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M
odern economics defines tax as a mode of income redistribution.1 There might be other ways also to look at it—the usual meaning of tax people think is that a tax is imposed by the government to fulfil its important
obligations on the expenditure front.2 We may take an example to see how taxes redistribute income:
Suppose an economy has a flat rate of income tax 30 per cent. Just see the impact of this tax on the income disparity of two people A and B earning Rs. 50,000 and Rs. 80,000, respectively.
Indivi- dual | Nominal Income | Income Disparity before Tax | Income after Paying Tax | Income Disparity after Tax |
A | Rs. 50,000 | Rs. 30,000 | Rs. 35,000 | Rs. 21,000 |
B | Rs. 80,000 | Rs. 56,000 |
We see here through the above-given Table as how the income disparity between two individuals A and B decreases from Rs. 30,000 to Rs. 21,000 after paying taxes—this is the first level when incomes of these individuals have got re-distributed.
Now the money the government has got by tax collection, i.e., Rs. 39,000 (Rs. 15,000 + Rs. 24,000) will be spent on different sectors—infrastructure, education, health etc.—which will provide services to each and everybody alike. Here income is re-distributed at the secondary level. Consider a person who pays income tax, but does not take services of government schools for his children’s education, nor goes to the government hospitals for medical services and compare him with a person who has no option other than the government schools and the hospitals—the higher tax payer getting no government services and a lower tax payer getting all the services. Here income looks re-distributed from the consumption side.
The point where tax looks as being imposed is known as the incidence of tax
—the event of tax imposition.3
The point where tax makes its effect felt is known as the impact of tax—the after effect of tax imposition.4
The tax which has incidence and impact both at the same point is the direct tax—the person who is hit, the same person bleeds.5 As for example income tax, interest tax, etc.
The tax which has incidence and impact at the different points is the indirect tax—the person who is hit does not bleed6 someone else’s blood. As, for example, excise, sales tax, etc., are imposed on either the producers or the traders, but it is the general consumers who bear the burden of tax.