What is an indirect tax? (2024)

Consumers pay indirect taxes as part of the market price for goods and services

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The U.S. tax system includes both direct and indirect taxes. Unlike direct tax, which is paid directly to the government by the taxpayer, an indirect tax is essentially passed on or shifted to someone else (like consumers) to fund rather than the person or business that owes the tax.

We don’t always realize we’re paying indirect taxes because they are not always demarcated on a bill or deducted from our paychecks, but most of us will encounter them frequently in our daily lives.

Key insights

Indirect tax is generally paid by the ultimate consumer of a good or service, even if that person is not the one who sends the tax to the government.

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Types of indirect taxes include sales tax, excise tax, value-added tax (VAT) and gross receipts tax.

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Indirect taxes may help to fund certain programs and initiatives that are related to the industries where the tax originates, such as environmental programs or infrastructure.

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How does indirect tax work?

Indirect taxes are generally funded by a different person or group than who is responsible for paying the tax. Sales tax is a good example.

In a hypothetical scenario, Jane Smith lives in Indiana. She goes to a car dealer to buy a new car for $30,000. Along with the price of the car, she will also pay the Indiana 7% state sales tax (there are usually other taxes added on to the purchase of a car, but we’ll just look at sales tax for now). This brings her total to $32,100. The car dealer will take the extra $2,100 and send it to the Indiana Department of Revenue. The dealer has paid the sales tax that they are legally responsible for, but the money comes out of Jane’s pocket.

This is what indirect tax means. It may not feel indirect to the consumer, as the money actually comes out of their pocket, but it is indirect to everyone else along the production and sales lines.

Types of indirect tax

There are a number of indirect tax forms. In some cases, like sales tax, you may be able to see this identified on a receipt, but in other cases, you may not know how much you are actually paying in indirect tax.

Sales tax

In the U.S., 45 states include a sales and use tax on most purchases — all except Alaska, Delaware, Montana, New Hampshire and Oregon. Some states, including some that don’t have a state sales tax, also have local sales taxes.

These taxes cover sales of all tangible personal property. This means that items you can physically hold and buy are covered by the tax, while items that simply represent an asset, such as a stock certificate, are not. The state allows exemptions for certain necessary items, such as unprepared foods, medications and medical equipment.

People who live near the border of low and high sales tax areas will often choose to minimize their tax burdens by making their purchases in the lower sales tax areas. For example, people who live in Maine near the New Hampshire border will often travel to New Hampshire to go shopping instead of paying Maine’s sales taxes. While this technically incurs a sales tax liability that should be paid to the Maine Department of Revenue, very few people actually do this, and there is currently no good way to enforce the requirement.

Excise tax

Excise tax is similar to sales tax, but can be imposed at both the federal and state level. Sales of goods and services like airline tickets, gasoline, heavy equipment, alcohol and tobacco can all be subject to excise tax.

The money from excise taxes is usually invested in something related to the industry levying the tax. For example, state excise taxes on airline tickets may go to airport improvements, and taxes on gasoline or heavy equipment generally go toward road improvements or emissions offsets.

Excise tax can be imposed at various points along the supply chain including at manufacture, import, retail sale or consumption. It must be paid at the point where it is imposed, but it is almost always passed along to the consumer. Often, the manufacturer or retailer will pay the tax directly and then receive a credit for it where they ultimately get the money back from the consumer’s indirect payment.

Value-added taxes (VAT)

While this isn’t as common in the United States, VAT tax, or GST (general sales tax), is one of the most common ways sales tax is imposed in Canada and Europe. It is very similar to U.S. sales tax, except that it is usually included in the sticker price of an item instead of calculated at the time of purchase. It is a consumption tax that is paid at each stage of an item’s life: manufacture, wholesale, retail and consumption. When the item is resold, the seller can recoup most of the VAT tax they paid.

Since the item is resold at a slightly higher price to show increased value at every point along the supply chain, each person who resells the item will end up paying a small amount of the VAT tax. Since the consumer is the endpoint of the item’s life, that person ends up bearing the greatest VAT burden.

VAT usually includes many of the same exemptions as sales tax such as unprepared food items, medicines and necessary medical equipment.

Gross receipts tax

A gross receipts tax is similar to a value-added tax in that it is a percentage of the total sale price of a transaction, and it applies at each step of a product’s journey along the supply chain. Also, like sales tax and VAT tax, it is paid by the buyer and remitted to the tax authority by the seller.

The main difference between gross receipts tax and VAT tax is that gross receipts tax is paid in full by each buyer along the supply chain. VAT tax allows for a tax credit: The seller is only responsible for the difference in tax between the tax collected from the buyer and the tax paid when they originally bought the item. Gross receipts tax allows for no such credit — each buyer along the supply chain is responsible for the full amount of the tax.

Because of this, most states and countries prefer VAT tax over gross receipts tax as it is less regressive for industries with long supply chains.

Indirect tax vs. direct tax

Indirect tax is based on consumption, whereas direct tax is based on production. Indirect tax is paid by the ultimate consumer of a good or service, even if that person is not the same as the one who sends the tax to the government.

Policymakers often debate the fairness of indirect taxation. Some argue that it puts an unfair burden on lower-income consumers over higher-income business owners. Others argue that it is only fair that the consumers of a good or service pay the tax as a way to ensure its continued use in society.

Dennis Shirshikov, a professor of economics and accounting at the City University of New York, used sales tax as an example to help illustrate these complexities. “While a flat sales tax rate applies to all consumers, its burden is heavier on those with lower incomes, as they spend a larger portion of their earnings on taxable goods and services,” he explained. “This regressive nature raises questions about fairness and the optimal balance between direct and indirect taxation to fund public goods and services.”

Direct taxes, on the other hand, are things like personal and corporate income taxes, property taxes and estate taxes. They are calculated based on value and wealth, such as income, increased property value and inherited assets. Direct taxes are also paid directly by the person or entity who owns the value.

With regard to equitable taxation, Shirshikov explained that “direct taxes, with their ability to be scaled according to income, offer a mechanism for achieving greater equity. However, indirect taxes play a crucial role in funding essential public services efficiently.

Pros and cons of indirect tax

Direct taxes, with their ability to be scaled according to income, offer a mechanism for achieving greater equity.”
— Dennis Shirshikov, economics professor, City University of New York

There are plenty of advantages and disadvantages when it comes to indirect taxation:


  • Helps manage the consumption of valuable or controlled resources.
  • Can help fund important programs tied to consumption.
  • Ensures that everyone who uses a resource is paying for its use.
  • Can be temporarily lifted for a “tax holiday” to encourage buying or to offer taxpayers a break.


  • Can discourage certain purchases. This can be both a pro and a con.
  • Not always as transparent or obvious as direct taxation.
  • Can be highly regressive, as it places a larger financial burden on the individual consumers instead of wealthier corporations.
  • Offers very limited opportunity for tax credits or deductions to reduce overall tax paid.

Owe the IRS thousands? See if you qualify for relief.


    Who is responsible for paying indirect taxes?

    Indirect taxes are a shared responsibility. The retailer or manufacturer is responsible for collecting the indirect tax and sending it to the tax authority. The consumer is the one who actually pays the tax, but their responsibility for the tax depends on their consumption. The law, for example, cannot compel someone to pay a gas tax if they do not buy gasoline.

    How are indirect taxes calculated?

    Indirect taxes are usually calculated as a percentage of the value of the good or service purchased.

    What happens if indirect taxes are not paid?

    The consumer of the good has very little choice about paying indirect tax, as it is almost always baked into the total purchase price of whatever they are buying. If the retailer or manufacturer fails to remit indirect taxes to the government, they will incur a late-payment penalty or fine at the very least. Some states also include a tax misdemeanor or felony, depending on the amount of tax owed.

    Bottom line

    Indirect taxes are unavoidable in many cases for consumers. If you want a particular good or service, these taxes will often be included in the total price you pay. In the case of sales tax, you’ll usually be able to see this on a receipt, and you can calculate sales and local tax yourself as well. The retailer or seller will ultimately pay the tax to the government, but the consumer typically funds it.

    Indirect taxes do often go toward supporting programs and initiatives in the industries from which the tax originates and can help control the consumption of certain resources. For example, if you do not smoke, you will never pay an indirect tax on tobacco.

    Article sources
    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Tax Foundation Glossary, “Indirect Tax.” Accessed March 1, 2024.
    2. Tax Foundation, “Tax Rate Table.” Accessed March 2, 2024.
    3. Texas Department of Revenue, “Sales Tax Cases.” Accessed March 1, 2024.
    4. Illinois Department of Revenue, “Sales & Use Taxes.” Accessed March 3, 2024.
    5. Illinois Department of Revenue, “Is there a penalty if I do not pay my tax due by the due date?” Accessed March 1, 2024.
    6. IRS, “An overview of excise tax.” Accessed March 3, 2024.
    7. European Commission, “What is VAT?” Accessed March 3, 2024.
    8. Tax Foundation, “Gross receipts tax.” Accessed March 3, 2024.
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