1) Direct taxes
2) Indirect taxes.
Direct taxes are levied on income wealth or spending power or any combination of the three.
Indirect taxes are levied on goods and services and may be applied by either unit or percentage of value or at a flat rate or in any other combination of lump sum.
The relationship between an individual tax and income of a taxpayer may also help us classify the effect of those taxes; classified as proportional, progressive, or regressive.
Proportional taxes: Percentage of tax payable remains constant even as income rises.
Progressive taxes: Percentage of income paid will increase as income rises because rates of the taxes will be increasing progressively as income rises.
Regressive taxes: Percentage of income paid in taxes decreases when income rises. These taxes are usually a single figure.
Most of the people who determine which taxes to charge may actually decide that they themselves do not get charged or that those applicable to them are proportional or progressive.
Governor Ronald Reagan (as he then was) in commenting about the U. S tax structure observed,
“Once you are told the income tax will never be greater than 2% of the income and
That only from the rich. In our lifetime this law has grown from 31 to more than
440,000 words. We have received this progressive tax direct from Karl Max who
Designed it as an essential of a socialist state”
In the proportional tax bracket, the steepest rate of increase occurs through the middle income range where are to be found the bulk of our small businessmen, professional people and supervising personnel, the very people whom Max said should be taxed out of the system.
At 16,000-18,000 shillings of income, a man reaches the 50% rate; the government can only justify this bracket on a punitive basis.
There can be no moral justification for the progressive tax, that’s why bureaucrats
Pretend that it is proportionate taxation.
1) Direct taxes
They are levied on income, wealth and spending power with consequences that usually they are referred to as direct taxes because attainment brings the taxpayer directly in contact with the taxman. In some situations, this may not be the case.
They are usually preferred because they help maintain horizontal equity so that those who earn the same income are subjected to the same tax rate.
They also reflect equity in ensuring high income earners who rely more on the state for either the opportunities to earn that income or opportunity to protect that income are made to pay.
Progressive tax rates are utilized then vertical equity is achieved and the state uses the direct taxes to redistribute income. It is amenable to lower tax avoidance since people must earn a living.
Direct taxes have however been criticized on grounds that they may discourage people from working harder because if through a progressive tax rate, that is both high and steep, the taxes take a greater percentage of income than the person who earned it, the person will be discouraged from earning that income.
Under what circumstances may the progressive system be both steep and high?
Direct taxes may encourage tax evasion by encouraging people not to report circumstances relating to income thus resulting into a black market.
2) Indirect taxes.
Imposed on outlay of goods and services. They are indirect in the sense that the prices of goods may be inclusive of tax so that in paying for the goods, the taxpayer also pays for the tax. The burden is shifted to the consumer who may not realize the burden.
It increases the choices to taxpayers so that the taxpayer may choose to either spend on less tax or choose whichever of the goods that may be attracting the taxes.
It helps in inequitable allocation of resources so that some activities that may have an effect on health, the environment or other public affairs may be taxed out of existence.
Disadvantages of indirect taxes
Most indirect taxes tend to be regressive i.e. same rates apply to all the taxpayers and the more able to pay tend to pay less and tend to be subsidized by those who are less able to pay hence affecting the vertical equity.
In relation to foodstuffs, basic commodities etc, low income earners spend less income on these commodities and in paying the same taxes, shoulder the same budget.
The indirect taxes tend not to take into account the personal circumstances of the taxpayer.