Direct and Indirect Taxes

Look at the deposit in your bank account on payday. It's a bit smaller than the amount you were promised. That's because income tax went to the government first, and you got what was left. A tax where the person legally required to pay it (the taxpayer) and the person who actually bears the cost with their own money (the one who carries the burden) are the same is called a direct tax. The bill arrives with your own name printed right on it.

Now think about buying a chocolate bar for 1,100 won (about $0.80) at a convenience store. You don't feel like you're paying any tax. You just pay for a sweet snack. But look closely at the receipt, and there's 100 won of value-added tax (VAT) hiding in it. VAT is 10% of the pre-tax price of 1,000 won, so one-eleventh of the price on the tag is tax. The chocolate factory or the store owner sends the tax to the government later, but that money is already something you paid as part of the price.

A tax where the person who sends it to the tax office and the person who really pays it with their own money are different people is called an indirect tax. Every time you buy bread or see a movie, you're paying indirect taxes without realizing it.

Typical direct taxes include income tax, which is charged on the money a person earns by working, and corporate tax, which is charged on a company's profits. Korea's comprehensive real estate holding tax and property tax, which are billed to people who own a lot of real estate like houses and land, are direct taxes too.

The best thing about direct taxes is that they can be fitted to each person's situation. People who earn a lot can be charged a high rate, while people who are struggling can be charged a low rate or get their tax reduced. A system where the tax rate goes up as income goes up is called progressive taxation.

Thanks to this, direct taxes use money from wealthier people to fund social welfare and do a great job of narrowing the gap between rich and poor. But there's a catch. You can see real money leaving the income you worked hard to earn, so the gut-level pushback people feel, called 'tax resistance,' tends to be relatively strong.

The biggest advantage of indirect taxes is that they're very easy to collect. When you buy bread or clothes, the tax is automatically added to the price. People hand money to the government without even noticing they're paying tax. That means less tax resistance, and the government can reliably raise the money it needs to run the country.

But indirect taxes have a hidden downside. A billionaire and a student with an empty pocket who each buy a 1,100-won bottle of water at the grocery store pay the exact same 100 won in tax. To a rich person, 100 won is a speck of dust. To someone worried about their next meal, it weighs much more.

When you calculate the tax burden as a share of income, and poorer people end up carrying the heavier load, that's called regressivity. To head off this kind of unfairness, the government carefully balances the two kinds of taxes. For example, it exempts basic daily necessities like unprocessed food from VAT.