Indirect Tax Explained With a Direct Answer
Taxes are classified as direct or indirect, a classification that has an effect on concepts such as taxation or economic capacity, and progressivity in taxation. In our day to day, we make purchases and pay taxes without realizing it.
The so-called indirect taxes are generally paid when we purchase a product.
As its amount is integrated into the price, many times we are not aware of its existence, but if we want to dig deeper into understanding it, then it is best to use tax tools such as a tax tracker.
Economic Standpoint
From an economic point of view, indirect taxes, in terms of collection, have two advantages that direct taxes do not have.
On the one hand, indirect taxes are easier to collect, and secondly, taxpayers are less resistant to paying them because they pay it directly with consumption.
With direct taxes, the ability to contribute is deducted from the personal characteristics of the taxpayer and, therefore, they are applied to the income, assets, or other manifestations of the taxpayer's wealth and, in them, it is normally the taxpayer himself who pays them and does so directly to the corresponding Tax Administration.
Direct Tax
Direct taxes are applied on a direct or immediate manifestation of economic capacity, such as the possession of an estate or the obtaining of an income. This, which sounds so technical, means that this type of tax is applied to possessions or income that a person or company obtains.
Its greatest exponent is the income statement, and it is, in a sense, a more personalized type of tax. For its part, indirect taxes are levied on the consumption of goods and services, as well as the transfer of goods and rights in general.
The difference
The entity collecting the indirect tax will pay it to the government. This is mandatory. In contrast, a direct tax is paid by an individual. Indirect tax includes paying excise duties on liquor, fuel, and cigarettes while direct tax is strictly related to someone’s personal income or business income.
Consumption
Indirect taxes do not tax the taxpayer's wealth or ability to pay, but instead, tax the use that the taxpayer makes of their economic resources since this use is considered indirect of the person’s income. For this reason, they tax consumption.
Its mechanics, therefore, is to apply a percentage on the sale price of an item or service that the consumer must pay.
Everyone pays the same!
The taxpayer who bears the tax does not pay it directly but does so through an increase in the prices he pays. Specifically, they do not comply at all with the principle of progressivity since the percentage that is applied to the price of the good or service is the same regardless of whether who pays it has more or less economic resources.
The Activity
It is indirect because what is taxed is the activity but not the person, but the person indirectly ends up paying the tax when they carry out the activity or transaction subject to the tax. The classic example of an indirect tax is the sales tax, in which the person pays the tax only if he consumes a product or service that is taxed. Indirect taxes are regressive to the extent that they do not consult the economic capacity of the person who must pay them. Although in indirect taxes it can be established that when certain transactions have a higher rate, as in luxury goods that only people with a certain ability to pay can acquire.
The Characteristics
The indirect tax also reflects certain inequity, because it contemplates benefits that apply to everyone equally, both to those who do not have money and to those who have a lot. This is the case of products exempted from sales tax, where the upper classes end up benefiting when said benefit should be for the less favored.
Another characteristic of indirect taxes is that they are generally included (camouflaged or concealed) in the price of what is regularly consumed, so when they are paid indirectly, people do not notice it and offer less resistance to the state that imposes them. It is not the same to pay a little sales tax every day without realizing it rather than to pay a high amount of income tax at the end of the year.
Emerging Global Trends
The growing importance of indirect taxes: companies tend to focus on direct taxes; however, indirect taxes are increasingly being used to generate additional income: value-added tax (VAT), general sales tax, customs, and excise duties can account for more than half of tax revenues collected by many governments.
Managing the impact of this type of tax on business performance requires an understanding of emerging global trends and a clear strategy, although the scale and speed at which countries are announcing changes to their tax systems are complicating even the more experienced and better-equipped companies.
The Nature
Paying taxes indirectly means that you are paying what the government has imposed to generate their revenue. These are levied fees that the taxpayer has to take on and this has nothing to do with income or wealth. Many people think this is a heavy burden on those with less income because they pay the same taxes as people who earn more.
An example would be paying import duty tax on an item that you may have purchased from China. The tax will be the same for the person in a higher income bracket as it would for the person in the lower-income bracket. Therefore, a person earning $24,000 per year will pay the same tax on the item as would the person earning $153,000 per year.
This is clearly a huge burden on the person in the lower-income bracket.
In many cases, the government will also tax specific industries indirectly. It is for this reason that some economists might argue that these would result in having an incompetent marketplace. It also changes the market prices, creating an equilibrium and instability in prices.
Commonly Paid Indirect Taxes
The most commonly paid indirect taxes are those imposed on the supplier or manufacturer of products. The supplier and manufacturer pass these taxes down to the consumer.
Excise taxes on alcohol and cigarettes are the most commonly paid by the consumer.
Another form of indirectly paid taxes is VAT, which means Value Added Taxes.
Sales taxes are also indirect, but they can be direct as well. They are indirect when imposed in the production process as Value Added Tax. They are direct when imposed on products, which are purchased by the consumer.
Kinds of Indirect Taxes
There are different ways that you can pay taxes indirectly. Everyone has to pay taxes to the government in some form or the other, but this is especially true with indirect taxes. All products carry a taxable amount.
Let us look at some of the indirect taxes that consumers have to assume:
Sales Tax
Let us say you went to the mall to shop for an item, or you went to the grocery store to buy goods, these already have the potential of being indirectly taxed. Some of the goods that would have sales tax would be items of clothing, household goods, food, and other basic items of necessity. When you pay for an item at the cashier’s counter, the sales price is added to the total amount. The store is collecting that amount for the government.
Excise Tax
One of the most common forms of indirect tax is the excise tax. When the manufacturer purchases the materials to make a product for a company, they are the ones that pay the taxes indirectly on the materials. An example would be the materials used to make cigarettes. The manufacturer has the option to burden the consumer by putting a higher price on the cigarettes than is normal.
Custom Tax
Goods are always imported into a country. The goods are subject to customs tax and that is why these goods are usually more expensive than goods made in the country of origin. Let’s say that a country imports a container of bananas to the United States, the person importing this product is the one who pays the customs tax. The consumer is the one who eventually assumes the tax burden.
Fuel Tax
When you purchase fuel for your vehicle, you will definitely be incurring indirect tax. There is no going around this since fuel is a consumer necessity.
Value Added Tax
When it comes to Value Added Tax or VAT, the imposing of indirect taxes include the real value of an item, which is the sale price and the extra amount added, which is the VAT. For example, if you were to go to the department store to buy a stove and the salesperson told you it cost $1,000. This would be the sales price, but when you go to make the final purchase, 10% to 20% is added to the sale price. The receipt will show the sale price and the tax, which is added. The manufacturer is the one that collects that amount from the initial sale price and compensates the government.
The Advantages
While taxes might seem as if it is an extra burden for the consumer, indirect taxes are usually not thought of as such. There are some advantages to it. Those with lower income are contributing to paying taxes so that the country and their state can provide value-added services, which they can benefit from. Paying those taxes indirectly is not as obvious as paying direct taxes. It is usually incorporated into the price of a product. In other words, the consumer does not feel it as much since those taxes come in smaller values. In addition, they are not placed on the price tag, but only appear on the sales receipt.
Avoid Paying
You can avoid paying these taxes by not purchasing the goods.
Moreover, when you do have to pay this tax, the collection aspect of it comes easier. There is no filing of documents or anxiety to meet any government deadlines. It is a simple process. In fact, you have no dealings with the government. The company, manufacturer or supplier is the one collecting to pay the government. Harmful products like cigarettes and alcohol are taxed heavily and they carry indirect payment of taxes. Therefore, if you don’t want to pay those heavy taxes, then you would refrain from purchasing and consuming them.
Don't Stress over Taxes! We Help You Find the Best Offer.
Conclusion
When you buy any product on the market, pay attention to your receipt, so you can tell how much indirect taxes you are being charged. For the products that are not a necessity, leaving them on the shelf is a way you can save money on taxes.
If you want to learn more about how these taxes work in your daily life, visit the Goalry platform and go directly to the Taxry store.