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Direct & Indirect Taxes
Let's break down the two main types of taxes: direct and indirect taxes.
Direct tax: This is a tax that is paid directly by a person or business to the government from incomes or profits.
- Income Tax and Corporation Tax are common examples.
- Did you know that Scotland and the UK have Income Tax systems where higher earners contribute a greater proportion of their earnings in taxes than lower earners? This is called progressive taxation.
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An indirect tax is applied to a good or service at the point of sale.
- One example is Value Added Tax (VAT).
- Individuals do not pay indirect taxes directly to the government. Instead, the tax is included in the price that consumers pay for a good or service. The seller of the good or service deducts the VAT from the transaction and pays the tax to the government.
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Do indirect taxes contribute to income inequality?
Yes, they do. In the financial year ending 2022, indirect taxes increased income inequality by 3.5 percentage points (ONS).
- This is because indirect taxes tend to be more regressive than direct taxes. This means that the rate of indirect taxes are the same for everyone irrespective of income, which can be a problem because poorer people spend a greater proportion of their income on indirect taxes than richer people.
The Office for National Statistics divided the population into 5 equal groups - called 'quintiles' - to compare the impact the impact of indirect taxes on disposable income. In this graph it is important to remember that the poorest quintile refers to the poorest 20% of the population, and the richest quintile refers to the richest 20%. You can download the dataset used for this graph below:
ONS Indirect Taxation.xls26.5KB