Building Your Business Business Taxes How Indirect Taxes Affect Consumers Learn how indirect taxes work and how they differ from direct taxes By Jean Murray Updated on December 10, 2021 In This Article View All In This Article What Is an Indirect Tax? Indirect Taxes vs. Direct Taxes Indirect Tax Examples Frequently Asked Questions (FAQs) Photo: kate_sept2004/Getty Images The indirect tax is a tax that is paid through another party and then by the taxpayer. Taxes are always paid to some government entity, usually the Internal Revenue Service (IRS) for federal taxes or the state where the transaction takes place. But in many cases, the consumer isn't aware that the tax is being paid, which is why they are sometimes called hidden taxes. This article explains indirect taxes, with examples, and how they differ from direct taxes. What Is an Indirect Tax? Indirect taxes are placed on goods and services, which raises the price so that the consumer ends up paying more for the item. One example of this is the gasoline taxes set by states. If you buy gasoline in Texas, for instance, you pay a motor fuel tax of 20 cents a gallon. The producer pays the tax to the state, and it is built into the price you pay for gas. Indirect taxes on products can be imposed at any point along the supply chain, from importing the product to the manufacturer to the retailer to the consumer. An example of this is the value added tax (VAT tax), common in Europe, in which each level of the supply chain adds a tax and all of these taxes are paid by the consumer. Are Indirect Taxes Regressive Taxation? Regressive taxes are those which impose greater taxes on lower-income individuals than higher-income individuals. For example, two families with different income might each spend $100 on clothing. However, the family with the lower income pays more taxes as a percentage of their income than the higher income family. Some indirect taxes are considered regressive, including excise taxes. Tobacco taxes are the most regressive because smoking (cigarettes) is higher among people with a low annual household income than those with higher annual household incomes. Note Sales tax is a regressive tax because it affects lower-income people more for items like clothing and food. That's why some states don't impose sales taxes on groceries. How Direct Taxes Differ From Indirect Taxes A direct tax is paid directly to the government; an indirect tax is passed on by the company or agency in charge to the customer. The best example of a direct tax is income taxes, both personal and business income taxes. The tax is paid directly on the income of the person or business to the IRS and to the state (if it has income taxes). Other direct taxes are: Estate tax or wealth tax, paid based on the value of everything owned by the deceased at the time of death Capital gains taxes directly imposed on investors when they sell an investment for a gain Note The IRS says that business property taxes, which are based on property value, are indirect taxes, but personal property taxes are direct taxes. Indirect Tax Examples Here are some examples of indirect taxes to help illustrate how they are different from direct taxes. Import Duties or Tariffs Import duties are a type of indirect tax because they are imposed on goods when they come into the country. The customer ultimately pays this tax as an increased price for the goods. Tariffs are imposed by countries on each others' goods to give a price advantage to local goods, and they are usually managed through trade agreements between countries. Excise Tax Excise taxes are use taxes, which means you pay a tax for using or buying a product. But you don't see the tax because it is paid by the producer or manufacturer and included in the price of the product. Excise taxes are sometimes called sin taxes because they are on products considered unnecessary or "sinful," like tobacco, alcohol, or gambling. As mentioned above, gasoline taxes are excise taxes. Businesses also pay excise taxes on their use of specific products. For example, fuel taxes are excise taxes, as are taxes on environmental products such as domestic petroleum oil spills and ozone-depleting chemicals. Value-Added Tax (VAT) VAT taxes are common in Europe and other countries but aren't used in the U.S. A VAT is a series of taxes imposed on the production of products all through the process, with the customer paying the final tax. A VAT is different from sales tax because the only one paying sales tax is the consumer. Communications Service Tax Communications service taxes are determined by each state and they include taxes on cable and satellite television services, phone services, and mobile communications. In some states, the charges are passed on to the customers. Stamp Tax Stamp taxes are excise taxes imposed by states on documents; the stamp in these cases is like a notary stamp, not a postage stamp. For example, stamp taxes are often required on public documents for the transfer of property, like a mortgage. The stamp tax may be included in the cost of the document, so it would be an indirect tax. Frequently Asked Questions (FAQs) What is indirect tax compliance? Compliance in general means doing what you have been asked or ordered to do. In taxes, compliance means the process you use to follow tax regulations, like reporting and paying indirect taxes.Excise taxes are indirect taxes that businesses must pay if they sell products or have business activities that may be subject to these taxes. Complying with federal excise tax requirements means reporting your excise tax liability on IRS Form 720, the quarterly federal excise tax return, and making payments on the taxable amount. Who gets indirect taxes? The federal government imposes indirect taxes on both businesses and individuals and at various times during the buying process. Some indirect taxes, like excise tax, may be imposedWhen a product is imported into the countyWhen manufacturer sells to a retailerWhen the retailer sells the product to a consumer or businessWhen the product is used by the manufacturer or consumerThe retailer, manufacturer, or importer pays the tax and passes it along to the buyer. Why would a government choose to use an indirect tax over a direct one? Indirect taxes are often imposed by governments to change the behavior of consumers. Some indirect taxes, called "sin taxes," are designed to discourage certain kinds of activity. For example, tobacco products are addictive, so taxing them doesn't affect the amount of cigarettes, snuff, and cigars people buy. The federal government, states, and some localities tax tobacco, with the effect that the tax on a package of cigarettes might be as much as 40% of the sale price. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit 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. Texas Comptroller. "Motor Fuels Taxes in a Changing Texas Transportation Scene." Accessed Dec. 10, 2021. Tax Foundation. "What Is a Regressive Tax?" Accessed Dec. 10, 2021. Centers for Disease Control and Prevention. "Current Cigarette Smoking Among Adults in the United States." Accessed Dec. 10, 2021. Tax Foundation. "Which States Tax Groceries?" Accessed Dec. 10, 2021. IRS. "Activity 1: Classifying Direct and Indirect Taxes." Accessed Dec. 10, 2021. World Trade Organization. "Tariffs." Accessed Dec. 10, 2021. Mercatus Center, George Mason University. "Taxing Sin." Accessed Dec. 10, 2021. IRS. "An Overview of Excise Tax." Accessed Dec. 10, 2021. Florida Department of Revenue. "What is CST?" Accessed Dec. 10, 2021. Florida Dept. of Revenue. "Documentary Stamp Tax." Accessed Dec. 10, 2021. Tax Foundation. "Excise Tax Application and Trends: Tobacco." Accessed Dec. 10, 2021.