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What is an indirect tax?
An indirect tax is a tax that is imposed on a transaction. Contrast this with a direct tax, which is a tax imposed directly on a property, an entity, or a person. Indirect taxes are typically added to the prices of goods or services. Sales tax, value-added tax, excise tax, and customs duties are examples of indirect taxes.
Direct taxes are levied on individuals or organizations. Indirect taxes are placed on goods and services such as imports, fuel, liquor, and cigarettes. Taxes like this are considered indirect because they are paid indirectly by the final consumer who enjoys the use of the goods or services, and are collected by an intermediary, like a retailer or a manufacturer.
Customs duties are a form of indirect taxes applied to imported and exported goods. Importers and exporters can pass on the cost of the tax by embedding it in the price of the goods when they resell them. Excise taxes are placed on raw materials and paid for by manufacturers who consume the materials, and those taxes are embedded in the cost of the manufactured goods.
One of the sharpest criticisms of indirect taxes is that they are not equitable. The cost of an indirect tax remains the same regardless of how rich or poor the payer is; both pay the same rate, but the tax consumes proportionally more of the poor person’s income. In addition, indirect taxes are commonly “hidden” in the price that consumers are paying for that good or service.
Indirect tax example
Gasoline taxes are indirect taxes that are embedded in the price per gallon. Consumers are almost never aware that they all pay customs taxes when they buy imported goods; customs taxes are placed on goods and paid when the goods are exported or imported, and the cost of these taxes is passed along to the final consumer.
Nearly all consumer goods carry sales taxes, although unlike gas or customs taxes, sales taxes are usually itemized on bills. Services frequently incur sales taxes: if a plumber fixes your sink, the parts used to make the repair carry a sales tax that is passed on to you. Often people are taxed on both the whole bill and parts.