What are indirect taxes?
Indirect taxes can leave you facing some unexpectedly steep costs. Let’s look at how they work, how they are different, and why they can be controversial.
What are indirect taxes?
Indirect taxes are taxes levied on goods and services, for example, sales tax, VAT, and excise tax.
While legislators still set indirect tax rates and are designed to raise revenue for local and federal government, the way they are collected and paid differs from other taxes. Rather than being paid specifically by entities, the costs are spread throughout the production of a product or service. In practice, you pay indirect taxes when you buy certain goods or services.
We come across many indirect taxes every day. You can find indirect taxes everywhere, from product levies to sales tax, which are almost always included in the final price we pay for products and services. But these added costs can also be a hit to our financial planning – for people and businesses.
How do indirect taxes work?
Indirect taxes work differently to direct taxes in that the costs of the taxes are spread across the supply chain. Another person ultimately pays for the tax on a product or service.
For instance, if a tax is applied to a specific material, product, or service, a business using the taxed item can raise its prices so that customers pay the cost of using the material in advance. This is true for fuel, liquor, cigarettes, and many more.
As indirect taxes often apply to quite specific products and services, these taxes are paid by consumers when they buy these products. However, this also means that both high and low-income consumers pay the same level of tax, leading to criticisms that these taxes are regressive and impact low-income consumers more.
What are the different types of indirect taxes?
There is a wide range of different indirect taxes that both individuals and businesses come across almost every day. For individuals, these are some of the most common types of indirect taxes:
Import duty is applied to any product imported into the US when it passes through customs. When buying an imported product, consumers almost always need to pay import duty in advance.
Sales tax can be direct or indirect and applied across supply chains as a value-added tax.
Excise tax is applied to products such as cigarettes, liquor, and fuel and is designed to make these products less widely used by raising prices.
While you can apply other indirect taxes to properties, business licenses, and telecommunications, they only apply under certain circumstances, and you may not need to pay them at all. Ultimately, it is your individual state's responsibility to set indirect tax rates, so the amount you need to pay may vary from state to state.
Indirect vs. direct taxes
As mentioned above, direct taxes are charged to specific entities responsible for paying this tax directly. For example, income tax is designed to levy higher tax rates on those who earn higher incomes, and corporations of a certain size pay corporation tax. Usually, direct taxes apply to profits, wealth, and income. On the other hand, indirect taxes are paid by suppliers, with the costs passed along through the production process.
Criticism of indirect taxes
Indirect taxes are controversial for two main reasons.
On the one hand, while direct taxes are billed as direct tax and are accepted as such, indirect taxes are additional charges that aren’t widely documented as taxes. For this reason, they are called stealth taxes. Ultimately, they help governments raise revenue in the same way as normal taxes. But by not calling these levies taxes, they aren’t always seen as upfront taxes.
Secondly, indirect taxes tend to fall more heavily on lower-income individuals. While direct taxes can be applied progressively to those who can afford to pay more, indirect ones cut equally across income backgrounds. This means that indirect taxes take up a larger proportion of lower-income earners’ salaries than that of higher-income earners, so the taxes fall more heavily on those with less ability to pay.
Indirect taxes can burn a hole in your finances. But speaking to a financial advisor lets you set your finances in order and help you achieve your financial goals. Find your next advisor on Unbiased.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.