What is an Indirect Tax?

Brenda Scott

The most recognizable form of taxation is a direct tax; something that is paid directly by an individual, such as income and property taxes. In contrast, an indirect tax is collected by an intermediary who then remits it to the appropriate agency. The amount of tax paid is added to the cost of the item and indirectly passed on to the consumer. In some cases, the consumer may not even be aware of the tax, but he still pays it through an increased cost of goods.

Gasoline is often subject to an excise tax, which is an indirect tax.
Gasoline is often subject to an excise tax, which is an indirect tax.

Perhaps the most obvious indirect tax is the retail sales tax. This is usually a percentage of the cost of an item which is added to the price at the time of sale. In the United States, sales tax is not charged until the product is finally sold to an end user; wholesale goods and merchandise purchased for resale are exempt. The retailer who sells the item collects the tax from the customer and remits it to the taxing authority. In the US, sales tax is levied by individual states and local municipalities.

Excise tax is levied on items such as cigarettes.
Excise tax is levied on items such as cigarettes.

The valued added tax (VAT), also known as the goods and services tax (GST), is another popular form of indirect tax. This was first used in France to replace the traditional sales tax, and quickly spread across Europe. Under the VAT system, tax is collected at every step of the production process and is based upon the amount of value added to the item at that point.

Excise tax is another indirect tax used across the globe. This is levied on specific items, such as gasoline, alcohol, cigarettes or gambling. In the United States, these are sometimes referred to as a sin tax; they are only assessed against items some people consider vices. These provide a lucrative form of revenue for governments.

A stamp duty is an indirect tax that is assessed against certain documents, such as a bill of lading, insurance policy or promissory note. In the UK, various stamp duties are charged when buying or transferring stocks or when purchasing real property over a certain value. In India, these are also required for most contracts.

In the United States, labor and service is not subject to taxation, but this is not the case in every country. India taxes all labor and service activities, including trading, manufacturing and importing. The tax is considered a cost of production, and affects the final price of the product. Though the consumer may be unaware of the actual taxes involved, he still pays them indirectly.

Many nations also charge tariffs or duties on goods being imported into their country. How these are assessed varies greatly, and is also influenced by international treaties or trade blocs. The average consumer is generally unaware of what tariffs have been assessed on the products he purchases. The cost has been rolled into the final retail price of the items, however, so he is the one who ultimately pays for this indirect tax.

Determining the economic benefits and impacts of taxation is a much more complex process than just considering those taxes which are apparent to the consumer. Government entities should evaluate whether the imposition of an indirect tax against a commodity or process will increase revenues without overly depressing the demand for that product. If the demand is decreased too dramatically, then the total revenue realized will go down because of the loss of sales. Companies must also consider the overall impact of indirect taxation as well when considering business development in a particular location.

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