What Is The Difference Between Direct And Indirect Tax?

by Leon on March 11, 2013

direct and indirect taxNothing is certain in life, they say, except for death and taxes. We all have to deal with taxes in one way or another, which would lead the average person to believe that we all have a relatively firm grasp on what taxes we pay. On the contrary, most of us are surprisingly uninformed about our taxes and how they work. There are actually two kinds of taxes that all of us pay–direct and indirect. While we all pay these taxes, very few of us really understand the difference between them. In order to be an informed citizen and an intelligent consumer, it is important to know the difference between direct and indirect taxes.

Some taxes are relatively straightforward and simple, while others can be rather complicated. A direct tax, to begin, is a tax that is imposed directly onto a specific group of people or organizations, and collected directly from them. Income tax, for example, is a tax that is imposed directly onto people in the United States who earn an income. This tax is collected directly from them, either in the form of pay withholding or a personal payment after filing. When you pay your income tax, you are being taxed directly, and if you overpay on this direct tax you are issued a direct refund.

Indirect taxes work in a rather different way. When an indirect tax is imposed, the tax is collected from someone other than the individual or entity responsible for the tax. If that sounds unusual, or possibly even criminal, think about it on a deeper level to see what is really happening. Consider sales tax. Depending on the city and state in which you live, you might pay a tax of anywhere from zero to ten percent on the items you purchase. This sales tax is imposed on the vendors who sell the items, but it is absorbed by the consumers who buy them.

Direct taxes are relatively cut and dry. They are imposed upon specific groups of people, and collected from them based on the letter of the law. Indirect taxes, however, are much more flexible. Consider, for example, the taxes on items such as gasoline or tobacco. Again, the taxes are imposed on the vendors who sell them, but they are partially or entirely absorbed by the consumer. Vendors in many industries can choose how much of the tax burden they pass on to the consumer. Remember the case of sales tax. Most businesses couldn’t tolerate sending up to 10% of their sales profits to the government, but the average consumer will pay the tax willingly. In many ways, the burden of indirect tax is largely determined by market fluctuations.

Interestingly, indirect taxes have existed in the United States throughout its entire history, while no federal law mandated direct taxes until the early twentieth century. It is important to be informed on issues such as these, whether you’re attempting to claim tax back when leaving the UK, or trying to figure out your own tax burden as a consumer. Knowing about the taxes you pay will allow you to make informed decisions that will benefit you. No one enjoys paying taxes, but being informed about your civic duty will ensure that you make the most of it.

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