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Benefits of Indirect Taxation

A reader notes an edge that indirect taxes such as sales taxes have over direct taxes like income taxes. Enforcement of an indirect tax is much easier. But does this mean it should be used more?

Written by johnleemk on 12:41:02 pm Mar 24, 2007.

In response to Indirect Taxes Aren't Worth the Trouble, "tanstaafl" points out:

The regressivity of indirect taxes is indeed a problem and is one of the reasons why you will never see a country that relies solely on indirect taxation as it main means of generating revenue.

However, I would like to point out that a system of indirect taxation in these days of computerised systems is a wonderful enabler of efficiency in taxation i.e. curbing tax evasion. Having said that, I am 100% certain, Bolehland will not utilise the benefits of this and continue to stumble along with its existing inefficiencies.

Indeed, efficiency is an obvious benefit of indirect taxation. It's impossible to evade an indirect tax, unless the person you are buying goods from himself refuses to pay his taxes.

I don't think this necessarily justifies the use of indirect taxation, though. It certainly does not bear much on my main point that indirect taxation is regressive. It actively discriminates against the poor, and since the market already sufficiently does that (why else would these people be poor?) it seems a bit cruel to kick a man while he's down.

It is true, though, that relatively, indirect taxation might be a more efficient way of raising government revenue. Historically, indirect taxation was the way to go — as I understand it, direct taxes only became prevalent relatively recently, in the 19th century.

When you think about it, this makes sense. In times of poor bookkeeping and unorganised government, implementing something like an income tax would have been ridiculously impractical, unless you taxed the aristocracy — not exactly very conducive towards maintaining power.

On the other hand, an indirect tax would make perfect sense. It was easy to enforce and implement — rather than chasing down a few thousand consumers, all you had to do was to find the dozen tax-evading sellers behind the problem of tax evasion.

The fact that direct taxation has become more and more prevalent recently indicates to me that it is in fact a superior form of raising government revenue. Governments are notoriously immune to market forces, but they are as susceptible to incentives as the next firm, and increased revenue is about a good incentive as you can get for a bureaucracy to change.

That is not to say indirect taxes don't have their uses. If that were so, then they would no longer be in use. The fact is, indirect taxes are especially helpful for certain problems, such as dealing with negative externalities. (Pollution being one example.)

As for whether Malaysia will be able to effectively exploit indirect taxes, I am sure everyone familiar with its problems will be skeptical. Certainly, I am not convinced of the merits of the Value Added Tax (or did they decide to call it the Goods and Services Tax instead?) — it seems to be the wrong type of indirect tax to implement, anyway, unless they can't raise any revenue through normal forms of direct taxation.