Manon's Econ Blog

Direct and Indirect Taxes

Posted on: August 30, 2010

2. With the use of examples explain the difference between direct and indirect taxes.  (200-300)

There are two different ways government can collect taxes from people: with direct and indirect taxes.

Direct taxes depend on income; it is a fraction of income directly taken from the income someone receives. For example, if the tax rate is 10%, someone earning 1 million dollars a year will pay 100 000 dollars as taxes. Direct taxes could also be progressive, which means the fraction increases as income increases, but in any case it is taken directly from income.

Indirect taxes are depending on purchases; for each purchase some portion of the money paid goes to government. For example, the sales tax could be 7% for each computer, so everyone buying a computer would have to give 7% of the price paid to the government. Indirect taxes could also be fixed; for example for each pound of rice bought 1 dollar goes to the government.

Direct taxes cannot be escaped since they are directly taken from the income earned, but indirect taxes can somehow be escaped if the person does not buy the product. Nevertheless, government tries not to charge too much from people or they will find ways to not pay it anyway.

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