Indirect Tax: Definition, Meaning, and Common Examples

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Updated May 31, 2024 Reviewed by Reviewed by Lea D. Uradu

Lea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.

What Is an Indirect Tax?

An indirect tax is collected by one entity in the supply chain, such as a manufacturer or retailer, and paid to the government. However, the tax is passed onto the consumer by the manufacturer or retailer as part of the purchase price of a good or service. The consumer is ultimately paying the tax by paying more for the product.

Indirect Tax

How an Indirect Tax Works

In contrast to direct taxes, indirect taxes are taxation on an individual or entity, which is ultimately paid for by another person. The body that collects the tax will then remit it to the government. With direct taxes, the person immediately paying the tax is the person that the government is seeking to tax.

Excise duties on fuel, liquor, and cigarettes are all considered examples of indirect taxes. By contrast, income tax is the clearest example of a direct tax, since the person earning the income is the one immediately paying the tax. Admission fees to a national park are another example of direct taxation.

Note

Some indirect taxes are also referred to as consumption taxes, such as a value-added tax (VAT).

Regressive Nature of an Indirect Tax

Indirect taxes are commonly used and imposed by the government to generate revenue. They are essentially fees that are levied equally upon taxpayers, no matter your income, so rich or poor, everyone has to pay them.

But many consider them to be regressive taxes as they can bear a heavy burden on people with lower incomes who end up paying the same amount of tax as those who make a higher income.

For example, the import duty on a television from Japan will be the same amount, no matter the income of the consumer purchasing the television. And because this levy has nothing to do with a person's income, that means someone who earns $25,000 a year will have to pay the same duty on the same television as someone who earns $150,000.

There are also concerns that indirect taxes can be used to further a particular government policy by taxing certain industries and not others.

Note

Some economists argue that indirect taxes lead to an inefficient marketplace and alter market prices from their equilibrium price.

Common Indirect Taxes

The most common example of an indirect tax is import duties. The duty is paid by the importer of a good at the time it enters the country. If the importer goes on to resell the good to a consumer, the cost of the duty, in effect, is included in the price that the consumer pays. The consumer is likely to be unaware of this, but they will be indirectly paying the import duty.

Essentially, any taxes or fees imposed by the government at the manufacturing or production level is an indirect tax. In recent years, many countries have imposed fees on carbon emissions to manufacturers. These are indirect taxes since their costs are passed along to consumers.

Sales taxes can be direct or indirect. If they are imposed only on the final supply to a consumer, they are direct. If they are imposed as value-added taxes (VATs) along the production process, then they are indirect.

What Are Indirect Taxes in the U.S.?

Some examples of indirect taxes in the U.S. include taxes like sales taxes that are not paid directly to the government, but paid to a business that pays taxes to the government. Import taxes are also levied on goods coming into the U.S. The U.S. does not have a national sales tax.

How Do Businesses Offset the Cost of Taxes?

Businesses may increase the purchase price of the goods you buy with a sales tax to try to recoup some of the losses they face paying taxes.

What Are Value-Added Taxes (VATs)?

Value-added taxes (VATs) are taxes that are added in the production stages of a product. That cost can be deducted at the next stage of production. When the consumer pays for the product, the VAT is not deducted so the consumer ends up paying the tax.

The Bottom Line

Indirect taxes are common taxes levied on goods on services paid for by the consumer. They're not charged to an individual or a company. No matter your income, you will pay the same indirect sales tax on a product that other consumers pay.

Article Sources
  1. Georgia State University, Andrew Young School of Policy Studies. "Direct Versus Indirect Taxation: Trends, Theory and Economic Significance," Pages 1-2.
  2. European Parliament. "Indirect Taxation."
  3. Institute of Economic Affairs. "Aggressively Regressive: The 'Sin Taxes' That Make the Poor Poorer," Pages 8-9.
  4. U.S. Customs and Border Protection. "Customs Duty Information."
  5. Gillingham, Robert. “Poverty and Social Impact Analysis by the IMF,” International Monetary Fund, 2008, pp. 34-53.
  6. The University of Edinburgh. "Tax Team."
  7. Congressional Research Service. "Attaching a Price to Greenhouse Gas Emissions With a Carbon Tax or Emissions Fee: Considerations and Potential Impacts," Pages 1-10.
  8. Tax Foundation. "Value Added Tax (VAT)."
Related Terms

A widow(er)'s exemption is one of several forms of state or federal tax relief available to a surviving spouse in the period following their spouse's death.

Unrecaptured Section 1250 gain relates to an IRS tax rule directing that depreciation be recaptured when a gain is realized on the sale of depreciable real estate.

Use tax is a type of sales tax applied to purchases that will be used in one’s state of residence and on which no tax was collected in the state of purchase.

An ad valorem tax is a tax derived from an assessed value, such as the value real estate or personal property, with a tax rate applied.

A qualified higher education expense is a tax credit for the parents of students attending a college or other post-secondary institution.

A filing extension is an exemption made for taxpayers who are unable to file their federal tax return by the regular due date.

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