INDIRECT TAXES: MERITS AND DEMERITS

Indirect taxes are taxes on goods and services rather than on income or profits. These taxes are typically collected by businesses and passed on to consumers. They include VAT, excise duty, customs duty, and the Goods and Services Tax (GST).

Merits of Indirect Taxes

1. Revenue Generation:
   • Explanation: Indirect taxes are a significant source of revenue for the government. They are collected at various stages of production and distribution, providing a steady income stream.
   • Example: GST generates substantial revenue for both central and state governments. In 2022-23, GST collections were around ₹14.83 lakh crore, highlighting its role in revenue generation.
2. Broad Tax Base:
   • Explanation: Indirect taxes are applicable to a wide range of goods and services, which means they can cover a broad section of the economy.
   • Example: Excise duty on products like tobacco and alcohol captures revenue from consumption, ensuring that even those who use luxury goods contribute to the tax base.
3. Ease of Collection:
   • Explanation: Indirect taxes are relatively easier to collect than direct taxes because they are embedded in the price of goods and services. Businesses collect these taxes on behalf of the government.
   • Example: GST is collected at each stage of the supply chain, reducing the burden on the government to directly assess individual taxpayers.
4. Encourages Savings:
   • Explanation: Since indirect taxes are levied on consumption rather than income, they can encourage individuals to save more, as they are taxed on their spending rather than their earnings.
   • Example: Lower income tax rates combined with indirect taxes on luxury goods might incentivize savings and investments.
5. Non-Evasion:
   • Explanation: Indirect taxes are less prone to evasion compared to direct taxes because they are collected at multiple points in the supply chain.
   • Example: GST has a robust system of input tax credit and electronic filing, which helps in minimizing tax evasion.

Demerits of Indirect Taxes

1. Regressive Nature:
   • Explanation: Indirect taxes are considered regressive because they take a larger percentage of income from low-income individuals compared to high-income individuals. This is because the tax burden is not related to the taxpayer’s ability to pay.
   • Example: A flat rate of GST on essential goods affects low-income families more severely, as they spend a larger proportion of their income on these necessities compared to higher-income individuals.
2. Inflationary Pressure:
   • Explanation: Indirect taxes can contribute to inflation by increasing the cost of goods and services. This can reduce purchasing power and overall economic welfare.
   • Example: An increase in excise duty on fuel can raise transportation costs, leading to higher prices for goods and services across the economy.
3. Complexity and Compliance Costs:
   • Explanation: The system of indirect taxes, especially with multiple rates and exemptions, can be complex and burdensome for businesses to comply with.
   • Example: The GST system requires businesses to file multiple returns and maintain detailed records, which can be challenging and costly, particularly for small enterprises.
4. Economic Distortions:
   • Explanation: Indirect taxes can sometimes create economic distortions by altering consumer behavior and business practices.
   • Example: High GST rates on certain goods might lead to decreased consumption of those goods or encourage smuggling and black market activities.
5. Impact on Low-Income Groups:
   • Explanation: Since indirect taxes are added to the prices of goods and services, they can disproportionately impact lower-income groups who spend a higher percentage of their income on taxed items.
   • Example: Higher GST rates on essential items like food and healthcare can burden low-income families more than higher-income individuals.

Summary

Merits of Indirect Taxes:

1. Revenue Generation: Significant source of government revenue.
   • Example: GST collected ₹14.83 lakh crore in 2022-23.
2. Broad Tax Base: Applies to a wide range of goods and services.
   • Example: Excise duty on tobacco.
3. Ease of Collection: Collected through businesses, reducing direct tax administration.
   • Example: GST collected at each stage of the supply chain.
4. Encourages Savings: Taxes on consumption rather than income.
   • Example: Lower income tax rates combined with indirect taxes.
5. Non-Evasion: Less prone to evasion due to collection at multiple points.
   • Example: GST’s input tax credit system.

Demerits of Indirect Taxes:

1. Regressive Nature: Affects low-income individuals more.
   • Example: GST on essential goods.
2. Inflationary Pressure: Can increase the cost of goods and services.
   • Example: Excise duty on fuel.
3. Complexity and Compliance Costs: Can be burdensome for businesses.
   • Example: GST filing requirements.
4. Economic Distortions: Can alter consumer and business behavior.
   • Example: High GST rates might encourage smuggling.
5. Impact on Low-Income Groups: Disproportionately affects those with lower incomes.
   • Example: Higher GST on essentials like food and healthcare.

Indirect taxes play a crucial role in the Indian tax system, offering benefits in revenue generation and broad coverage but also presenting challenges related to their regressive nature and complexity.