Indirect Tax: What Is It? – Significance, Usefulness, And Examples

An indirect tax is a tax that you do not pay directly to the government. The government imposes these taxes on manufacturers, and the latter shifts the burden of the tax to its consumers. Indirect taxes are not levied on individual payers but rather on goods and services. The manufacturers are responsible for collecting taxes from their consumers.

Some of the major examples of indirect taxes are Sales Tax, VAT, Excise Tax, Gross Receipt Tax, and more.

In this article, you will learn about what is an indirect tax and how an indirect tax works generally, especially in the United States. Apart from that, you will also get to know about the major types of indirect taxes that are commonly known. Hence, to learn more about indirect taxes, read on through to the end of the article.

What Is An Indirect Tax?

According to Investopedia,

“An indirect tax is collected by one entity in the supply chain, such as a manufacturer or retailer, and paid to the government; however, the tax is passed onto the consumer by the manufacturer or retailer as part of the purchase price of a good or service. The consumer is ultimately paying the tax by paying more for the product.”

To understand indirect taxes, you will have to understand what direct taxes are. The government levies indirect tax on any individual or entity, but the payer of the tax is someone else. The entity that collects the taxes ultimately remits them to the government. However, in the case of direct taxes, the person or entity on whom the tax is levied pays the tax directly to the government.

Some simple examples of indirect taxes include excise duties on cigarettes, liquor, fuel, etc. Consumption taxes, such as the value-added tax on products and services, are examples of indirect taxes.

On the other hand, an example of direct tax is the income tax that individuals, businesses, and other entities pay to the government. In the case of direct taxes, the person or entity that earns the income pays the tax. Another clear example of direct tax is the admission fee to a national park.

How Does An Indirect Tax Work?

According to the Tax Foundation,

“Indirect taxes are generally simple, both for the government to levy and collect since they are applied broadly and automatically included in purchases. This does not mean that these taxes are transparent. Gross receipts taxes lead to tax pyramiding, while sales taxes are clearly marked on invoices and receipts.”

This is the type of tax that the government levies on goods and services rather than an individual or an entity. It commonly uses and imposes this type of tax mostly to generate revenue. You can consider these taxes as fees that the authority levies equally on taxpayers, despite their income level or background. Hence, anyone, whether rich or poor, needs to pay indirect taxes that are levied.

Are Income Taxes Regressive In Nature?

Hence, many people consider indirect taxes to be regressive in nature. This is because regressive taxes bear a heavy burden on people, especially the ones that come from lower-income backgrounds. It just does not seem right when people with lower incomes pay the same amount of taxes as those with higher incomes.

For example, if you buy an imported EV car from China, the import duty shall be the same for all, no matter what the income of the purchaser of the car. Furthermore, since this levy is not based on the income of the person, it means that someone with a yearly income of $35,000 will have to pay the same import duty as someone with a yearly income of $250,000.

Apart from that, there are also other concerns associated with indirect taxes. The government also uses indirect tax to further a particular government policy. Here, they tax some industries and not all industries. Hence, many experts and analysts argue that inefficiencies in the marketplace occur due to the presence of indirect taxes. These also alter prices in the market away from its equilibrium ranges.

Tax Foundation also adds here –

“Indirect taxes, like value-added taxes (VAT) and retail sales taxes, can be neutral because they have little effect on consumer behavior and apply to all business models the same. Indirect taxes like excise taxes are not neutral because they target specific industries and activities, like cigarettes and alcohol.”

Major Types Of Indirect Taxes That Are Common

The most common income tax that you come across is import duties. The importer of the good pays the tax at the time the good enters the country. If the importer of the good goes on to resell the item to a new customer, the latter has to pay the full price of the good, including its original price, the seller’s profits, plus the import taxes.

In many cases, the consumer is unaware of this. However, they will be the ones who will, in the end, pay the import duty for the product.

Essentially, if the government imposes a tax at the manufacturing or production level, it becomes an indirect tax. In the last few years, many countries have imposed carbon emission fees for manufacturers. However, these are indirect taxes since the consumers pay for them in the end.

Some sales taxes also fall under indirect taxes. If these taxes are imposed as value-added taxes along with the production process, these fall under indirect tax. However, if the government imposes a tax on the final supply to a consumer, it falls under direct taxes.

Summing Up

Hope this article was helpful for you in getting a better idea of what indirect taxes are. When the government requires a fee to be paid by individuals and entities, it levies taxation on them. In the case of an indirect tax, the government or authority levies taxes on an individual or entity, but the payer is someone else.

Some of the major examples of indirect taxes include excise tax, sales tax, consumption tax, etc. Do you have more information to add about how indirect taxes work in the United States? Share your information with us in the comments section below.

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