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What are Direct Taxes? – Understanding the main Impact Direct Taxes have on Investing & Household Income

People have been paying and complaining about Direct taxes for a long time. Based on historic records, some people have been running away from paying taxes for years.

Foremost, let us understand what taxes are. Taxes are compulsory financial charge or levies imposed by governments on individuals or entities, primarily to raise revenue for government expenditures.

In spite of that, they also serve other purposes as well. For example, the government can use taxes to change behavior of its citizens by imposing sin taxes.

In economic terms, taxation transfers wealth from households or businesses entities to the government.

This has influence; It can either increase or reduce economic growth and economic welfare as a whole.

Taxes can be characterized as regressive, progressive, or proportional taxes.

When economists talk about taxes, they sometimes divide them into direct taxes and indirect taxes.


Understanding Direct Taxes.

Direct taxes are paid directly by the individual or business to the government. The burden of the tax cannot be passed on to someone else.

Such direct taxes are calculated based on the ability of the individual or corporation to pay, which means that the higher their capability of paying is, the higher their taxes are.

This makes it difficult to find ways to legally avoid or illegally evade tax obligations. Brutally, the tax liability is yours to pay.

In most cases, direct taxes are taxes on incomes, including corporate profits and wealth.

This economic principle states that those who have more resources or earn a higher income should pay more taxes.

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The power of direct taxation applies to every individual however oppressive. The people have the alternative either to pay the tax, or let their property be taken by the authority.


Examples of Direct Taxes.

Common examples of direct tax are: income tax or corporate tax that are impose on business profits, capital gain tax which is a tax imposed on profit when you sell or dispose something that is an asset.

Also, inheritance tax which is paid when a person’s estate is worth more than a threshold level when they die.

Every time you get paid by your employer, you have to pay taxes which is levied by the government through respective authorities.

This kind of direct tax is called income tax.  It is normally calculated as a small percentage of your gross pay.

Income tax is filed annually, although deductions from one’s salary can be done on a monthly basis.

The same applies to corporate tax and capital gain, where the percentage of the profit is paid to the government as tax.

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Impact of Direct Tax on Household Income.

Household incomes are generated from various sources: wages, salaries and other non-labour income like an investment activity.

In this sense, the tax impact on household income can be of importance for personal opportunities in terms of consumption, savings and investments.

 Consequently, for the economic activity in the country given the fact that the household sector is the largest net saver in the national economy.

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The tax impact on households is manifested in two ways: directly, when the object of taxation is the personal income in its various dimensions, or indirectly, when the object of taxation is the individual elements of personal wealth


Impact of Direct Tax on Investing. 

Most investors overlook taxes when making plans for their investment, even though they know they have to pay taxes.

Tax rules are complex. Before you make any investment, you need to think about the tax on any return you make.

Taxes erode returns, at the same time reduce portfolio growth. Managing investments for tax efficiency is an important aspect for an investor.

There are generally 2 types of taxes; short term capital Gains and long-term capital gain.

Short-term capital gains are taxed at marginal tax rate. So, an investor may end up paying whatever rate the tax bracket is.

Long-term capital gains which apply to investments held for more than a year, often come at a lower rate.

Being tax efficient with investments allows more money to be reinvested back into a portfolio, this enables the portfolio to grow over time.

When you have less money to invest, definitely, you will not earn high returns because taxes reduce your investable income.

If you really want to save on taxes, try and invest in investments that you can hold for a long period rather than things that you are looking to buy and sell over the course of a year or two.

It’s very important as an investor to know the broad details of taxation on investment income, you have to know which sources of income are more favorable or less favorable than other.

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Key takeaway

The ability to charge taxes by the government is a way to redistribute the wealth of a nation. A failure to pay tax along with evasion of or resistance to taxation, is punishable by law.

Without the right tax planning, the real returns on investment for investors could be badly affected than they originally planned.

High marginal tax rates can discourage saving or investment, while specific tax preferences can affect the allocation of economic resources.

On the other hand, Lower marginal tax rates on the returns to assets (such as interest, dividends, and capital gains) can encourage saving.

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