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.
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. 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. 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.
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.
