What Is an Indirect Tax?

Updated on November 18, 2022

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A woman hands a cashier a credit card in a retail store. — Photo:
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Definition

An indirect tax is a tax ultimately paid by a different taxpayer than the one who collects and remits the tax to the government.

Key Takeaways

An indirect tax is a tax that, while legally imposed on one party, is actually ultimately borne by another party.
Examples of indirect taxes include sales tax, excise tax, value-added tax, and tariffs.
Governments have tax codes that dictate who and what is subject to the indirect tax as well as how one may pay the indirect tax.
Indirect taxes can be regressive, depending on the particular indirect tax, meaning that lower-income taxpayers pay a higher percentage of their income toward indirect taxes than higher-income taxpayers.

How Indirect Tax Works

An indirect tax is a tax whose payment can be shifted to another party from the party legally responsible for remitting the tax to the government.

In general, the jurisdiction imposing an indirect tax has a tax code governing the collection and remittance of the tax.

This tax code may have rules pertaining to:

Who is subject to the indirect tax
What is subject to the indirect tax
How one may pay the indirect tax
How one may file a return for the indirect tax

Often, indirect taxes are built into the price charged to consumers. This means that when a new indirect tax is imposed, consumer prices of the affected goods and services generally increase as a result.

Note

In states that have a sales tax, consumers pay indirect taxes to retailers, which are responsible for collecting sales taxes and remitting them to the state government. Retailers generally charge higher prices to customers, then collect sales taxes from them at the point of sale.

Example of Indirect Taxes

Sales tax as collected by the states that impose them is an example of an indirect tax because retailers — though they are the party legally responsible to remit the sales tax to the state — shift the actual payment of the sales tax to their customers.

For example, retailers in California are required to report and pay sales tax to the California Department of Tax and Fee Administration (CDTFA). They may seek reimbursement for those taxes from their customers by charging more at the point of sale. For example, if they are required to pay $1.75 in sales tax on a sale, they can pass that cost onto the buyer, informing them that tax is included.

Types of Indirect Taxes

There are a variety of indirect taxes that can be imposed. In the chart below, we describe some of the common types of indirect taxes.

Indirect Tax Type	How It Works
Sales Tax	A tax paid on the percentage of the selling price of all or most goods or services
Excise Tax	A tax paid on the sale of certain, specific goods or services
Value-Added Tax (VAT)	A tax collected at every stage of the production and marketing processes of goods and services
Tariff	A tax levied on imported goods

Indirect Tax vs. Direct Tax

While an indirect tax is ultimately paid and remitted by different taxpayers, a direct tax is remitted to the government by the same taxpayer who is responsible for paying it to the government. A direct tax cannot be shifted to others.

Income tax is an example of a direct tax because the same taxpayer earning the income who is liable for the tax is the same party that pays the taxes.

Criticism of Indirect Taxes

A common criticism of indirect taxes is that they are generally expected to be regressive, meaning that the tax takes a larger percentage of low-income taxpayers’ means than high-income taxpayers’ means.

Note

Essentially, with regressive taxes, taxpayers with higher incomes carry a smaller share of the burden relative to their incomes.

For example, let’s say that a low-income household of four people with a combined household income of $30,000 per year buys five gallons of milk per month. The next street over, there is a high-income household of four people with a combined household income of $300,000 per year, and they also purchase five gallons of milk per month.

Since both families pay the same sales tax rate in their city, both the low-income family and the high-income family pay the same amount of sales tax on their milk. But, as a percentage of income, a greater share of the low-income family’s income goes toward milk sales taxes than the percentage of the high-income family’s income.

Frequently Asked Questions (FAQs)

Do I need to pay indirect taxes?

Whether you need to pay indirect taxes depends on whether the jurisdiction where you live imposes indirect taxes on the activities you pursue, the goods and services you purchase, or the property you own.

How much are indirect taxes?

The amount of an indirect tax depends on the kind of tax and the jurisdiction imposing it.

Sales taxes in the United States, for example, are typically a combination of a state-determined sales tax rate and a locality-determined sales tax rate, so you will likely pay a different sales tax rate in one state, county, or even city than you would in another state, county, or city.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

IRS. “Lesson 4: Direct and Indirect Taxes.”
California Department of Tax and Fee Administration. “Applying Tax to Your Sales and Purchases.”
U.S. Bureau of Labor Statistics. “The Effects of Tariff Rates on the US Economy.”
IRS. “An Overview of Excise Tax.”
New York State Department of Taxation and Finance. “Sales and Use Tax.”
Deloitte. “Indirect Tax Services.”
Tax Foundation. “State and Local Sales Tax Rates, 2021.”