What Is an Indirect Tax?

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DEFINITION
An indirect tax is a tax ultimately paid by a different taxpayer than the one who collects and remits the tax to the government.

An indirect tax is a tax ultimately paid by a different taxpayer than the one who collects and remits the tax to the government. They are taxes that are not paid to the government directly. For example, you pay indirect taxes when you buy goods or services because the retailers initially collect them, not the government.

Learn what an indirect tax is, how it works, and other examples of when you may pay an indirect tax.

Definition and Example of Indirect Tax

An indirect tax is a tax whose payment can be shifted to another party from the party legally responsible for remitting the tax to the government.

In states that have a sales tax, consumers pay indirect taxes to retailers, which are responsible for collecting sales taxes and remitting them to the state government. Retailers generally charge higher prices to customers, then collect sales taxes from them at the point of sale.

So, sales tax as collected by the states that impose them is an example of an indirect tax because retailers — though they are the party legally responsible to remit the sales tax to the state — shift the actual payment of the sales tax to their customers.

For example, retailers in California are required to report and pay sales tax to the California Department of Tax and Fee Administration (CDTFA). They may seek reimbursement for those taxes from their customers by charging more at the point of sale. For example, if they are required to pay $1.75 in sales tax on a sale, they can pass that cost onto the buyer, informing them that tax is included.

How Indirect Taxes Work

In general, the jurisdiction imposing an indirect tax has a tax code governing the collection and remittance of the tax.

This tax code may have rules pertaining to:

  • Who is subject to the indirect tax
  • What is subject to the indirect tax
  • How one may pay the indirect tax
  • How one may file a return for the indirect tax

Often, indirect taxes are built into the price charged to consumers.  This means that when a new indirect tax is imposed, consumer prices of the affected goods and services generally increase as a result.

Do I Need To Pay Indirect Taxes?

Whether you need to pay indirect taxes depends on whether the jurisdiction where you live imposes indirect taxes on the activities you pursue, the goods and services you purchase, or the property you own.

How Much Are Indirect Taxes?

The amount of an indirect tax depends on the kind of tax and the jurisdiction imposing it.

Sales taxes in the United States, for example, are typically a combination of a state-determined sales tax rate and a locality-determined sales tax rate, so you will likely pay a different sales tax rate in one state, county, or even city than you would in another state, county, or city.

Types of Indirect Taxes

There are a variety of indirect taxes that can be imposed. In the chart below, we describe some of the common types of indirect taxes.

Indirect Tax Type How It Works
Sales Tax A tax paid on the percentage of the selling price of all or most goods or services
Excise Tax A tax paid on the sale of certain, specific goods or services
Value-Added Tax (VAT) A tax collected at every stage of the production and marketing processes of goods and services 
Tariff A tax levied on imported goods

Indirect Tax vs. Direct Tax

While an indirect tax is ultimately paid and remitted by different taxpayers, a direct tax is remitted to the government by the same taxpayer who is responsible for paying it to the government. A direct tax cannot be shifted to others.

Income tax is an example of a direct tax because the same taxpayer earning the income who is liable for the tax is the same party that pays the taxes.

Criticism of Indirect Taxes

A common criticism of indirect taxes is that they are generally expected to be regressive, meaning that the tax takes a larger percentage of low-income taxpayers’ means than high-income taxpayers’ means.

Essentially, with regressive taxes, taxpayers with higher incomes carry a smaller share of the burden relative to their incomes.

For example, let’s say that a low-income household of four people with a combined household income of $30,000 per year buys five gallons of milk per month. The next street over, there is a high-income household of four people with a combined household income of $300,000 per year, and they also purchase five gallons of milk per month.

Since both families pay the same sales tax rate in their city, both the low-income family and the high-income family pay the same amount of sales tax on their milk. But, as a percentage of income, a greater share of the low-income family’s income goes toward milk sales taxes than the percentage of the high-income family’s income.

Key Takeaways

  • An indirect tax is a tax that, while legally imposed on one party, is actually ultimately borne by another party.
  • Examples of indirect taxes include sales tax, excise tax, value-added tax, and tariffs.
  • Governments have tax codes that dictate who and what is subject to the indirect tax as well as how one may pay the indirect tax.
  • Indirect taxes can be regressive, depending on the particular indirect tax, meaning that lower-income taxpayers pay a higher percentage of their income toward indirect taxes than higher-income taxpayers.

Article Sources

  1. IRS. “Lesson 4: Direct and Indirect Taxes.” Accessed Feb. 7, 2022.

  2. California Department of Tax and Fee Administration. “Applying Tax to Your Sales and Purchases.” Accessed Feb. 7, 2022.

  3. Princeton University. “Do Indirect Taxes Promote Accountability? Testing The Effects of Revenue Modality on Citizen Behavior.” Accessed Feb. 7, 2022.

  4. Tax Foundation. “State and Local Sales Tax Rates, 2021.” Accessed Feb. 7, 2022. 

  5. U.S. Bureau of Labor Statistics. “The Effects of Tariff Rates on the US Economy.” Accessed Feb. 7, 2022.

  6. IRS. “An Overview of Excise Tax.” Accessed Feb. 7, 2022. 

  7. New York State Department of Taxation and Finance. “Sales and Use Tax.” Accessed Feb. 7, 2022. 

  8. Deloitte. “Indirect Tax Services.” Accessed Feb. 7, 2022.