Category: Taxation
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Tax systems are generally evaluated on the basis of a number of criteria, especially in regard to equity or the fairness of a particular tax system as well as the so-called allocative efficiency of the tax itself, that is, how the tax affects individual well-being either through the direct effect of paying the tax or the indirect effect (described as distortionary) caused by the tax on commodities or services.

In economic theory it has been observed that the allocative efficiency of direct (progressive) taxes is superior to that of indirect (regressive) taxes.

Put differently, raising taxes through a direct tax like income tax would imply a lesser burden on individuals than the same amount raised through an indirect tax like excise duty or ad valorem tax.

The reason for this is that indirect taxation increases the burden on individuals since it distorts their choices as a result of price changes. An indirect tax, therefore, has a greater negative effect on markets than a direct taxation. From an economic (and social) welfare perspective, paying direct taxes is considered fair especially when (assuming minimal tax avoidance and evasion) income tax takes a larger percentage from the income of high-income earners than it does from low-income individuals. In any event, high income earners would still be better off (in terms of the choices they make) in a tax regime which is primarily based on income taxation.

In recent years, however, we have seen a gradual and partial shift from income to more indirect taxation, and the 2015 Budget is no different with the imposition of additional indirect taxes. The further switching from a direct to a more indirect tax regime will affect both individuals and markets but has become inevitable given the political commitment to reduce the tax rates for high-income earners.

What, you may ask, are the advantages of indirect taxation? First, there is no theoretical certainty that allocative efficiency applies in the case of direct taxation but Ill put this theoretical argument aside.

Second, the administrative costs of a direct tax are higher than those of an indirect tax, since a direct tax regime may have many exemptions. In fact, from an administration cost point of view, indirect taxes are considered superior.