This post is on indirect taxes and the government. Governments have the choice to levy either direct or indirect taxes. In levying direct taxes, the impact and the incidence of the tax are on the same person. This implies that the person who is subject to tax pays it.
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However, the impact and incidence of tax are not on the same person in indirect taxes. As a result, the person who is subject to the tax is the one who pays it. Therefore, governments may choose to levy direct taxes, indirect taxes, or a mixture of both. This post is about indirect taxes as a government tax choice.
What is indirect tax?
An indirect tax is a tax imposed on one person but paid in whole or in part by another. It is demanded from one person on whom it is not imposed. The person on whom it is demanded must collect it from the person on whom it is imposed.
This means that the person from whom the tax is demanded collects it on behalf of the government and remits it to the government on behalf of the person it is imposed on. Examples of indirect taxes are consumption taxes such as value-added tax and excise tax.
The tax is collected on an agency basis, in which registered taxpayers are required to collect it from the taxpayer and remit it to the government. For example, in the case of VAT, a registered taxpayer collects VAT from clients and customers and remits it to the government after deducting the VAT they had paid to inform them of the VAT on purchases.
Examples of indirect taxes
There are many types of indirect taxes. However, the following are some examples of indirect taxes:
- Value-added taxes
- Excise taxes.
- Sales taxes
What are the advantages of indirect taxes for the government?
For the government, indirect taxes have several advantages and disadvantages. The following are some of the advantages of indirect taxes for the government:
a. Wide scope
Indirect taxes can bring everyone into the tax net, regardless of whether they are in the high, middle, or lower social strata. For example, VAT on potato chips in a restaurant is payable by everyone who desires to consume the food, from corporate chiefs to street boys.
Indirect taxes are levied on basically all goods and services, with a few exceptions. The taxes are levied on goods and services such as comfort goods (e.g., alcohol, wine, cigarettes) and necessities (e.g., food, bottled water).
b. Flexible, not fixed
The majority of indirect tax rates are flexible rather than fixed. Governments have leeway to increase or decrease tax rates and the scope of taxes, depending on prevailing economic, political, and social conditions. Governments also consider the country’s economic requirements, such as tax revenue and inflation management, before changing tax rates and tax scope.
c. Economical to collect
Appointed taxpayers are responsible for collecting indirect taxes on behalf of the government. The collection of indirect taxes involves low costs since they are collected on an agency basis. The appointed taxpayers are responsible for collecting taxes throughout the supply chain. The government does not pay the taxpayers to collect the taxes. Collecting taxes on behalf of the government is considered a national duty.
d. Greater coverage
Governments use indirect taxes to widen the tax base in the country. This is so that a variety of goods and services consumed by the nation’s citizens can be subject to indirect taxes. This widespread coverage ensures that many people are in the tax net. The coverage also assures the government a continued and sufficient supply of tax revenues.
e. Reduction of tax evasion opportunities
Since indirect taxes are included in the prices of goods and services, consumers do not have the leeway to negotiate the taxes in those prices. This makes it difficult for taxpayers to evade taxes on goods and services. For example, a smoker does not have the opportunity to negotiate the excise duty on the price of a packet of cigarettes.
f. Controls consumption of harmful products
Taxes are often used to control the consumption of specific goods that the government deems harmful to consumers or the environment. For example, goods such as alcoholic beverages (beer, wine) and cigarettes are subject to punitive excise taxes because they are considered harmful to citizens’ health.
Besides, plastic products are subject to high excise tax rates due to their negative environmental impact. The indirect taxes imposed on these goods and services increase their prices. The government hopes that the price increase will deter consumption of the goods and services.
g. Protection of domestic economy
Every government has the mandate to protect the domestic economy from interference by external economic, social, and political forces, including the dumping of cheap products and services. Governments impose indirect taxes for domestic economic management.
The government can increase or decrease the taxes depending on the level of protection desired. For example, very high excise taxes are levied on the importation of certain products, such as manufactured sugar, to protect the local sugar industry. Hence, indirect taxes are effective tools for domestic economic management.
This section discussed some of the advantages of indirect taxes for the government. However, indirect taxes also have disadvantages for the government.
What are the disadvantages of indirect taxes for the government?
There are several disadvantages of indirect taxes to the government that may result in the government collecting less than anticipated tax revenue and making tax collection difficult. The following are some of the disadvantages of indirect taxes for the government:
a. It is not possible to estimate its effects
There is uncertainty in estimating the effects of indirect taxes on the demand for goods and services. For example, when excise taxes are imposed on alcoholic drinks, prices increase. The consumption of those particular alcoholic drinks will go down. However, the overall consumption of alcoholic drinks does not go down. People continue drinking.
Due to the high cost of alcoholic beverages, consumers frequently look for cheaper options made by companies that do not impose any taxes. This eventually affects tax collection. Therefore, it is not possible to estimate the effect of levying indirect taxes.
b. Uneconomical to collect
Sometimes, the cost of collecting indirect taxes is high. Since indirect taxes are levied along the supply chain, collecting the tax from every consumer is uneconomical. Besides, collecting the tax from the government-appointed agents who collect it from consumers may also be expensive. The government requires tax officers to ensure that agents collect the correct amounts of tax and remit them to the government on time. This increases the cost of collecting the tax.
c. Negative effects on employment and production
Imposing indirect taxes increases the prices of goods and services. For example, imposing 16% VAT increases the price of the good or service by 16% or more. However, when the prices of goods or services increase, demand for them will decrease. This will harm the production of goods or services. The reduced demand for goods and services will negatively affect employment and production.
d. Inflation spiral-overs
When indirect taxes are imposed, the prices of goods and services will increase. This will result in higher production costs as raw material prices increase. The cost of wages and salaries will increase too, since workers will demand increased salaries to cater for the increased costs of goods and services.
The higher wages and salaries will result in higher prices. This price-cost-wage/salary-price movement will set the country’s economy on an inflationary path. Hence, indirect taxes create inflationary pressures in the economy and result in inflationary spirals. This is a disadvantage for the government.
e. Assessment of income
When indirect taxes are levied, it is difficult to make an accurate assessment of the income of all classes of people since the taxes do not impose an equal tax burden on all classes of people. Hence, assessing people’s income is difficult.
f. Negative effect on work and savings
Governments have many responsibilities, among them developing the country. For the government to perform its responsibilities, it requires revenue. There are several sources of government revenue, including direct and indirect taxes and non-tax sources, both domestic and international.
This post addressed some of the advantages and disadvantages of indirect taxes for the government as the tax-levying body. There are other advantages and disadvantages that were not addressed. A government’s decision on whether to levy a particular type of tax depends on factors such as the tax’s advantages and disadvantages, the tax’s purpose, and the need for tax revenue.
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Dr. Wakaguyu
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