Indirect Tax: Definition, Types & Examples

KEY TAKEAWAYS

• A tax on products and services rather than on income or profits is an income tax.
• Consumption taxes are another name for some indirect taxes.
• The excise tax on alcohol and cigarettes is the most typical example of an indirect tax. VATs (Value Added Taxes) are another type of indirect tax.
• The government frequently uses and imposes indirect taxes in order to raise money.

What Is an Indirect Tax?

An indirect tax is paid to the government by one party in the supply chain. This is often a producer or retailer. It is then transferred to the customer as part of the cost of a good or service. The final recipient of the tax is the consumer, who pays extra for the goods.

By comparing indirect taxes to direct taxes, one may define indirect taxes. Taxation on a person or an entity that is ultimately covered by another person is known as an indirect tax. The tax will subsequently be sent to the government by the organization that collects it. However, in the case of direct taxes, the target of taxation is the party that pays the tax right away.

Cigarettes, alcohol, and fuel excise taxes are all instances of indirect taxes.

Contrarily, income tax is the best illustration of a direct tax because it is paid directly by the individual who receives the income. Another blatant instance of direct taxation is the payment of entrance fees to a national park.

Types of Indirect Taxes

There are four main types of indirect taxes. They are as follows:

1. Sales Tax

People are already on the verge of paying indirect taxes whenever they purchase at malls or department stores. Such taxes apply to products such as clothing, home goods, and other essentials. The sales tax that the shop collects and disburses to the government is added to the total sale price after payment at the counter.

2. Customs Tax

The cost of imported goods is frequently high. The reason for this is customs tax. An importer must pay a customs charge when a container from another nation enters the US. Consumers then pay for this expenditure.

3. Excise Tax 

Excise tax is another often used tax. Indirect taxes are already due when a producer purchases the raw materials for the company’s goods, such as tobacco for cigarette makers. The manufacturer can shift the cost to the customers through a routine aspect of the business by charging more for the smokes.

4. Gas Tax

Buying gas for a vehicle has an additional indirect tax cost attached to it. 

Indirect Tax Advantages

1. They Are Subtle

As they are included in an item’s retail price, indirect taxes are not always apparent. Simply because the tax is levied in small amounts, people don’t feel like they are paying taxes. 

Add to that the fact that they are only visible on the transaction receipt and are not mentioned on the price tag. They can also be avoided by not purchasing the products.

2. Easy Collection

Indirect taxes are paid at the time a customer purchases a product, unlike direct taxes, which require the completion of paperwork and filing. The provider is responsible for collecting the tax and paying the government.

3. Prevents the Use of Harmful Substances and Items

Alcohol and cigarettes, two harmful substances, are substantially taxed. By taxing these goods, consumers are deterred from buying them due to their high cost, preventing them from consuming hazardous substances.

Indirect Tax Disadvantages

1. Indirect Taxes Have a Regressive Tendency

People with low incomes typically see a bigger percentage of their income taken away by indirect taxes.

2. Can Lead to Tax Evasion

Taxes on dangerous goods may promote the sale of illicit goods like alcohol and cigarettes.

Indirect Tax Examples

Import duties are the most typical example of an indirect tax. When a good enters the country, the importer is responsible for paying the duty. The cost of the duty is essentially disguised in the price that the customer pays if the importer decides to resale the product to a consumer. Although the consumer is most likely ignorant of this, they are nonetheless indirectly responsible for paying the import duty.

In essence, an indirect tax is any tax or levy levied by the government at the level of production or industry.

Many nations have recently started charging manufacturers for carbon emissions. Since the expenses of these taxes are passed on to consumers, they are indirect taxes.

Summary

Taxes that can be transferred to another company or person are known as indirect taxes. They are typically levied against a producer or supplier, who subsequently passes the tax on to the buyer.

Cigarettes, alcohol, and fuel excise taxes are all instances of indirect taxes.