Indirect Tax: Definition, Types & Examples

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

In this lesson we will discuss the concept of indirect taxes and go over some examples of how these taxes are included in the purchase price of the goods we buy.

Indirect Tax

As a financially savvy consumer and taxpayer Tom likes to know about how much of his spending is actually going toward the goods and services he purchases compared to what goes toward taxes. He grasps the concept that he pays taxes in the form of real estate property taxes, sales tax, and income tax. What shocked him is the existence of other indirect taxes. Let's take a look at what these indirect taxes are and show how they are passed down to consumers such as Tom.

Definition

An indirect tax is a tax which is passed on to the consumer but hidden within the purchase price. With an indirect tax the consumer does not know at the time of purchase how much of the price is for the product itself compared to how much is for taxes. With a direct tax the value of the taxes is made more clear to consumers and taxpayers. Most instances of sales tax in the US are examples of direct taxes. When Tom pays for a soda that sells for $1.99 his actual cost is $2.11 if his state has a 6% sales tax. If he pays property taxes on his home he can easily see the exact amount of his property taxes on his tax assessment.

One major concern with indirect taxes is that they are a regressive tax. This means that the tax amount is the same for each taxpayer. Sales tax for example doesn't change depending on whether you are poor or make a million dollars a year. Because of this, indirect taxes tend to make up a greater portion of spending in lower socioeconomic groups. If a rich man and a poor man spend the same amount of money on gas and groceries, both will pay the same amount of tax but the total tax will make up a greater percentage of the poor man's income.

Examples

So what kind of indirect taxes does Tom come across on a regular basis? More than you would think! The price of gasoline contains various taxes that have been paid by importers and distributors that ultimately drive the price up from what it actually costs. Common types of goods that have indirect taxes are those associated with vices such as alcohol and tobacco. Distributors pay a tax on the volume of alcohol or the number of tobacco products when they make or bring the product into the state. If Tom buys a tank of gas for his car, a pack of cigarettes, or a bottle of liquor he won't see the tax on his receipt like he would see the sales tax.

In some cases, the same product might have both indirect and direct taxes associated with it. Gasoline in the US is priced so that the price listed at the pump includes all taxes, both direct and indirect. Retail products such as alcohol and tobacco may have a sales tax charged at the register in addition to the indirect taxes already included in the price.

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