This article explains indirect taxes, with examples, and how they differ from direct taxes.
What Is an Indirect Tax?
Indirect taxes are placed on goods and services, which raises the price so that the consumer ends up paying more for the item. One example of this is the gasoline taxes set by states. If you buy gasoline in Texas, for instance, you pay a motor fuel tax of 20 cents a gallon. The producer pays the tax to the state, and it is built into the price you pay for gas. Indirect taxes on products can be imposed at any point along the supply chain, from importing the product to the manufacturer to the retailer to the consumer. An example of this is the value added tax (VAT tax), common in Europe, in which each level of the supply chain adds a tax and all of these taxes are paid by the consumer.
Are Indirect Taxes Regressive Taxation?
Regressive taxes are those which impose greater taxes on lower-income individuals than higher-income individuals. For example, two families with different income might each spend $100 on clothing. However, the family with the lower income pays more taxes as a percentage of their income than the higher income family. Some indirect taxes are considered regressive, including excise taxes. Tobacco taxes are the most regressive because smoking (cigarettes) is higher among people with a low annual household income than those with higher annual household incomes.
How Direct Taxes Differ From Indirect Taxes
A direct tax is paid directly to the government; an indirect tax is passed on by the company or agency in charge to the customer. The best example of a direct tax is income taxes, both personal and business income taxes. The tax is paid directly on the income of the person or business to the IRS and to the state (if it has income taxes). Other direct taxes are:
Estate tax or wealth tax, paid based on the value of everything owned by the deceased at the time of death Capital gains taxes directly imposed on investors when they sell an investment for a gain
Indirect Tax Examples
Here are some examples of indirect taxes to help illustrate how they are different from direct taxes.
Import Duties or Tariffs
Import duties are a type of indirect tax because they are imposed on goods when they come into the country. The customer ultimately pays this tax as an increased price for the goods. Tariffs are imposed by countries on each others’ goods to give a price advantage to local goods, and they are usually managed through trade agreements between countries.
Excise Tax
Excise taxes are use taxes, which means you pay a tax for using or buying a product. But you don’t see the tax because it is paid by the producer or manufacturer and included in the price of the product. Excise taxes are sometimes called sin taxes because they are on products considered unnecessary or “sinful,” like tobacco, alcohol, or gambling. As mentioned above, gasoline taxes are excise taxes. Businesses also pay excise taxes on their use of specific products. For example, fuel taxes are excise taxes, as are taxes on environmental products such as domestic petroleum oil spills and ozone-depleting chemicals.
Value-Added Tax (VAT)
VAT taxes are common in Europe and other countries but aren’t used in the U.S. A VAT is a series of taxes imposed on the production of products all through the process, with the customer paying the final tax. A VAT is different from sales tax because the only one paying sales tax is the consumer.
Communications Service Tax
Communications service taxes are determined by each state and they include taxes on cable and satellite television services, phone services, and mobile communications. In some states, the charges are passed on to the customers.
Stamp Tax
Stamp taxes are excise taxes imposed by states on documents; the stamp in these cases is like a notary stamp, not a postage stamp. For example, stamp taxes are often required on public documents for the transfer of property, like a mortgage. The stamp tax may be included in the cost of the document, so it would be an indirect tax. Excise taxes are indirect taxes that businesses must pay if they sell products or have business activities that may be subject to these taxes. Complying with federal excise tax requirements means reporting your excise tax liability on IRS Form 720, the quarterly federal excise tax return, and making payments on the taxable amount.
When a product is imported into the countyWhen manufacturer sells to a retailerWhen the retailer sells the product to a consumer or businessWhen the product is used by the manufacturer or consumer
The retailer, manufacturer, or importer pays the tax and passes it along to the buyer.
