Sources of Taxes; Direct and Indirect Taxes

1Why this matters

When the price of a crate of soda goes up, when a new employee finds less money in her pay than she expected, or when a shopkeeper pays the district before opening in January, a tax is at work. Knowing what is taxed, who collects it and who finally carries the cost helps you set prices, read a payslip and plan a business.

2Sources of tax revenue

Governments tax four broad things: what people earn, what they spend, what they own, and what crosses the border. Business activity is also taxed. In Rwanda, RRA collects the central government's taxes and also collects the decentralised taxes that belong to the districts and the City of Kigali.

Governments also receive non-tax revenue, such as fees for services, fines, and grants or loans from partners. These are not taxes.

3Direct taxes

A direct tax is paid by the same person or business on whom the law places it; the burden cannot easily be passed on to someone else. Examples: PAYE, corporate income tax, rental income tax, immovable property tax and trading licence tax.

• Advantages: it can be linked to ability to pay (a higher income pays more); the amount is fairly certain and predictable; the taxpayer knows exactly what they pay.
• Disadvantages: if rates are high it can discourage work and investment; because it is felt directly it may tempt people to evade; it needs good records and can be costly to administer.

4Indirect taxes

An indirect tax is placed on goods and services. The seller or importer pays it to RRA, but the burden passes to the final buyer through a higher price. Examples: VAT, excise duty and customs duties.

• Advantages: hard to evade because it is collected at the point of sale or at the border; everyone who buys contributes; paid in small amounts, so it feels convenient; it can discourage harmful goods.
• Disadvantages: it raises prices; it takes a larger share of a poor family's income than a rich family's, because poorer families spend almost all of what they earn; the buyer often does not notice how much tax is paid.

5Progressive, proportional and regressive taxes

• Progressive: the rate rises as income rises. PAYE is progressive (0%, 10%, 20%, 30% on successive bands of monthly salary).
• Proportional: the same rate at every level. VAT at 18% and corporate income tax at 28% are proportional to the value taxed.
• Regressive: takes a larger share of a small income than of a large one. A fixed amount charged to everyone in a group is regressive within that group.

Worked example: a fixed tax and who bears it

This case is written by Ganzaa. The trading licence figures are from RRA's published table (2023); check the current table before using them in a real business.

RRA's table places annual turnover between 12,000,000 and 20,000,000 Frw in one band, which pays 160,000 Frw a year. Two hardware shops in Huye fall in this band: shop A with turnover 12,500,000 Frw and shop B with 19,500,000 Frw.

1. Direct or indirect? The shop owner pays it on her own business activity and cannot add it to a single sale as a separate tax, so it is a direct tax.
2. Share of turnover, shop A: 160,000 ÷ 12,500,000 × 100 = 1.28%.
3. Share of turnover, shop B: 160,000 ÷ 19,500,000 × 100 ≈ 0.82%.
4. Conclusion: the smaller shop pays a larger share of its turnover, so within the band this fixed amount is regressive.

Practice