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What is an 'Indirect Tax'

An indirect tax is a tax that is paid to the government by one entity in the supply chain, but it is passed on to the consumer as part of the price of a good or service. The consumer is ultimately paying the tax by paying more for the product. An indirect tax is shifted from one taxpayer to another.

BREAKING DOWN 'Indirect Tax'

Import duties, fuel, liquor and cigarette taxes are all considered examples of indirect taxes.

Indirect taxes are defined by contrasting them with direct taxes. In the case of direct taxes, the person immediately paying the tax is the person that the government is seeking to tax. 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 is another clear example of direct taxation.

Examples of Indirect Taxes

The most common example if 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 hidden in the price that the consumer pays. The consumer is likely to be unaware of this, but he will nonetheless 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 along the production process, then they are indirect.

Regressive Nature of Indirect Taxes

Indirect taxes are essentially fees that are levied equally upon taxpayers, no matter their income. As such, they are regressive taxes. For example, the import duty on a television imported from Japan will be the same amount, no matter what the income of the consumer purchasing the television is.

There are also concerns that indirect taxes can be used to further a particular government policy by taxing certain industries and not others. For this reason, some economists argue that indirect taxes lead to an inefficient marketplace and alter market prices from their equilibrium price.

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