(a) Differentiate between direct and indirect taxation (b) Highlight any five advantages of indirect taxation to developing countries

Answer Details

(a) Direct versus indirect taxation. A direct tax is levied directly on the income, wealth or profit of individuals and firms, and the burden (impact) cannot be shifted onto another person; the person assessed actually bears it. Examples are personal income tax, company (corporate) tax and capital gains tax. An indirect tax is levied on goods and services, and its burden can be shifted, wholly or partly, from the producer or seller onto the final consumer through a higher price. Examples are value added tax (VAT), import duties and excise duties.

(b) Five advantages of indirect taxation to developing countries

• Difficult to evade: since the tax is included in the price of goods, anyone who buys the good pays it, so evasion is hard.
• Convenient to pay: it is paid in small amounts as goods are bought, so the burden is hardly felt.
• Wide coverage: it reaches almost everybody, including those in the informal sector whose incomes cannot easily be assessed.
• Can discourage harmful goods: heavy duties on goods such as alcohol and tobacco reduce their consumption.
• Easy and cheap to collect: it is collected at a few points (ports, factories, points of sale), lowering administrative cost, and yields large, elastic revenue.