Understanding the importance of taxation

In an ideal economy, the government often levies a certain fee on individuals and corporate residents. This practice is known as taxation. It has always been in existence since the beginning of civilisation, and it is considered the most trusted source of revenue for the government. However, not many people are familiar with the importance of taxes.

To the average individual, a tax is an involuntary levy that citizens of a nation have to pay to the government. Beyond being involuntary, taxes are not paid in exchange for anything. So, they really cannot be compared to public service. Although taxes are not the only way governments make money, they are generally famous because they are compulsory. In fact, in many countries, tax evasion—the deliberate failure to pay one's full tax liabilities—is punishable by law.

Classification of taxes

Depending on how the funds are remitted to the government, there are two major tax classes. They include direct and indirect taxes.

Direct tax

As the name suggests, this tax is paid directly to the government agency that is responsible for collecting it. The direct tax is dependent on an individual's ability to pay. The implication is that people who earn more money will have to pay higher taxes, although they might not be the biggest recipients of the positive effects of the tax.

Indirect Taxes

This type of tax is supply chain-related. It is not a tax that you can pay directly to the government. Rather, a body in the supply chain is responsible for getting it from the populace and paying the government. Many people are not aware that they pay such a tax as it is often embedded in the cost of goods and services. Examples include general and selective sales taxes, value-added taxes (VAT), taxes on any aspect of manufacturing or production, taxes on legal transactions, and customs or import duties.

Common types of taxes

There are several very common types of taxes. These are different avenues through which government in nations around the world generate revenue to foster economic development. These avenues are also designed to encourage individuals at different levels of the society to participate in it.

Income Tax

Income tax is a type of tax imposed by governments on income made by firms and persons operating within their jurisdiction. Taxpayers are required by law to file an income tax return each year in order to establish their tax obligations. Governments generate revenue from income taxes. They are used to pay for government obligations, fund public services, and provide commodities to residents.

Sales Tax

This is a tax that a nation's citizens must pay for selling some goods. It comes in various forms, such as an excise tax, a provincial sales tax, a goods and services tax, or a value-added tax.

Inheritance Tax

This is the type of tax that an individual must pay before inheriting the property of a deceased relative.

Property Tax

This tax is usually paid to the local government and depends on the property's value.

Capital Gains

This type of tax is imposed on a business or a group of people after they profit from the sale of real estate, bonds, stocks, and other assets.

Corporate Tax

This is one of the most well-known types of taxes; it is simply the tax imposed on a business's profits.

Why do we pay tax?

Interestingly, there are several reasons why the government imposes taxes on corporate residents. Citizens and corporate residents need to understand that taxes are the major source of income for the government. As you may know, the government is not a business organisation. As a result, tax funds help the government build and maintain essential public amenities like education and healthcare.

If people fail to pay their taxes, the economy will crumble as the tax collected is used to better the economy and all those who are living in it. Governments provide public services such as police services, roads and other amenities to the public. The government also pays the salaries of civil servants. All of these things are only possible because citizens pay taxes.

Also, there are continuous demands on the government to increase its expenditure as people want more goods and services from the government. These demands include free housing and free basic services such as electricity and water supply. The provision of these services to the needy is paid for through taxes raised by the more privileged citizens, leading to a large redistribution of income from the payers to the recipients.

Governments also place certain taxes, known as excise taxes, on certain products to slow down how people consume these products. Some of these products are tobacco and, in some economies, alcoholic beverages.

Key Take-aways

• A tax is an involuntary levy that citizens of a nation have to pay to the government.
• There are two major classes of tax: direct and indirect.
• The government imposes a tax on citizens for several reasons.
• If enough people fail to pay their taxes, the economy will crumble.
• Deliberately avoiding tax payment can be considered an offence punishable by law.

Final Words

In the past, taxes were essential for supporting the lifestyles of the ruling class, building defences, and raising armies. However, taxes are essential for funding government projects in the modern economy. Therefore, paying taxes is compulsory as deliberately avoiding tax payments can be considered an offence in most countries.

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