What Is an Indirect Tax?
An indirect tax is collected by entities like manufacturers or retailers in the supply chain and then paid to the government. This tax is passed on to consumers as part of the purchase price of goods or services, meaning consumers ultimately bear the tax burden by paying more for the products.
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How an Indirect Tax Works
Indirect taxes, unlike direct taxes, are imposed on individuals or entities but are paid by someone else. The entity collecting the tax will remit it to the government. Examples of indirect taxes include excise duties on fuel, liquor, and cigarettes. In contrast, income tax represents a direct tax, as the individual earning the income directly pays the tax. Admission fees to national parks are another example of direct taxation.
Some indirect taxes, such as value-added tax (VAT), are also referred to as consumption taxes.
Regressive Nature of an Indirect Tax
Indirect taxes are commonly used by governments to generate revenue. These taxes are levied equally on taxpayers regardless of their income, making them regressive. This can disproportionately affect individuals with lower incomes who end up paying the same amount of tax as those with higher incomes.
Indirect taxes, like import duties on goods, impose a uniform burden on consumers regardless of their income levels.
Common Indirect Taxes
Import duties are a prevalent example of indirect taxes where the importer pays the duty at the point of entry, and this cost is typically passed on to the consumer through higher prices. Other examples include taxes imposed at the manufacturing level, such as carbon emission fees.
Sales taxes can be direct or indirect, depending on whether they are levied on the final consumer or incorporated into the production process as value-added taxes (VATs).
What Are Indirect Taxes in the U.S.?
In the U.S., common indirect taxes include sales taxes paid to businesses, which are then remitted to the government, and import taxes imposed on goods entering the country. The U.S. does not have a national sales tax system in place.
How Do Businesses Offset the Cost of Taxes?
Businesses may increase the prices of goods to account for taxes paid, such as sales taxes, in an effort to recover their tax expenditures.
What Are Value-Added Taxes (VATs)?
Value-Added Taxes (VATs) are taxes added at various production stages, with the ability to deduct the cost in subsequent stages of production. When the consumer purchases the product, the VAT is not deducted, resulting in the consumer bearing the tax burden.
The Bottom Line
Indirect taxes are levied on goods and services, and consumers bear the tax burden. These taxes are not directly charged to individuals or companies, leading to a uniform tax rate irrespective of income levels.