Chapter 8: Consumption and Indirect Tax Models

There is no formal definition of what constitutes an indirect tax (Kay & King, 1990). However, in common use it usually means those taxes that are levied on the sale of goods and services, and that are generally collected and remitted by the vendor of those goods and services, rather than the purchaser. Examples of such taxes include excise duties, sales taxes, value added taxes (VAT), and import or export duties.

Indirect taxes thus defined have two characteristics in which they differ from direct taxes such as income tax. First, because in most instances it is not possible to identify the consumer (and thus their personal characteristics) as opposed to the purchaser of a good, the amount of tax paid on a particular purchase is usually (but not always) the same for everyone;¹

otherwise, an arbitrage opportunity would exist, with those facing low tax rates able to purchase goods and sell them on to those facing higher tax rates. Second, the tax schedule is generally linear – the same tax rate applies to the first dollar of spending on a particular good or service as does on the millionth dollar. There are exceptions to these rules of course: some price subsidies – which can be considered as a negative indirect tax – are available only to certain parts of the population, and on a limited amount of expenditure; and some durable purchases, such as housing or cars, are subject to non-linear tax schedules where rates are higher for more expensive purchases. But generally, linear tax schedules unrelated to purchaser characteristics apply. These features considerably simplify data requirements and calculations in indirect tax micro-simulation (relative to direct tax and benefit micro-simulation, for instance).