By Jeevan Pokhrel

Unit 13: Tax

Concept and Meaning
A tax is a compulsory financial charge or some other type of levy imposed on a tax payer by a governmental
organization in order to fund government spending and various public expenditures. The most important
sources of revenue for the government in most countries is taxation. In developing countries, the
government is trying at increasing the proportion of the national income which is collected as taxes. Taxes
can be analyzed under two headings:
1. Direct Tax
2. Indirect Tax
Direct Taxes
Direct taxes are those taxes which are paid by the person on whom they are levied. The burden of such
taxes cannot be shifted to anybody else. These taxes are levied generally on income or wealth of the person.
Income tax, wealth tax or gift tax are examples of direct taxes. Thus, if the impact and incidence of a tax
both fall on the same person, it is direct tax. Here impact refers to the initial burden of a tax while incidence
refers to the final burden.
Advantages of Direct Taxes
Following are the main advantages of direct taxes:
1. Economical:
Direct taxes are economical. The cost of collecting direct taxes is very low as these taxes are usually
collected at the sources. For example, income tax is deducted every month from the salary of a
person. This saves both time and expenses of the tax collecting officials.
2. Equitable:
Since the burden of direct taxes cannot be shifted, lower incomes can be exempted while higher
incomes can be taxed at a higher rate. In this way, equality of sacrifice can be attained through
progressive taxes.
3. Elastic:
Direct taxes are elastic, because the government is able to obtain more yields from them with every
increase in tax rates.
4. Certain:
A direct tax confirms with the principle of certainty. On the one hand, the taxpayers are certain as
to how much they are expected to pay; and on the other hand, the government can properly estimate
the yields from the direct taxes and can adjust its income and expenditure.
5. Educative value:
Direct taxes are helpful in creating civic consciousness in the minds of the taxpayers. Taxpayers
are aware about the amount collected from them and can check the wastage in government
expenditure.

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Disadvantages of Direct Taxes

Following are the disadvantages of direct taxes:
1. Inconvenient:
The great disadvantage of a direct tax is that it pinches the payer. He ‘squeaks’ when a lump
sum is taken out of his pocket. The direct taxes are thus very inconvenient to pay.
2. Evadable:
Direct taxes are taxes on honesty and so people try to evade them by concealing their income
or wealth or both.
3. Arbitrary:
Another objection against direct taxes is that they are invariably levied arbitrarily by the
government. No well-defined principles are considered while fixing the rates of taxes. This is
against the spirit of social justice.
4. Not suitable for underdeveloped countries:
Direct taxes are not suitable for Underdeveloped countries like Nepal, where the majority of
people are below the absolute poverty line.
5. Obstacles to capital formation:
If the taxes are too heavy, they discourage saving, and investment. In that case, the country will
suffer economically weak.
Indirect Taxes
An indirect tax is one, whose impact and incidence fall on different persons. An indirect tax is imposed on
one person, but is paid partly or wholly by another. Thus, an indirect tax may be shifted from one person
to another. An indirect tax is generally levied on goods. It is first collected from the producers of the goods,
the producers shift it on to the wholesale dealer, the wholesale dealer shifts it on to the retailers, and the
retailers, ultimately, shift it on to the consumers. Thus, ultimately the consumers bear the burden of indirect
taxes. Custom Duties, VAT and Excise Duties are the main indirect taxes levied by the Government in
Nepal.
Advantages of Indirect Taxes
1. Convenience:
Indirect taxes are mostly levied on commodities and are paid by consumers when they buy them in
the market. The amount of the tax is included in the price of the commodity and the consumer pays
the tax without experiencing its pinch.
2. Contribution from Poor:
It is a sound principle that every individual should pay something, however little, to the state. The
poor are always exempted from paying direct taxes. They can be reached only through indirect
taxation.
3. Elastic:
They are very elastic in yield, indirect taxes imposed on necessary goods yield large amounts of
revenue, because people must buy these things.
4. Progressive:
Indirect taxes can be made progressive by levying high rates of taxes on luxury goods and
exempting necessaries from the burden of taxation.
5. Social Welfare:
Indirect taxes when levied on harmful commodities like liquor, cigarettes, etc. serve a great social
purpose because they limit the consumption of such commodities.

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6. Wide Coverage:
Indirect taxes possess the quality of wide coverage. It covers every member of the society - poor
and rich, since tax is paid at the time of purchase.
7. No tax Evasion:
Indirect taxes cannot be evaded, as they are a part of the price. They can be evaded only when the
taxed article is not consumed, and this may not always be possible.
Disadvantages of Indirect Taxes
1. Regressive:
Indirect taxes are regressive in nature because they fall on all persons indiscriminately irrespective
of their ability to pay. Poor and rich both are taxed at the same rate. Hence, the poors feel heavy
burden than that of rich.
2. Uncertainty:
Revenue from indirect taxes cannot be estimated with certainty. As soon as a commodity is taxed,
the market price tends to rise, which results in fall in demand depending upon elasticity of demand.
3. Uneconomical:
Indirect taxes are uneconomical because they involve high cost of collection.
4. Rise in price:
They cause the price of an article to rise by more than the tax. It is so because the commodities are
sold from one dealer to another and every dealer raises the price of the commodities with a plea
that the tax on it has been raised.
5. Non-civic consciousness:
They do not develop civic consciousness, because often the taxpayer does not even know that he is
paying a tax. The tax is concealed in the price.

Value Added Tax (VAT)

Value Added Tax (VAT) is a consumption tax imposed on the value added at each stage of the production
and distribution chain of goods and services. It is a commonly used tax system in many countries around
the world. It’s one of the types of indirect tax. Note: See the earlier table where the National Income has
been calculated from Value Added Method. VAT is levied on that value added at a given percentage.

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