Question
What is the difference between direct tax and indirect tax? Explain the role of government budget in influencing allocation of resources.
Solution
| Direct Tax | Indirect Tax |
| It is imposed on the income of a person based on the principle of ability to pay. The income tax burden is equitably distributed on different people and institutions. Thereby the tax burden falls more on the rich than on the poor. | It is imposed on an individual but is paid by another person either partly or wholly. Hence, the impact and incidence of taxes are on different persons. |
| Tax burden cannot be shifted to another person. | Tax burden can be shifted to another person. |
| Prices are not affected. | Prices are affected because the price of the product is inclusive of tax. |
| Examples: Income and property tax | Examples: Union excise duties and custom duties |
Through the budgetary policy, the government can reallocate resources so that social and economic objectives can be met in the following ways:
i. The government ensures productive expenditure to maximise the welfare of the nation with minimum level of profit.
ii. The government regularises the activities of the private sector to provide social benefit to the poor.
iii. The government imposes taxes on socially unsafe goods such as alcohol and tobacco to shift resources to the production of socially essential goods.
