An indirect tax, unlike a direct tax such as the income tax, is a tax collected on a product by the retailer or manufacturer; however, the end consumer of the final product ultimately bears much of the burden through the higher price of a good or service. Sales and value-added taxes (VATs) are two examples of indirect taxes.
Examples of an Indirect Tax:
Indirect taxes include:
Despite sellers and manufacturers collecting the tax to remit to the government, the consumer still bears the burden of an indirect tax. The ability to shift the cost onto the consumer depends on the elasticity of demand for the good. If the demand is inelastic (i.e., the demand does not change significantly when the price changes), the cost can easily be shifted onto the consumer. The inverse is true for elastic demand, as the increase in price from the tax will result in less demand for the good.
Indirect Taxes and Sound Tax Policy
The Tax Foundation’s principles of sound tax policy are simplicity, transparency, neutrality, and stability. These principles should serve as touchstones for policymakers and taxpayers everywhere.
Indirect taxes are generally simple for the government to both levy and collect since they are applied broadly and automatically included in purchases. This does not mean that these taxes are necessarily transparent. Gross receipts taxes are opaque and lead to tax pyramiding, while sales taxes are clearly marked on invoices and receipts.
Indirect taxes like value-added taxes (VAT) and retail sales taxes can be neutral because they have little effect on consumer behavior and apply to all business models the same. However, other indirect taxes, like excise taxes, are not neutral because they target specific industries and activities, like cigarettes and alcohol.
All tax revenue is subject to economic cycles and changing taxpayer behavior, but among indirect taxes, broad-based consumption taxes are more stable than taxes that target a narrow tax base, such as cigarette smokers.
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