are imposed or levied on goods and services. The producers or sellers bear the initial burden of tax before shifting them to the final consumers in the form of higher prices. Unlike direct tax, the tax payers under indirect tax are usually not aware of the amount being paid for such tax.
Types of indirect taxes
1) Custom duties or tariffs: These are grouped into two:
- Import duties: Import duties are taxes levied on goods imported or brought into the country from other countries. They are paid initially by the importer. The main purposes of import duties are to generate revenue for government, reduce importation of non-essential commodities, to correct an adverse balance of trade, to protect infant industries and also to prevent dumping of goods.
- Export duties: These are taxes levied on goods sent out (or exported) to other countries. Such tax is paid by the exporter.
2) Excise duties: Excise duties are taxes levied on certain goods produced within the country, i.e. locally manufactured goods.
3) Sales tax: This is the type of tax levied on the sale of certain commodities. The tax is collected either at the wholesale or retail stage and passed unto the consumers in the form of higher prices.
4) Purchase tax: This is the type of tax levied on certain consumer commodities such as cars, television sets, etc. The tax is usually collected at the wholesale stage. It is based on the value of goods under consideration. Luxury goods attract higher purchase tax than essential goods.
5) Value added tax (VAT): This is the type of tax imposed on goods and services at each stage of production. The burden of taxation is finally borne by the final consumers. VAT is used to generate revenue for the government.
Classification of indirect tax
- Ad valorem tax: This is a form of indirect tax imposed on commodities in accordance with their respective values and at specific percentages. Luxury goods attract high percentage of tax than essential goods.
- Specific tax: In this type of indirect tax, a fixed sum is imposed or levied per unit of a commodity, irrespective of its value, e.g. equal percentage of tax is levied on both luxury and essential commodities.
Advantages or Merits of Indirect Taxes
- Source of government revenue: Indirect tax is used to generate substantial revenue for government.
- Less burden of tax: The consumer usually pays a smaller amount of tax thereby experiencing less burden.
- Protection of infant industries: Indirect tax can be used to protect infant or local industries when heavy taxes are imposed on imported goods.
- To correct balance of payment deficit: If a country exports less and imports more, balance of payment deficit will occur. In order to correct the situation, high import duties are imposed to ensure improvement in the balance of payment.
- To check importation of harmful commodities: Commodities that are considered harmful are taxed heavily in order to discourage their importation.
- To regulate production and consumption of harmful goods: Goods considered as being harmful can be taxed heavily to prevent their production and consumption.
- Easy and cheap to collect: As soon as a consumer purchases a taxed commodity, he has paid the tax.
- Prevention of dumping: High import duties can be imposed on certain imported goods as a way of discouraging dumping of such goods.
- It bridges the gap between the rich and the poor: This is achieved through high taxes imposed on luxury goods consumed or used by the rich.
- It leads to less squabbles: This is because the buyer of the commodity is not aware of the amount he is paying as tax when he purchases the commodity.
- They are not easy to evade: Once the buyer purchases the commodity, he indirectly pays the tax.
Disadvantages or Demerits of Indirect Taxes
- Indirect taxes are regressive: In this manner, the burden of tax falls heaviest on those with smaller income as both the rich and the poor pay the same amount of money on the same type of goods.
- High cost of collection: Taxes accruing from indirect taxes are difficult and expensive to collect and remit to the appropriate quarters.
- They are inflationary in nature: Since the producer’s costs of production are increased by taxation, they would charge high prices. If such taxes are high, this may lead to inflation.
- It could lead to industrial unrest: Increase in the price of commodities will warrant demand for higher wages by workers and if such demand is not met, it could lead to industrial unrest or strike.
- Difficulties in its determination: Indirect tax is always prone to difficulties in determining the actual amount to be paid as tax.
- Uncertainty in revenue generation: The amount of revenue that can be generated from indirect tax cannot be calculated with any degree of certainty.
- It discourages investment: High custom duties on raw materials or finished products do discourage prospective investors.
- It increases prices of commodities: Indirect taxes are incorporated into goods and services. They are thus passed to final consumers who buy them on higher prices.