Indirect Tax: Definition, Meaning, and Common Examples (2024)

What Is an Indirect Tax?

An indirect tax is collectedby 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.

How an Indirect Tax Works

In contrast to direct taxes, indirect taxes are taxation on an individual or entity, which is ultimately paid for by another person. The body that collects the tax will then remit it to the government.With direct taxes, the person immediately paying the tax is the person that the government is seeking to tax.

Excise duties on fuel, liquor, and cigarettes are all considered examples of indirect taxes. By contrast, income tax is the clearest example of a direct tax, since the person earning the income is the one immediately paying the tax. Admission fees to a national park are another example of direct taxation.

Regressive Nature of an Indirect Tax

Indirect taxes are commonly used and imposed by the governmentto generate revenue. Theyare essentially fees that are levied equally upon taxpayers, no matter your income, so rich or poor, everyone has to pay them.

But many consider them to beregressive taxes asthey can bear a heavy burden on people with lower incomes who end up paying the same amount of tax asthose who make a higher income.

For example, the import duty on a television from Japan will be the same amount, no matter the income of the consumer purchasing the television. And because this levy has nothing to do with a person's income, that means someone who earns $25,000 a year will have to pay the same duty on the same television as someone who earns $150,000.

There are also concerns that indirect taxes can be used to further a particular government policy by taxing certain industries and not others.

Common Indirect Taxes

The most common example ofan indirect tax is import duties. The duty is paid by the importer of a good at the time it enters the country. If the importer goes on to resell the good to a consumer, the cost of the duty,in effect,is included in the price that the consumer pays. The consumer is likely to be unaware of this, but they will be indirectly paying the import duty.

Essentially, any taxes or fees imposed by the government at the manufacturing or production level is an indirect tax. In recent years, many countries have imposed fees on carbon emissions to manufacturers. These are indirect taxes since their costs are passed along to consumers.

Sales taxes can be direct or indirect. If they are imposed only on the final supply to a consumer, they are direct. If they are imposed as value-added taxes (VATs) along the production process, then they are indirect.

The Bottom Line

Indirect taxes are common taxes levied on goods on services paid for by the consumer. They're not charged to an individual or a company. No matter your income, you will pay the same indirect sales tax on a product that other consumers pay.