Governments collect taxes by direct and indirect means. An example of a direct tax is payroll tax, where tax is deducted by an employer from an employee's income, and paid directly to a collection agency, such as the Internal Revenue Service in the United States. An indirect tax is a tax which is not paid directly to the collection agency by the person paying the tax, but goes an intermediary, who then passes the tax to the collection agency. Sales taxes are examples of indirect taxes.
Progressive Advantage of Direct Taxes
One advantage of direct taxation is that it is easy to apply in a progressive manner. Progressive taxes are a fair way of generating revenue, because multiple rates of taxation can be applied, based on the ability of the tax payer to pay the tax, especially if tax rates increase marginally. For example, a government may apply income tax to earnings at a rate of 10 per cent, for all income earned up to £13,000. Then it applies a rate of 15 per cent to income over £13,000. A person earning more than £13,000 will pay tax at a rate of 10 per cent on the first £13,000 earned, and only pays 15 per cent on earnings over that amount. Progressive, marginal, direct taxation is therefore fair because higher earners bear a greater part of the tax burden, based on their ability to pay higher rates of tax.
Transparency of Direct Taxation
Direct taxes, which go directly by the person bearing the burden of the tax, are transparent taxes. For example, when an employer deducts taxes from the wages of an employee, the employee can see the amount of tax deducted, as it is included on his or her wage statement, or payslip. Self-employed tax payers can also see the amount of tax they need to pay to the government, when they complete their tax returns. In a democracy, tax transparency means that governments have to justify taxes they impose to their voters, and taxpaying voters always aware of the tax burdens imposed on them by politicians.
Environmental Benefits of Indirect Taxation
Governments use Indirect taxes, such as taxes added to the price of goods and services, to modify the behaviour of individuals in order to help achieve environmental goals. For example, the true price of gasoline, at point of delivery to the public is low. The price does not encourage people to reduce their use of gasoline by using public transport, or buying more fuel-efficient vehicles. If a government wishes to reduce the use of gasoline as part of an environmental protection goal, it can artificially inflate the price of gasoline to the consumer, by imposing a sales tax to increase the price. When a government imposes a high enough tax on gasoline, it results in a reduction of demand for gasoline, and thus aids the government in implementing its environmental policy.