Classification of taxes

Business studies study module

Taxes are classified according to;

  1. Structure of the tax
  2. Impact of the tax on the tax payer.

According to the structure

In this case, taxes are classified according to the relationship between the amount paid on tax and the income of the tax payer. These are:

  1. Progressive tax
  2. Regressive tax
  • Proportional tax

Progressive tax

This is a type of tax where the rate/amount paid increases proportionately with increase in income.e.g tax may be as follows

Income                               Rate

0-5000                                    20%

5001-10000                            25%

10001-15000                          30%    e.t.c

-In progressive tax, those with higher income rates remit a higher proportion of their income as tax compared to those in lower income brackets.

This type of tax is based on the belief that one only needs a certain amount in order to have a decent standard of living.

Advantages of progressive tax

  • It reduces income inequality as the rich are taxed more
  • It encourages people to work harder/more in order to maintain their standard of living
  • The revenue collected is higher
  • The unit cost of collecting tax reduces as the tax increases.

Disadvantages of progressive tax

  • It is oppressive-some people are taxed more than the others and punishes people for their hard work.
  • It may discourage people from working more as any additional income goes tax
  • Investors may be discouraged from venturing into risky but more profitable businesses as these would attract more tax
  • It assumes that people earning the same amount of money/income have similar needs and ability to pay tax-which in reality may not be true.
  • It can lead to tax evasion taxpayers falsifying their level of income.

Regressive tax

This is a type of tax that takes a higher proportion of low income earners as compared to high income earners. The fax burden falls more heavily on the poor (opposite of progressive)

Example: sales tax where people pay the same amount irrespective of the level of income.

The assumption is based on the understanding that the one who deems it necessary to buy a certain products considers the utility derived from it to be equal to its price, which includes tax.

  1. Proportional Tax

This is a type of tax where the rate of tax remains the same irrespective of the level of income or value of property to be taxed e.g. if the rate is 20% then a person who earns ksh.5000 will pay 20/100 x5000=ksh.1000

Ksh.10, 000 will pay 20/100×10,000=ksh.2000 e.t.c

Example: corporation tax where companies are expected to pay a fixed proportion of their profits as tax.

  1. Digressive tax

This is a type of tax where the tax rate increases up to a given maximum after which a uniform tax rate is levied for any further income.

Classification according to impact on the tax-payee

Based on the impact, the tax has on the tax payer; tax may be classified as either:

  1. Direct tax
  2. Indirect tax

Direct tax

These are taxes where the impact and the incidence of the tax are on the same person. It is not possible to shift/pass any part of the tax burden to anybody else.

This type of tax is based on incomes, profits and property of individuals as well as companies.

They include:

Personal income tax

This is a tax that is imposed on incomes of individuals and is usually progressive in nature.

Example pay-As You-Earn (PAYE) for salaries.

In most cases it is paid through check-off system where the employer deducts it from the employee’s salary and remits it to the tax authorities.

Corporation tax

This is tax levied on profits of companies. It is usually proportional in nature.

  • Stamps duty

This is tax paid in areas such as conveyance of land or securities from one person to another.

Estate (death) duty

This type of tax is imposed on property transferred after the owners’ death. The tax helps in raising government revenue and also in redistributing income since the inheritor has not worked for it.

Wealth tax

This is tax levied on personal wealth beyond a certain limit.

Capital gains tax

This is tax levied on gains realized when a fixed asset is sold at a price higher than the book value.

  • Capital transfer (gifts) Tax

This is tax imposed on the value of property transferred from one person to another as a gift. The tax is designed to seal loopholes wherea wealthy person may try to avoid tax transferring his/her property to a friend or a relative as a gift.

This type of tax is progressive in nature. It however does not affect transfers between spouses or to charitable organizations.

 



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