Direct tax

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. It is also significant in the European Union, where direct taxation remains the sole responsibility of member states.

General meaning

In general, a direct tax is one imposed upon an individual person or property as distinct from a tax imposed upon a transaction. In this sense, indirect taxes such as a sales tax or a value added tax 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 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.
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.
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:
Justice William Paterson quotes Smith approvingly, noting that indirect taxes are “circuitous modes of reaching the revenue of individuals,” which implies that direct taxes are those which are not circuitous.
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:

Examples of direct taxes

Direct taxation can apply on income or on wealth. Here below a few examples of direct taxes existing in the United States :

Income tax: it is the most important direct tax in many developed countries. It is based on incomes of taxpayers. A certain amount of money is taken from the wage of the individuals. When this type of tax is applied to corporations and firms, it is called corporate income tax.
Transfer taxes: the most frequent form of transfer taxes is the estate tax. Such a tax is levied on the taxable portion of the property of a deceased individual. A gift tax is also another form of transfer taxes when a certain amount is collected from people who are transferring properties to another individual.
Entitlement tax or payroll taxes: this type of direct tax serves to finance social security and health services. The entitlement tax is collected through payroll deductions. Their importance increases with the rise of the development of the welfare state during the twentieth century.
Property tax: property tax is charged on properties such as land and buildings.
Capital gains tax: this tax is collected when an individual earns gains from the sale of capital, for example when an individual sells stocks, real estate, or a business. The tax is computed by determining the difference between the acquisition amount and the selling amount.
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, in particular when different tax rates are applied. Moreover, direct taxes can be evaded whereas indirect taxes cannot be evaded.
Direct taxes decrease the savings and earnings of individuals and firms. Indirect taxation however make goods and services more expensive. Contrary to indirect taxation which leads to inflation, 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.

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. So, direct taxes can be progressive, proportional or regressive according to their structure. It differs from indirect taxes which are generally regressive because everyone pays the same amount regardless of ability to pay.
Moreover, direct taxation are transfers which can have a redistributive preoccupation. Indeed, taxation is a main tool of the redistributive function of the government identified by Richard Musgrave in his The Theory of Public Finance. A progressive direct taxation could participate in the reduction of inequalities and correcting difference in living standards among the population.
Another effect of a progressive direct taxation is that such tax structure act as automatic stabilizers when prices are stable. Indeed, when incomes 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. This mechanism of progressive taxation participates to the stabilization of the economy, another function of the government in the works of Musgrave. When incomes fall, tax revenues fall too 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 by reason of ownership as well as capitations. Income taxes on income from personal services such as wages are indirect taxes in this sense. The United States Court of Appeals for the District of Columbia Circuit has stated: “Only three taxes are definitely known to be direct: a capitation , a tax upon real property, and a tax upon personal property.” 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, 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.’”
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. After the 1895 Pollock ruling that taxes on income from property should be treated as direct taxes, 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. 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. 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.
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. paragr. 50,166 ; Perkins v. Commissioner, 746 F.2d 1187, 84-2 U.S. Tax Cas. paragr. 9898 .

Direct taxation in India

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 of the Central Boards of Revenue Act, 1963 of India defines "direct tax" as follows: