Question

What is the difference between direct tax and indirect tax? Explain the role of government budget influencing allocation of resources.

Answer 1

A direct tax is the one the final burden of which is borne by the person on whom it is imposed. Example: income tax.

An indirect tax is the one the final burden of which can be shifted to other persons. Example: sales tax.

One of the objectives of a government is to maintain the optimum allocation of resources. Inflationary gap or excess demand is corrected by reducing subsidies and increasing the taxes. Whereas, deflationary gap or deficient gap is corrected by increasing the subsidies and reducing the taxes.