Direct tax

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Although the actual definitions vary between jurisdictions, in general, a direct tax is a tax imposed upon a person or property as distinct from a tax imposed upon a transaction, which is described as an indirect tax. There is a distinction between direct and indirect taxes depending on whether the tax payer is the actual taxpayer or if the amount of tax is supported by a third party, usually a client. The term may be used in economic and political analyses, and may have legal implications in some jurisdictions. In the United States of America, the term has special constitutional significance because of two provisions in the U.S. Constitution that any direct taxes imposed by the national government be apportioned among the states on the basis of population. [1] [2] It is also significant in the European Union, where direct taxation remains the sole responsibility of member states. [3]

Contents

General meaning

In general, a direct tax is one imposed upon an individual person (juristic or natural) or property (i.e. real and personal property, livestock, crops, wages, etc.) as distinct from a tax imposed upon a transaction. In this sense, indirect taxes such as a sales tax or a value added tax (VAT) are imposed only if and when a taxable transaction occurs. People have the freedom to engage in or refrain from such transactions; whereas a direct tax (in the general sense) is imposed upon a person, typically in an unconditional manner, such as a poll-tax or head-tax, which is imposed on the basis of the person's very life or existence, or a property tax which is imposed upon the owner by virtue of ownership, rather than commercial use. Some commentators have argued that the distinction rests on whether the burden of taxation can be shifted from one legal person to another. [4] [5]

Direct taxes are thought to be borne and paid by the same person. The person who pays the amount of direct tax does not recover all or part of the tax elsewhere. It is in this sense that direct taxation is opposed to indirect taxation. It is the notion of fiscal incidence which allows to analyse who ultimately, weights the burden of a tax, that determines whether the tax is direct or indirect. Direct taxation is generally declarative (established either by the person concerned or by a third party).

The unconditional, inexorable aspect of the direct tax was a paramount concern of people in the 18th century seeking to escape tyrannical forms of government and to safeguard individual liberty.

In The Wealth of Nations, Adam Smith was the first to extensively discuss in English the distinction between direct and indirect taxation by those names, as in the following passage [a] :

It is thus that a tax upon the necessaries of life operates exactly in the same manner as a direct tax upon the wages of labour. ... if he is a manufacturer, will charge upon the price of his goods this rise of wages, together with a profit; so that the final payment of the tax, together with this overcharge, will fall upon the consumer. [6] : 333 

Justice William Paterson quotes Smith approvingly, [7] : 180-181 (seriatim op.)  noting that indirect taxes are “circuitous modes of reaching the revenue of individuals,” [7] : 180  which implies that direct taxes are those which are not circuitous. [b]

The Pennsylvania Minority, a group of delegates to the 1787 U.S. Constitutional Convention who dissented from the document sent to the states for ratification, objected over this kind of taxation, and explained:

The power of direct taxation applies to every individual ... it cannot be evaded like the objects of imposts or excise, and will be paid, because all that a man hath will he give for his head. This tax is so congenial to the nature of despotism, that it has ever been a favorite under such governments. ... The power of direct taxation will further apply to every individual ... however oppressive, the people will have but this alternative, either to pay the tax, or let their property be taken for all resistance will be vain. [8]

Examples of direct taxes

Direct taxation can apply on income or on wealth (property tax; estate tax or wealth tax). Here below a few examples of direct taxes existing in the United States (though not all of these meet the US constitutional definition of a direct tax, as stated below): [9]

Effects of direct taxation and comparison of indirect taxation

Direct taxation has a few advantages and also some inconveniences in comparison of indirect taxes. It promotes equality and equity because direct taxes are based on ability to pay of the taxpayer and in the case of a progressive tax structure, every person is taxed differently depending on their income. Another advantage of direct taxation is that the government and the taxpayer know the amount they will receive and they pay, even before the collection of the tax. Direct taxation and in particular income tax act as automatic stabilizers. Some direct taxes are easy to collect for the government and the fiscal administration because they are collected at the source. Yet, tax collection can be expensive depending on the efficiency of the fiscal administration. Running the tax collection office has some administrative costs (keeping the records of incomes of the population for example), in particular when different tax rates are applied. Moreover, direct taxes can be evaded (tax evasion affects mainly direct taxes) whereas indirect taxes cannot be evaded (when the taxed transaction occurs, it is not possible to avoid the burden of the tax). [9]

Direct taxes decrease the savings and earnings of individuals and firms. Indirect taxation however make goods and services more expensive (the burden of the tax is reflected in the prices). Contrary to indirect taxation which leads to inflation (increasing of the prices), direct taxes can help to reduce inflation.

There is no consensus among the academic literature to designate if direct taxation is more efficient or not. Earlier works based on static models favour direct taxation whereas the recent literature, based on neoclassical growth models, shows that indirect taxation is more efficient. The conclusions of these debates are that the answers are mostly conjectural, depending on the economic structure. [10]

Direct taxes and progressivity

Contrary to indirect taxes such as value-added taxes, direct taxes can be adjusted to the ability to pay of the taxpayer according to their status (income, age...). So, direct taxes can be progressive (the tax rate increases as the taxable amount increases), proportional (the tax rate is fixed, it does not change when the taxable base amount increases or decreases) or regressive (the tax rate decreases as the taxable amount increases) according to their structure. [4] It differs from indirect taxes which are generally regressive because everyone pays the same amount regardless of ability to pay (meaning the burden of the tax is greater for the poorer than for the richer).

Moreover, direct taxation are transfers which can have a redistributive preoccupation (combined with the will of increasing tax revenue). [11] Indeed, taxation is a main tool of the redistributive function of the government identified by Richard Musgrave in his The Theory of Public Finance (1959). A progressive direct taxation could participate in the reduction of inequalities and correcting difference in living standards among the population. [11]

Another effect of a progressive direct taxation is that such tax structure act as automatic stabilizers when prices are stable. Indeed, when incomes (in the example of a progressive income tax) decrease, as a result of recession, the average tax rate is reduced – individuals have to face lower tax rates because their earnings and their incomes have been reduced. And similarly, when incomes are increasing, the average tax rate increases also. [12] This mechanism of progressive taxation participates to the stabilization of the economy, another function of the government in the works of Musgrave (stabilization branch of the government which prevents major fluctuations in real GDP). When incomes fall, tax revenues fall too (and in the case of progressive taxation, even tax rates drop also) reducing tax burden on taxpayers.

U.S. constitutional law

In the United States, the term “direct tax” has acquired specific meaning under constitutional law: a direct tax includes taxes on property [13] : 618  by reason of ownership [14] [15] (such as an ordinary real estate property tax imposed on the person owning the property as of January 1 of each year) as well as capitations. [7] : 175 (Chase, J.)  [7] : 183 (Iredell, J.)  Income taxes on income from personal services such as wages are indirect taxes in this sense. [16] [17] : 15  [18] [c] The United States Court of Appeals for the District of Columbia Circuit has stated: “Only three taxes are definitely known to be direct: (1) a capitation [...], (2) a tax upon real property, and (3) a tax upon personal property.” [19] In National Federation of Independent Business v. Sebelius, the Supreme Court held that the ObamaCare penalty imposed upon individuals for failure to possess health insurance, though a tax for constitutional purposes, [20] : 570  is not a direct tax, reasoning that the tax is neither a tax on property, nor a capitation in that “it is triggered by specific circumstances” rather than levied “‘without regard to property, profession, or any other circumstance.’” [20] : 571 

In the United States, the Constitution requires that direct taxes imposed by the national government be apportioned among the states on the basis of population. [1] [2] After the 1895 Pollock ruling that taxes on income from property should be treated as direct taxes, [13] : 634  this provision made it difficult for Congress to impose a national income tax that applied to all forms of income until the Sixteenth Amendment was ratified in 1913. Since then, Federal income taxes have been subject to the rule of uniformity but not the rule of apportionment. [17] : 18  Before then, the principal sources of revenue for the federal government were excise taxes and customs duties. Their importance thus decreased during the twentieth century and the main federal government's resources have become individual income taxes and payroll taxes. [12] Other evolutions were observed at the local and state level with a decrease of importance of property taxes whereas income and sale taxes became more important. [12]

In the context of income taxes on wages, salaries and other forms of compensation for personal services, see, e.g., United States v. Connor, 898 F.2d 942, 90-1 U.S. Tax Cas. (CCH) paragr. 50,166 (3d Cir. 1990) (tax evasion conviction under 26 U.S.C.   § 7201 affirmed by the United States Court of Appeals for the Third Circuit; taxpayer's argument—that because of the Sixteenth Amendment, wages were not taxable—was rejected by the Court; taxpayer's argument that an income tax on wages is required to be apportioned by population also rejected); Perkins v. Commissioner, 746 F.2d 1187, 84-2 U.S. Tax Cas. (CCH) paragr. 9898 (6th Cir. 1984) (26 U.S.C.   § 61 ruled by the United States Court of Appeals for the Sixth Circuit to be “in full accordance with Congressional authority under the Sixteenth Amendment to the Constitution to impose taxes on income without apportionment among the states”; taxpayer's argument that wages paid for labor are non-taxable was rejected by the Court, and ruled frivolous).

Direct taxation in India

Direct tax is a form of collecting taxes applicable on the general public by the means of their personal income and wealth generated and collected through formal channels and worthy government credentials such as Permanent account number and bank account details.

Section 2(c) of the Central Boards of Revenue Act, 1963 of India defines "direct tax" as follows:

″(1) any duty leviable (or) tax chargeable under-
(i) the Estate Duty Act, 1953 (34 of 1953.);
(ii) the Wealth-tax Act, 1957 (27 of 1957.);
(iii) the Expenditure-tax Act, 1957 (29 of 1957.);
(iv) the Gift-tax Act, 1958 (18 of 1958.);
(v) the Income-tax Act, 1961 (43 of 1961.)
(vi) the Super Profits Tax Act, 1963 (14 of 1963.); and
(2) any other duty or tax which, having regard to its nature or incidence, may be declared by the Central Government, by notification in the Official Gazette, to be a direct tax.″ [21] [22]

Direct taxation in other countries

General government revenue, in % of GDP, from direct taxes. For this data, the variance of GDP per capita with purchasing power parity (PPP) is explained in 43% by tax revenue. GDP per capita PPP vs direct taxes 2016.svg
General government revenue, in % of GDP, from direct taxes. For this data, the variance of GDP per capita with purchasing power parity (PPP) is explained in 43% by tax revenue.

Tax policy in the European Union (EU) consists of two components: direct taxation, which remains the sole responsibility of member states, and indirect taxation, which affects free movement of goods and the freedom to provide services. With regard to European Union direct taxes, Member States have taken measures to prevent tax avoidance and double taxation. EU direct taxation covers, regarding companies, the following policies: the common consolidated corporate tax base, the common system of taxation applicable in the case of parent companies and subsidiaries of different member states (to avoid withholding tax when the dividend qualifies for application of the EC Parent-Subsidiary Directive, [23] the financial transaction tax, interest and royalty payments made between associated companies and elimination of double taxation if the payment qualifies for application of the EC Interest and Royalties Directive. [24] Regarding direct taxation for individuals, the policies cover taxation of savings income, dividend taxation of individuals and tackling tax obstacles to the cross-border provision of occupational pensions.

See also

Notes

  1. ↑ While Sir James Steuart's An Inquiry into the Principles of Political Œconomy predated Smith's work by nearly a decade, Steuart's discussion of direct and indirect taxation occurred under the alternative categorical names of cumulative and proportional taxation, respectively; Steuart also discussed a nonmonetary form of taxation which he denoted "personal", which involved compelled individual service (e.g., militia or military service, jury duty, etc.). The likely first use of the concept of direct taxation was in Mirabeau's Théorie de l'Impôt in 1760.
  2. ↑ Whatever this precisely means, however, is unclear. Nonetheless, “the distinction was widely understood among the founding generation” of the United States. Natelson, Robert (2015). "What the Constitution Means by "Duties, Imposts, and Excises"—and "Taxes" (Direct or Otherwise)". Case Western Reserve University Law Review. 66 (2): 297.: 345 
  3. ↑ Nonetheless, Adam Smith appears to have considered taxes on “revenue” to have been direct, explaining the advent of indirect taxation as a result of “the state not knowing how to tax, directly and proportionably, the revenue of its subjects.” [6] : 331  Moreover, Justice William Paterson quotes this passage approvingly. [7] : 180 

Related Research Articles

A tax is a mandatory financial charge or levy imposed on a taxpayer by a governmental organization to support government spending and public expenditures collectively or to regulate and reduce negative externalities. Tax compliance refers to policy actions and individual behavior aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing the correct tax allowances and tax relief. The first known taxation occurred in Ancient Egypt around 3000–2800 BC. Taxes consist of direct or indirect taxes and may be paid in money or as labor equivalent.

<span class="mw-page-title-main">Taxation in the United States</span> United States tax codes

The United States has separate federal, state, and local governments with taxes imposed at each of these levels. Taxes are levied on income, payroll, property, sales, capital gains, dividends, imports, estates and gifts, as well as various fees. In 2020, taxes collected by federal, state, and local governments amounted to 25.5% of GDP, below the OECD average of 33.5% of GDP.

<span class="mw-page-title-main">Sixteenth Amendment to the United States Constitution</span> 1913 amendment

The Sixteenth Amendment to the United States Constitution allows Congress to levy an income tax without apportioning it among the states on the basis of population. It was passed by Congress in 1909 in response to the 1895 Supreme Court case of Pollock v. Farmers' Loan & Trust Co. The Sixteenth Amendment was ratified by the requisite number of states on February 3, 1913, and effectively overruled the Supreme Court's ruling in Pollock.

An income tax is a tax imposed on individuals or entities (taxpayers) in respect of the income or profits earned by them. Income tax generally is computed as the product of a tax rate times the taxable income. Taxation rates may vary by type or characteristics of the taxpayer and the type of income.

Brushaber v. Union Pacific Railroad Co., 240 U.S. 1 (1916), was a landmark United States Supreme Court case in which the Court upheld the validity of a tax statute called the Revenue Act of 1913, also known as the Tariff Act, Ch. 16, 38 Stat. 166, enacted pursuant to Article I, section 8, clause 1 of, and the Sixteenth Amendment to, the United States Constitution, allowing a federal income tax. The Sixteenth Amendment had been ratified earlier in 1913. The Revenue Act of 1913 imposed income taxes that were not apportioned among the states according to each state's population.

A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. "Regressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from high to low, so that the average tax rate exceeds the marginal tax rate.

<span class="mw-page-title-main">Progressive tax</span> Higher tax on richer source

A progressive tax is a tax in which the tax rate increases as the taxable amount increases. The term progressive refers to the way the tax rate progresses from low to high, with the result that a taxpayer's average tax rate is less than the person's marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability to pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, such as a sales tax, where the poor pay a larger proportion of their income compared to the rich.

Tax noncompliance is a range of activities that are unfavorable to a government's tax system. This may include tax avoidance, which is tax reduction by legal means, and tax evasion which is the illegal non-payment of tax liabilities. The use of the term "noncompliance" is used differently by different authors. Its most general use describes non-compliant behaviors with respect to different institutional rules resulting in what Edgar L. Feige calls unobserved economies. Non-compliance with fiscal rules of taxation gives rise to unreported income and a tax gap that Feige estimates to be in the neighborhood of $500 billion annually for the United States.

A wealth tax is a tax on an entity's holdings of assets or an entity's net worth. This includes the total value of personal assets, including cash, bank deposits, real estate, assets in insurance and pension plans, ownership of unincorporated businesses, financial securities, and personal trusts. Typically, wealth taxation often involves the exclusion of an individual's liabilities, such as mortgages and other debts, from their total assets. Accordingly, this type of taxation is frequently denoted as a netwealth tax.

<span class="mw-page-title-main">Indirect tax</span> Type of tax

An indirect tax is a tax that is levied upon goods and services before they reach the customer who ultimately pays the indirect tax as a part of market price of the good or service purchased. Alternatively, if the entity who pays taxes to the tax collecting authority does not suffer a corresponding reduction in income, i.e., the effect and tax incidence are not on the same entity meaning that tax can be shifted or passed on, then the tax is indirect.

Tax withholding, also known as tax retention, pay-as-you-earn tax or tax deduction at source, is income tax paid to the government by the payer of the income rather than by the recipient of the income. The tax is thus withheld or deducted from the income due to the recipient. In most jurisdictions, tax withholding applies to employment income. Many jurisdictions also require withholding taxes on payments of interest or dividends. In most jurisdictions, there are additional tax withholding obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties, rent or even the sale of real estate. Governments use tax withholding as a means to combat tax evasion, and sometimes impose additional tax withholding requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.

In France, taxation is determined by the yearly budget vote by the French Parliament, which determines which kinds of taxes can be levied and which rates can be applied.

<span class="mw-page-title-main">Income tax in the United States</span> Form of taxation in the United States

The United States federal government and most state governments impose an income tax. They are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. Most business expenses are deductible. Individuals may deduct certain personal expenses, including home mortgage interest, state taxes, contributions to charity, and some other items. Some deductions are subject to limits, and an Alternative Minimum Tax (AMT) applies at the federal and some state levels.

<span class="mw-page-title-main">Tax policy</span> Choice by a government as to what taxes to levy, in what amounts, and on whom

Tax policy refers to the guidelines and principles established by a government for the imposition and collection of taxes. It encompasses both microeconomic and macroeconomic aspects, with the former focusing on issues of fairness and efficiency in tax collection, and the latter focusing on the overall quantity of taxes to be collected and its impact on economic activity. The tax framework of a country is considered a crucial instrument for influencing the country's economy.

Tax protesters in the United States have advanced a number of arguments asserting that the assessment and collection of the federal income tax violates statutes enacted by the United States Congress and signed into law by the President. Such arguments generally claim that certain statutes fail to create a duty to pay taxes, that such statutes do not impose the income tax on wages or other types of income claimed by the tax protesters, or that provisions within a given statute exempt the tax protesters from a duty to pay.

Taxes in India are levied by the Central Government and the State Governments by virtue of powers conferred to them from the Constitution of India. Some minor taxes are also levied by the local authorities such as the Municipality.

The history of taxation in the United States begins with the colonial protest against British taxation policy in the 1760s, leading to the American Revolution. The independent nation collected taxes on imports ("tariffs"), whiskey, and on glass windows. States and localities collected poll taxes on voters and property taxes on land and commercial buildings. In addition, there were the state and federal excise taxes. State and federal inheritance taxes began after 1900, while the states began collecting sales taxes in the 1930s. The United States imposed income taxes briefly during the Civil War and the 1890s. In 1913, the 16th Amendment was ratified, however, the United States Constitution Article 1, Section 9 defines a direct tax. The Sixteenth Amendment to the United States Constitution did not create a new tax.

Tax protesters in the United States advance a number of constitutional arguments asserting that the imposition, assessment and collection of the federal income tax violates the United States Constitution. These kinds of arguments, though related to, are distinguished from statutory and administrative arguments, which presuppose the constitutionality of the income tax, as well as from general conspiracy arguments, which are based upon the proposition that the three branches of the federal government are involved together in a deliberate, on-going campaign of deception for the purpose of defrauding individuals or entities of their wealth or profits. Although constitutional challenges to U.S. tax laws are frequently directed towards the validity and effect of the Sixteenth Amendment, assertions that the income tax violates various other provisions of the Constitution have been made as well.

Tax protester arguments are arguments made by people, primarily in the United States, who contend that tax laws are unconstitutional or otherwise invalid.

Taxes in Germany are levied at various government levels: the federal government, the 16 states (Länder), and numerous municipalities (Städte/Gemeinden). The structured tax system has evolved significantly, since the reunification of Germany in 1990 and the integration within the European Union, which has influenced tax policies. Today, income tax and Value-Added Tax (VAT) are the primary sources of tax revenue. These taxes reflect Germany's commitment to a balanced approach between direct and indirect taxation, essential for funding extensive social welfare programs and public infrastructure. The modern German tax system accentuate on fairness and efficiency, adapting to global economic trends and domestic fiscal needs.

References

  1. 1 2 "Article I, Clause 3, Section 2". Constitution of United States. National Archives. 1791.
  2. 1 2 "Article I, Clause 4, Section 9". Constitution of United States. National Archives. 1791.
  3. ↑ EUR–Lex: Taxation.
  4. 1 2 Britannica Online, Article on Taxation
  5. ↑ Financial Dictionary Online Direct Tax http://financial-dictionary.thefreedictionary.com/Direct+taxes Direct taxes]
  6. 1 2 Smith, Adam (1786) [1776]. Wealth of Nations. Vol. 3 (4 ed.).
  7. 1 2 3 4 5 Hylton v. United States , 3Dall.171 (1796).
  8. ↑ The Address and Reasons of Dissent of the Minority of the Convention, of the State of Pennsylvania, to their constituents.
  9. 1 2 "Direct Taxes: Taxes that are paid straight or directly to the government". corporatefinanceinstitute. Archived from the original on 2020-09-25.
  10. ↑ Tresch, Richard (2015). Public Finance: A Normative Theory (third ed.). Elsevier. pp. 220–221.
  11. 1 2 Canceill, Geneviève (1985). "L'effet redistributif de l'impôt direct et des prestations familiales". Économie et Statistique. 177: 23–39. doi:10.3406/estat.1985.4976.
  12. 1 2 3 Stiglitz, Joseph (2000). Economics of the public sector (third ed.). New York: Norton & Company. pp. 455–466.
  13. 1 2 Pollock v. Farmers' Loan & Trust Co. , 158U.S.601 (1895).
  14. ↑ Fernandez v. Wiener, 326U.S.340 , 362(1945).
  15. ↑ Bromley v. McCaughn, 280U.S.124 , 137(1929).
  16. ↑ Springer v. United States , 102U.S.586 , 598(1871).
  17. 1 2 Brushaber v. Union Pacific Railroad , 240U.S.1 (1916).
  18. ↑ Moore v. United States , 602U.S.___ , *7(2024).
  19. ↑ Opinion on rehearing, July 3, 2007, p. 20, Murphy v. Internal Revenue Service and United States, case no. 05-5139, United States Court of Appeals for the District of Columbia Circuit, 2007-2 U.S. Tax Cas. (CCH) paragr. 50,531 (D.C. Cir. 2007) (dicta).
  20. 1 2 NFIB v. Sebelius , 567U.S.519 (2012).
  21. ↑ "The Central Boards of Revenue Act, 1963" . Retrieved January 1, 2019.
  22. ↑ "Section 2, Central Boards of Revenue Act, 1963" . Retrieved January 1, 2019.
  23. ↑ Parent Subsidiary Directive, by Salvador Trinxet Llorca.
  24. ↑ European Union Direct Taxes, by Salvador Trinxet Llorca

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