This week we got the first glimpse of what the 2014 Budget may look like. We had the announcement that the Government shall be shifting emphasis to indirect taxation rather than direct taxation, when raising additional revenue.

The need to raise additional revenue is evident for a number of reasons – the Government’s stated intention not to reduce expenditure on social initiatives, the need to narrow the fiscal deficit with the objective of having a balanced budget in a couple of years and the need to implement some of the initiatives that form part of the political programme of this government.

I must say that I believe that the Government’s decision to shift emphasis to indirect taxation should lead to some serious debate on fiscal policy, which should keep us away from the silly issues that debates on the Budget usually bring up. I would also like to state at the outset that I favour indirect taxation rather than direct taxation as it gives the individual more freedom on how to use his money.

Direct taxation has its own uses but should be levied for those specific uses and should not be used to cross-subsidise certain forms of consumption.

In the case of direct taxation, the state levies the tax on the income and the individual cannot in any way reduce the tax burden unless he earns less money. On the other hand, indirect taxation is very often a tax on consumption (of goods and services). Thus, if an individual wishes to reduce one’s tax burden, that person may always opt not to consume that good or service or buy a lower cost brand.

In the case of indirect taxation, the individual may directly influence the amount he pays in tax through his own decisions.

What else do economists say about direct and indirect taxation? Both yield a high amount of revenue compared to the cost of collection. This is because very often the tax is collected at the source where the income is generated by the supplier providing the good or service.

Direct taxation is seen to be more socially just because it is progressive in nature – that is, the more one earns, the higher the percentage one pays in tax. Moreover, direct taxes are constructed in such a manner that they take account of firms and people’s ability to pay tax, as tax allowances are used to take account of specific responsibilities.

On the other hand, direct taxation may cause people to work less, may absorb from companies resources that would otherwise be available for investment, and may lead to higher levels of tax evasion.

Indirect taxes have their disadvantages too. They are often regressive in nature, meaning they fall more heavily on people with lower incomes. They tend to boost inflation as they add to the prices of goods and services.

There may also be uncertainty as to how much revenue they will actually generate because individuals and companies do have the possibility to reduce the tax burden through their decisions. To complete the loop, it is worth mentioning that among the advantages of indirect taxes there is the fact that the tax base is wider, as they are paid by young and old, men and women, high-income earners and low-income earners alike.

One important advantage of indirect taxes is that they can be used for specific aims. For example, cigarettes are heavily taxed to reduce their consumption or a levy is imposed on a particular product or service to have an impact only on those people consuming it.

In the long run, what one needs to consider is the percentage of our gross domestic product that is absorbed by taxation in whatever form and shape, and how that is evolving over time. There is no magic number against which one can benchmark.

However, it is accepted that while taxation is required for the Government to deliver its services and to achieve an element of equity in our society, taxation also makes an economy less efficient. We therefore need to find the balance between direct and indirect taxes and between equity and efficiency, just as other countries have done.