The difference between direct & indirect taxes

Written by jason chavis
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The difference between direct & indirect taxes
Many goods and services have either direct or indirect taxes. (Image by Flickr.com, courtesy of Mike Licht)

Economists often refer to the difference between direct and indirect taxation. When the government imposes some sort of tax, it can either be directed toward a specific target or spread out to what the market allows. Certain laws exist defining the limitations of what can be directly or indirectly taxed.

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Function

Direct taxes, in terms of economics, are any taxation levied directly on an individual from an exchange of funds. Indirect taxes are levied as a result of this exchange.

Significance

According to InvestorGuide.com, the law can dictate where an indirect or direct tax comes from. However, it cannot determine the way those funds are collected through indirect taxation. When a tax is placed on a particular item, the cost of the item increases to accommodate according to market forces to pay the tax.

Effects

Direct taxation can become indirect taxation through market forces. For example, sales tax is levied as a direct tax on retailers, but is paid indirectly through the customer.

Considerations

The U.S. Constitution and the Supreme Court define a major difference between direct and indirect tax. Direct taxes are applied to tangible concepts like property, while indirect taxes are applied to a usage of those taxes, as in the sale of the property.

History

There was no federal law mandating direct taxes, except when apportioned, until 1913 with the passage of the 16th Amendment. Indirect taxes have been applied since the start of the United States.

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