Edited by Emilio Albi and Jorge Martinez-Vazquez
Chapter 2: Direct versus Indirect Taxation: Trends, Theory, and Economic Significance
* Jorge Martinez-Vazquez, Violeta Vulovic, and Yongzheng Liu 1 INTRODUCTION AND SOME DEFINITIONS One of the oldest questions in the theory and practice of taxation is that of the appropriate mix of direct and indirect taxes. The choice between direct and indirect taxes has contributed to a long animated debate, in political and academic circles, regarding the virtues and defects of those two forms of taxation. In this chapter we provide an overview of the evolution of the ratio of direct taxes to indirect taxes across countries over the past three decades, the theorizing that has gone behind the alleged superiority of one form of taxation or the other, the determinants that appear to be behind the intensity with which both forms of taxation are used, and the economic relevance of the choice of tax structure in terms of economic growth, macroeconomic stability, the distribution of income, and the flow of foreign direct investment (FDI). To get started it is helpful to have a working definition of direct and indirect taxes. Following Atkinson (1977) we will define as direct taxes those that may be adjusted to the individual characteristics of the taxpayer and as indirect taxes those that are levied on transactions irrespective of the circumstances of buyer or seller. Thus, conventional income taxes can be classified as direct taxes and the same can said for most taxes on assets and wealth as long as there are potential adjustments for the characteristics of owners. For example, property taxes on owner-occupied housing...
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