How Indirect Taxes Work and Affect Consumers

Indirect taxes, sometimes referred to as hidden taxes, are a form of indirect tax compliance as they are taxes paid without the apparent knowledge of the taxpayer. Governments rely on both direct tax and indirect tax to generate revenue and sustain the economy, maintaining the tax foundation required for public services.

Also, the IRS is responsible for federal taxation. States are managed by each individual state's tax department. As a result, every law-abiding citizen must pay taxes. However, you are often unaware how indirect taxes work and affect consumers. So, this blog post will enlighten you on indirect taxes, how they work and how they affect consumers. So read on to learn more.

What are indirect taxes?

They are taxes you pay, often included in the purchase price of consumer goods and services, which result in a price increment upon purchase. While these taxes are generally standard, states with no income tax significantly depend on indirect taxes and other forms of taxes for government revenue. As a result, the cost of living in states with no income taxes is usually high.

For instance, Texas, the lone star state, has its residents pay a tax of 20 cents per gallon on fuel. Essentially, the manufacturer or producer already pays the tax to the government and builds in the tax into the commodity or service you buy. As a result, these taxes are paid directly by businesses but indirectly by you, every time you buy a commodity.

Indirect taxes exist at any point along the supply chain of goods and services, from the producer to the retailer and final consumer. A typical example is a VAT where each level in the supply chain adds indirect taxes for the final consumer to pay at purchase time. 

Types of indirect taxes

Indirect taxes are all around you as long as you purchase goods and services. As a result, they can take various forms. Here are a few examples of types to keep you well informed.

Excise Taxes

Excise taxes are widespread since they are associated with several consumer products. Essentially, product manufacturers pay them and then include them in the price when you buy. Although usually, you shop at a shopping mall, you pay indirect taxes even though you may not see it on your cash receipt. Examples of excise taxes are sin taxes, usually placed on commodities considered to have severe effects like tobacco, alcohol, and fuel because of the environment.

Value-added taxes (VAT)

Although not common in the United States, VAT is another type of indirect tax. It works through the production prices of goods and having the consumer pay the final tax upon purchase. It is pretty different from sales tax since only the consumer pays VAT.

Sales tax

Sales taxes, often aligned with services tax, add to the final cost on many consumer products you pay for at the register. Examples of items that have sales taxes include household items, consumables, and other things you perhaps buy at the shopping mall.

Sales taxes, often known as conventional or retail taxes, are only due from the final purchaser of a commodity or service. It takes a lot of paperwork to prove who is ultimately liable for paying sales tax because most goods in modern economies go through a number of manufacturing steps that are frequently handled by many entities.

Sales taxes can be levied independently by states, counties, municipalities, and other governmental entities. Sales taxes and use taxes, which are imposed on items imported into a nation, are closely related. These are often established at the same rate as sales taxes, with the exception of when they apply to major purchases of physical goods, but they are challenging to execute. For instance, if a Georgian purchased a car in Florida, they would be required to pay the same local sales tax as if they had done so in Georgia.

Customs Tax or Import duties

Customs tax is the reason imported commodities are pretty pricey. The reason is that exporters pay customs tax before their products can enjoy sales in another country. As a result, when exporters pay customs tax, they add the tax to the final sales prices on the imported products, which trickle down to end-users or final consumers. Also, countries impose customs taxes and tariffs on imported products to encourage you to patronize more homemade products.

Example of Indirect Taxes

Let's use VAT as an example to show how an indirect tax is levied. Let's take the scenario where John visits the outlet store to purchase a $500 refrigerator. The salesperson will respond by stating the sale price, which is $500, and it is the correct response when the customer asks.

The actual value of the refrigerator is less than that, but because a value added tax (often 10% to 20%), also called hidden taxes, has been imposed, the sale price is now $500. John can see the exact cost of the refrigerator before tax was added by looking at his receipt. The tax is taken out of the sale price and paid to the government by the manufacturer of the unit or item.

How indirect taxes affect consumers

Typically there are three categories of taxes in the United States: regressive, proportional and progressive taxes, each having its peculiarities. Also, these tax categories affect people differently according to their income generation rate.  

Essentially, indirect taxes are regressive taxes because consumer earnings do not affect or influence them. Moreover, regressive taxes affect low-income earners in comparison to higher-income earners. As a result, you pay the same tax as any other consumer, no matter your earning capacity. Examples include VAT, sin taxes, sales taxes, excise taxes, etc. 

Why do governments impose indirect taxes?

On spending are indirect taxes levied. They increase a company's cost of manufacturing, which moves the supply curve of the company upward. Specific taxes are a fixed amount of tax imposed on a product, while ad valorem taxes are a percentage of the selling price (such as VAT). Indirect taxes, such as the goods and services tax, can be either specific or ad valorem.

Generally, in recent years, governments have increasingly used indirect taxes as a method to levy behavioral modifications among residents. For example, governments use sin taxes to regulate how you consume certain products believed to have grave consequences on your health or the environment. For instance, tobacco, alcohol, fuel, and other toxic or addictive substances are heavily taxed to discourage or control consumer usage.

General Benefits of Indirect taxes

Like it or not, they have some advantages, even though they seem like so much burden on citizens and state residents at first sight. While every state has the right to place indirect taxes on whatever commodity is necessary, here are a few general advantages of imposing such taxes.

Indirect Taxes are pretty discreet

While governments are customary to impose direct income taxes on people, indirect taxes make taxation unnoticeable. As a result, it is easier for people to pay than dealing with the subtle burden of direct income taxes and filing tax documents every tax season. Additionally, independent contractors do not pay direct income taxes because they do not receive W-2 forms, and their 1099 forms are not subject to direct income taxes.

Independent contractors still pay income taxes using the information provided on the 1099 form. These individuals are responsible for paying their own federal and state income taxes, as well as self-employment taxes. Therefore, indirect taxation provides a means for self-employed people to contribute to government revenue generation. 

Payment and collection are easy

Unlike direct income taxes, which are closely monitored for tax compliance, they do not require you to file any document. However, businesses are responsible for tracking and submitting these taxes to the government It is somewhat like automatic taxation built into the commodities you purchase as a consumer. Furthermore, it is easy for the government to collect without completing your tax forms. 

It works as an excellent behavior modifier

Banning the supply and demand for certain harmful or high impact substances might only encourage full-scale supply on the black market and a resultant unrepentant demand from consumers. However, indirect taxes levy a controlled influence on consumer behaviors towards such discouraged or prohibited substances, eventually reducing consumption and circulation in recent years.

Indirect taxes are paid by all consumers, regardless of income level

Indirect taxes give the poor a chance to actively contribute to the process of raising money for a country or state, contrasting with direct tax systems, which often exempt them.

Stops the use of potentially harmful goods

Cigarettes and alcohol both have hefty taxes. Taxpayers are discouraged from purchasing these commodities because of their high price, which ends at the consumer level as increased costs, which prevents them from consuming dangerous drugs.

Indirect and Direct Taxes: A Comparative Analysis

Direct tax and indirect taxes differentiate on how they are collected, impacting taxpayers across the spectrum.

As implied by the name, direct taxes are paid to the government directly, whereas indirect taxes are paid through another party. It means that even though the tax is placed on a specific business or supplier, the burden will ultimately be passed on to consumers.

While indirect taxes are levied on the commodities that consumers purchase, most direct taxes are deducted from an individual's wages. Additionally, direct taxes are determined based on a person's ability to pay. Contrarily, indirect taxes apply to everyone who purchases the goods or services and do not take into account the consumer's financial situation.

Excise tax, VAT, and services tax are a few examples of how indirect taxes work and impact the taxable value of products. Income tax, corporation tax, and real and personal property taxes are a few types of direct taxes.

Final thought

Indirect taxes are somewhat equalizing as it affects everyone from producers to retailers to consumers. Moreover, it creates a system where both taxing authorities and citizens play a role in active income generation for the government. What's more? Tax evasion is significantly controlled. However, the poor and very low-income earners are often at a disadvantage since indirect taxes don't consider your earning capacity.