An indirect tax (such as sales tax, per unit tax, value added tax (VAT), or goods and services tax (GST ), excise, consumption tax, tariff) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the consumer). The intermediary later files a tax return and forwards the tax proceeds to government with the return. In this sense, the term indirect tax is contrasted with a direct tax, which is collected directly by government from the persons (legal or natural) on whom it is imposed. Some commentators have argued that "a direct tax is one that cannot be charged by the taxpayer to someone else, whereas an indirect tax can be."
An indirect tax may be used to raise the price of products for consumers. Examples would be fuel, liquor, and cigarette taxes. An excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately, the manufacturer transfers the burden of this duty to the buyer of the car in the form of a higher price. Thus, an indirect tax is one that can be shifted or passed on. The degree to which the burden of a tax is shifted determines whether a tax is primarily direct or primarily indirect. This is a function of the relative elasticity of the supply and demand of the goods or services being taxed. Under this definition, even income taxes may be indirect.
The concept of Value Added Tax (VAT) as an indirect tax was the brainchild of a German industrialist, Dr. Wilhelm von Siemens in 1918. A hundred years later, the tax which was devised to be efficient and relatively simple to collect and enforce is, together with Goods and Services Tax (GST), now in place in over 140 countries globally.
Indirect taxation is a policy commonly used to generate tax revenue. The burden of an indirect tax falls on the final consumer of goods and services while paying for purchase of goods or for enjoying services. An indirect tax is usually applied to everyone in the society whether rich or poor.
Indirect taxation can be viewed as having the effect of a regressive tax. A regressive tax costs a higher percentage of income for the poor than for those with higher incomes. For example, tax on an item worth $25,000 paid by a person with a salary of $100,000 constitutes a lesser percentage of income than that paid by a person with a salary $50,000, as the tax amount depends on the item and not the income. Similarly, consider an item with a sales tax of $50. Person A, with a $10,000 salary, pays 0.5 percent of his salary while person B, with a $1,000 salary, pays 5 percent of his salary. This reflects the concept of regressive tax.
For an indirect tax, the taxpayer pays the tax but the burden is shifted to the ultimate consumer. For a direct tax, the taxpayer has to bear the burden of tax personally. The side effect of this is observed as a widening of the gap between the rich and poor. In Washington state, the poor paid 17 percent of their salary as Sales Tax (a type of indirect tax) as compared to the rich who paid only 2.4 percent. A large family with few wage earners would pay a greater amount of indirect tax on life's necessities than that paid by a smaller family.
The term indirect tax has a different meaning in the context of American Constitutional law: see direct tax and excise tax in the United States. In the United States, the federal income tax has been, since its inception on July 1, 1862, an indirect tax (more specifically an excise). During the 1940s, its application grew from a historical average of about 8% to around 90% of the population paying it as a measure to support the war effort.
Manufacturers are considered to be:
To cover these costs, manufacturer adds them to COGS (cost of goods sold), where the buyer ends up paying for these costs. Thus, it is considered to be an indirect tax.