Direct tax

Though the actual definitions vary between jurisdictions, in general, a direct tax is a tax imposed upon a person or property as distinct from a tax imposed upon a transaction, which is described as an indirect tax. The term may be used in economic and political analyses, but does not itself have any legal implications. However, in the United States, the term has special constitutional significance because of a provision in the U.S. Constitution that any direct taxes imposed by the national government be apportioned among the states on the basis of population. In the European Union direct taxation remains the sole responsibility of member states.

General meaning

In general, a direct tax is one imposed upon an individual person (juristic or natural) or property (i.e. real and personal property, livestock, crops, wages, etc.) as distinct from a tax imposed upon a transaction. In this sense, indirect taxes such as a sales tax or a value added tax (VAT) are imposed only if and when a taxable transaction occurs. People have the freedom to engage in or refrain from such transactions; whereas a direct tax (in the general sense) is imposed upon a person, typically in an unconditional manner, such as a poll-tax or head-tax, which is imposed on the basis of the person's very life or existence, or a property tax which is imposed upon the owner by virtue of ownership, rather than commercial use. Some commentators have argued that "a direct tax is one that cannot be shifted by the taxpayer to someone else, whereas an indirect tax can be."

The unconditional, inexorable aspect of the direct tax was a paramount concern of people in the 18th century seeking to escape tyrannical forms of government and to safeguard individual liberty.

The distinction between direct and indirect taxation was first extensively discussed by Adam Smith in his Wealth of Nations, as in the following passage:

It is thus that a tax upon the necessaries of life operates exactly in the same manner as a direct tax upon the wages of labour. ... if he is a manufacturer, will charge upon the price of his goods this rise of wages, together with a profit; so that the final payment of the tax, together with this overcharge, will fall upon the consumer.

The Pennsylvania Minority, a group of delegates to the 1787 U.S. Constitutional Convention who dissented from the document sent to the states for ratification, objected over this kind of taxation, and explained:

The power of direct taxation applies to every individual ... it cannot be evaded like the objects of imposts or excise, and will be paid, because all that a man hath will he give for his head. This tax is so congenial to the nature of despotism, that it has ever been a favorite under such governments. ... The power of direct taxation will further apply to every individual ... however oppressive, the people will have but this alternative, either to pay the tax, or let their property be taken for all resistance will be vain.

U.S. constitutional law

In the United States, the term "direct tax" has acquired specific meaning under constitutional law: a direct tax is a tax on property "by reason of its ownership" (such as an ordinary real estate property tax imposed on the person owning the property as of January 1 of each year) as well as a capitation (a "tax per head"). Income taxes on income from personal services such as wages are indirect taxes in this sense. The United States Court of Appeals for the District of Columbia Circuit has stated: "Only three taxes are definitely known to be direct: (1) a capitation [ . . . ], (2) a tax upon real property, and (3) a tax upon personal property." In National Federation of Independent Business v. Sebelius, the Supreme Court held that a penalty directly imposed upon individuals for failure to possess health insurance, though a tax for constitutional purposes, is not a direct tax. The Court reasoned that the tax is not a capitation because not everyone will be required to pay it, nor is it a tax on property. Rather "it is triggered by specific circumstances."

In the United States, Article I, Section 9, Clause 4 of the Constitution requires that direct taxes imposed by the national government be apportioned among the states on the basis of population. After the 1895 Pollock ruling (essentially, that taxes on income from property should be treated as direct taxes), this provision made it difficult for Congress to impose a national income tax that applied to all forms of income until the 16th Amendment was ratified in 1913. After the Sixteenth Amendment, no Federal income taxes are required to be apportioned, regardless of whether they are direct taxes (taxes on income from property) or indirect taxes (all other income taxes).

Types of direct taxes

• Income tax is a tax imposed on people's wages. The actual amount of this tax, that the government obtains from a person's salary, is usually computed as a certain tax rate multiplied by the income. However, there are countries which have a more sophisticated way of collecting the income tax e.g. using a special tax base. The tax rate varies from country to country based on their taxation system that can be proportional, regressive or progressive.

• Transfer tax is a tax or in other words fee that is levied on a transfer of title to property from one person (entity) to another. The most frequent types of this tax are Gift tax or Estate tax.

• Capital gains tax is such type of tax that an individual is charged when selling a specific type of an asset, bond or stock. The tax is computed from the positive difference between the selling price and the purchase prize.

• Property tax is another type of direct tax. It is imposed on land, real estate, buildings and is used for services like fire departments, schools etc.

Direct taxation in India

Direct tax is a form of collecting taxes applicable on the general public by the means of their personal income and wealth generated and collected through formal channels and worthy government credentials such as Permanent account number and bank account details.

Section 2(c) of the Central Boards of Revenue Act, 1963 of India defines "direct tax" as follows:

(1) any duty leviable (or) tax chargeable under-

(i) the Estate Duty Act, 1953 (34 of 1953.);

(ii) the Wealth-tax Act, 1957 (27 of 1957.);

(iii) the Expenditure-tax Act, 1957 (29 of 1957.);

(iv) the Gift-tax Act, 1958 (18 of 1958.);

(v) the Income-tax Act, 1961 (43 of 1961.);

(vi) the Super Profits Tax Act, 1963 (14 of 1963.); and

(2) any other duty or tax which, having regard to its nature or incidence, may be declared by the Central Government, by notification in the Official Gazette, to be a direct tax.″

Direct taxation in other countries

General government revenue, in % of GDP, from direct taxes. For this data, the variance of GDP per capita with purchasing power parity (PPP) is explained in 43% by tax revenue.

Tax policy in the European Union (EU) consists of two components: direct taxation, which remains the sole responsibility of member states, and indirect taxation, which affects free movement of goods and the freedom to provide services. With regard to European Union direct taxes, Member States have taken measures to prevent tax avoidance and double taxation. EU direct taxation covers, regarding companies, the following policies: the common consolidated corporate tax base, the common system of taxation applicable in the case of parent companies and subsidiaries of different member states (to avoid withholding tax when the dividend qualifies for application of the EC Parent-Subsidiary Directive, the financial transaction tax, interest and royalty payments made between associated companies and elimination of double taxation if the payment qualifies for application of the EC Interest and Royalties Directive. Regarding direct taxation for individuals, the policies cover taxation of savings income, dividend taxation of individuals and tackling tax obstacles to the cross-border provision of occupational pensions.

Advantages of direct tax

• Equality - This tax promotes equality since it is levied differently on people with different ability to pay. People who earn more money are charged a higher amount than the ones earning less. Thus this, in general, contributes to promoting equality among citizens within a country.

• Social awareness - Since people know how much they are supposed to pay to the government, they might get a feeling of responsibility for public goods that are provided by the country. Furthermore, there have been studies proving that due to this social awareness, the rate of lesser crimes and cases of damaging public goods has decreased.

• Certainty - The amount of the tax is definite and known in advance for the taxpayer, which promotes certainty because each taxpayer knows already before the submission date, how much they are supposed to give to the government.

• Wealth distribution - Since people in different categories of wages are charged a different tax rate, as mentioned in the first advantage, high-income people pay to the government regarding the tax more money, which can be later on distributed to the poor citizens or to provide public, especially merit goods. This, according to a vast majority of economists, is a very effective way to improve economic situation in a country.

• Economical raising - For the government, it is really economical because it does not involve that much money and time to collect the taxes. This process occurs right at the source using automatic systems.

• Regulation of inflation - Despite not being that efficient as indirect taxes, direct taxes can be also used to control and regulate the inflation rate. Government can increase direct taxes in order to decrease the demand of the product, which will result in lower consumption of goods because people will not have that much money to spend. Therefore, this will affect the inflation rate.

Disadvantages of direct tax

• Tax evasion - As long as the tax system is never 100% tight, people can misuse it for their own benefit using tax evasion. This illegal methode lies in misrepresenting the data in order to pay lower taxes. e.g. declaring less income, gain or profit, or, on the other hand, overstating deductions. In contrast, tax avoidance is a legal way of diminishing the tax using loophole etc.

• Social conflict - Not everybody has to pay direct taxes, thus it might lead to conflicts between the ones paying the taxes and the ones not paying them.

• Demotivation to work - Harder work is associated with a higher income. So people normally tend to work as much as possible to earn more money but the higher the income is, the more taxes are supposed to be paid to the government. Due to this "paradox" people can be demotivated in some cases to work harder.

• Inconveniency - It usually takes a lot of time to undergo some lenghty formalities in order to submit the tax and therefore, people incline to tax evasion.

• Limited investment - Rich people are usually the ones who invest their capital but they are also charged a high tax. This existence decreases their possibilites and thus limits their ability to invest. As a result, less capital is being invested and the country's economic growth is slowed down.

See also

• Indirect tax
• United Kingdom Corporation Tax
• Income tax in the United States

Sources

• Foster, Robert (1895). Commentaries on the Constitution of the United States: Historical and Judicial. Vol. 1. Boston: The Boston Book Co. pp. 415–423.