Indirect tax
An indirect tax is a tax that is levied upon goods and services before they reach the customer who ultimately pays the indirect tax as a part of market price of the good or service purchased. Alternatively, if the entity who pays taxes to the tax collecting authority does not suffer a corresponding reduction in income, i.e., the effect and tax incidence are not on the same entity meaning that tax can be shifted or passed on, then the tax is indirect.
An indirect tax is collected by an intermediary from the person who pays the tax included in the price of a purchased good. 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 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."
Indirect taxes constitute a significant proportion of total tax revenue raised by the government. Data published by OECD show that the average indirect tax share of total tax revenue for all member countries in 2018 was 32.7% with standard deviation 7.9%. The member country with the highest share was Chile with 53.2% and at the other end was USA with 17.6%. The general trend in direct vs indirect tax ratio in total tax revenue over past decades in developed countries shows an increase in direct tax share of total tax revenue. Although this trend is also observed in developing countries, the trend is less pronounced there than in developed countries.
Indirect taxes have several uses, the most prominent one is to raise government revenue. Sales tax and value-added tax play the major role in this, with VAT being more commonly used around the world. The distinction between these two taxes is that sales tax is paid by the customer at the moment of purchase of the final good or service, whereas VAT is a multistage tax imposed on goods and services that is collected in parts at each stage of production and distribution of goods and services in proportion to the value added by each taxpaying entity.
Apart from the role in raising government revenue, indirect taxes, in the form of tariffs and import duties, are also used to regulate quantity of imports and exports flowing in and out of the country. In case of imports, by tariff imposition the government protects domestic producers from foreign producers that may have lower production costs, and thus are able to sell their goods and services at lower prices, driving domestic producers out of the market. After tariff imposition, imported goods become more expensive for domestic consumers, hence domestic producers are better-off than before tariff imposition.
Furthermore, indirect taxes in the form of excise taxes are used to reduce the consumption of goods and services that create negative externalities. For instance, an excise tax imposed on a pack of cigarettes increases the price of cigarettes, which leads to decreased consumption of cigarettes, which leads to the reduction of health conditions caused by smoking and second-hand smoking. Moreover, the tax discourages the youth from taking up smoking as they have quite elastic price elasticity of cigarette demand.
The concept of value-added tax 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 the goods and services tax, now in place in over 140 countries globally.
File:GDP per capita PPP vs indirect taxes 2016.svg|thumb|General government revenue, in % of GDP, from indirect taxes. For this data, the variance of GDP per capita with purchasing power parity is explained in 0 % by tax revenue.
Characteristics of indirect taxes
of indirect taxes is not clear, in fact, statutory incidence in most cases tells us nothing about economic incidence. The incidence of indirect tax imposed on a good or service depends on price elasticity of demand and price elasticity of supply of a concerned good or service. In case the good has an elastic demand and inelastic supply, the tax burden falls mainly on the producer of the good, whereas the burden of the good with an inelastic demand and elastic supply falls mainly on consumers. The only case when the burden of indirect tax falls totally on consumers, i.e., statutory and economic incidence are the same, is when the supply of a good is perfectly elastic and its demand is perfectly inelastic, which is, however, a very rare case. The shifting of the tax incidence may be both intentional and unintentional. In fact, economic subject may shift the tax burden to other economic subject by changing their market behavior. For example, tax imposed on the output of a firm's good may lead to higher consumer prices, reduced wages paid to firm's employees and reduced returns to firm's owners and shareholders or reduced supply of the good on the market, or any combination of mentioned consequences.Indirect taxes have a substantial regressive effect on the distribution of income since indirect tax is usually imposed on goods and services irrespective of consumer's income. In practice, the effective indirect tax rate is higher for individuals with lower income, meaning that an individual with lower income spends on a good or service higher proportion of their income than an individual with higher income. For example, consider a good with $100 sales tax imposed on it. An individual with the income $10,000 pays 1% of their income as the tax while a poorer individual with income $5,000 pays 2% of their income. Moreover, the regressivity of indirect tax systems affects the total progressivity of tax systems of countries given the importance of indirect tax revenues in government budget and the degree of regressivity of the indirect tax system, which ranges among countries. Furthermore, the extent of regressive nature of an indirect tax depends on the type of indirect tax. Empirical evidence suggests that excise taxes are in general more regressive than VAT. This could be attributed to the fact that excise taxes are levied on goods such as alcohol, tobacco, and these goods comprise a higher share of budgets among poorer households, while at the same time, poorer households are likely to consume goods with reduced VAT rates given that in some countries there is a VAT deduction on necessities such as food and medicine. As a result of the regressive nature of indirect taxes and the fact that they tend to be unresponsive to economic conditions, they cannot act as automatic stabilizers within the economy, unlike some of direct taxes.
Indirect taxes, specifically excise taxes, are attractive because they have a corrective nature. Such taxes raise revenue and at the same time they correct a market failure through increasing price of the good and thus decreasing its consumption. Therefore, less revenue needs to be raised through other taxes, which could be more distortionary, to cover the market failure. The economy benefits from the reduced extent of the negative externality and from lower reliance on other taxes that distort production. Apart from generating revenue and reducing the consumption of goods creating negative externalities, excise taxes can be tailored to impose tax burdens on those who cause the negative externality or those who benefit from government services. Examples are petrol tax, argued to be user fees for the government provided roads, and tobacco tax, imposed on smokers who through smoking create a negative externality of consumption. The design of such excise tax determines the consequences. Two main types of excise taxes are specific tax and ad valorem tax. Specific and ad valorem taxes have identical consequences in competitive markets apart from differences in compliance and enforcement. As for imperfectly competitive markets, such as the cigarette market, ad valorem taxes are arguably better as they automatically produce higher per-unit taxes when firms reduce production to increase prices, whereas specific taxes need to be readjusted in this case, which is administratively and legislatively difficult process.
Moreover, indirect taxes are usually associated with relatively lower administrative costs than direct taxes. In general, the administrative costs of tax system are determined by its complexity, and most costs associated with administering come from special provisions such as deductibility of certain categories of expenditures, which is typical for direct taxes such as personal and corporate income taxes. The indirect evidence may be drawn from the fact that developing countries have significantly lower direct-to-indirect tax ratio than developed countries given that choice of tax mix in developing countries is mainly based on administration and capacity issues. Developing countries used to heavily rely on trade taxes collected at centralized ports of entry into the country, which is associated with the relatively low cost of collection and enforcement. The relative importance of trade taxes in developing countries in recent years is on decrease due to trade liberalization, however, the drop of importance of indirect taxes in developing countries was partially offset by increases in the relative importance of domestic consumption taxes such as VAT. Empirical evidence suggests that income levels are associated with reduced reliance on expenditure taxes, countries with larger government size are more likely to rely more on direct taxes and that the countries prefer to use taxes for which there are relatively large tax bases available. At the same time, developing countries tend to have lower government size, which restricts them to have a more complex and efficient tax system, lower income levels in the country, and it is more practical for them to focus on taxing larger tax bases due to its lower administrative costs. Furthermore, different types of indirect taxes differ in terms of administrative costs. VAT, in which the large proportion of the revenue is generated by large corporations responsible for large part of the economy's values added has lower administrative costs than sales tax, in which the tax is imposed only at the final level in countless retail outlets of various sizes. Moreover, VAT is associated with relatively low administrative costs due to lower enforcement and collection costs due to the fact that VAT is collected throughout the production chain, which allows for the comparison of reported sales on each stage of the vertical production chain by the fiscal authority.