Updated July 18, 2023
Introduction to Indirect Taxes
Indirect taxes are the taxes paid by the producer or retailer of the product, but the burden is passed upon the customers in the form of higher purchase prices.
Since the tax is paid by one individual or entity and borne by others indirectly, these taxes are called indirect taxes. These taxes are levied equally upon individuals or customers irrespective of the level of their incomes.
Indirect taxes are the way of revenue generation by the government. Sometimes, they are considered regressive because they are imposed on everyone equally, regardless of whether they are rich or poor. The most common types of indirect taxes are sales tax, excise tax, customs tax, gas tax, etc.
Sales taxes are levied on clothing, household items, and basic commodities. At the time of sale, a certain amount is added to the price before taxes for sales tax. Excise tax is levied on goods like cigarettes, alcohol, health-related goods and services, tobacco, and other products; it is levied in the same way by raising the purchase price of these commodities. Custom taxes are levied on imported goods when they enter the national border, the importer needs to pay the taxes and can pass them on to the customers in the form of a higher purchase price. The customers pay fuel or Gas tax for buying gas for the vehicles.
Examples of Indirect Taxes
Let us look into some examples with the calculations for the above mentioned indirect taxes.
ABC company is carrying on its clothing store in a state of the USA. Suppose the state sales tax rate is 5% and the country sales tax is 3%. The price of a particular piece of kid clothing is $200. What would be the amount charged from the customer including the charges for sales tax?
|Particulars||Values (In $)|
|Kid clothing price||200|
|Total sales tax rate||8%|
|Sales tax to be added||16 (200*8%)|
|Final selling price||216 (200+16)|
Total sales tax of 8% is the combination of 5% of state sales tax and 3% of country sales tax. The sales tax figure is derived by multiplying the original price with a sales tax rate of 8%. The final selling price after adjusting for sales tax is $216.
Let us take another example of the sales tax. This time a grocery store is operating in a state where state sales tax is 7.25% and country sales tax is usual 3%. If a customer purchased a product whose original price was $150, what will be the final price the customer will have to pay?
|Particular||Values (In $)|
|Price of Grocery item||150|
|Total sales tax rate||10.25%|
|Sales tax to be added||15.375 (150*10.25%)|
|Final selling price||165.375 (150+15.37)|
The difference between the previous and this example is of state sales tax which is 7.25% in this case. The rest of the method remains the same; the sales tax figure is calculated by multiplying the price before tax with a sales tax rate of 10.25%. And the final purchase price that the customer will have to pay is $165.37.
Let us take the example of ad valorem (according to value) excise duty. Ad valorem excise tax is charged as a fixed percentage value of the purchase price of the product. The calculation is similar to sales tax; it is just levied on different categories of products. Let us take an example where a customer buys product A whose price before tax was $375 and there is an excise tax payable at the percentage of 10% of the purchase price. We need to calculate the excise tax to be paid and the final selling price charged by the customer.
Values (In $)
|Price of Product A||375|
|Excise tax to be added||37.5 (375*10%)|
|Final selling price||412.5 (375+37.5)|
The table shows that the excise tax to be paid is $37.5 and the final selling price is $412.5.
In this example, we will look into specific excise tax which is levied as a fixed dollar amount irrespective of the purchase price. This type of excise tax is different from Ad valorem excise tax, sales tax, customs tax, or Gas tax, which are all calculated as a fixed percentage of the purchase price.
So, let us assume a store is selling a product in a state of the USA, on which excise duty is charged at $5 per product if the total units sold are less than 1,000 and $7 above 1000 units. The store is currently at the level of 1200 units, and the price of the product before the excise tax is $260. What would be the final selling price?
|Particular||Values (In $)|
|Price of the product before the excise tax||260|
|No. Of units sold||1200|
|Specific excise tax for units sold above 1000||7|
|Final selling price||267 (260+7)|
As the number of units sold by the store has already exceeded 1000 units, therefore, the excise tax would be levied for the amount of $7 on each unit sold. The final selling price would be $267.
To sum up, indirect taxes are taxes that are paid by one entity and borne by other entities or individuals. These taxes serve as a source of revenue generation for the government which can be used for the welfare of the nation. Excise taxes, custom tax, sales tax, and fuel tax all are part of indirect taxes that are ultimately borne by the customers in the form of higher purchase prices.
This is a guide to Indirect Taxes. Here we discuss the definition and explanation of indirect taxes along with different examples. You may also have a look at the following articles to learn more –