Indirect Tax

An indirect tax is a tax that is collected by an intermediary, such as a shop, manufacturer or importer, and paid to the government, while its cost is passed on to the final buyer through higher prices. The most common indirect taxes are value added tax (VAT), general sales tax, excise duties on items such as fuel, tobacco and alcohol, and customs duties on imports. The business files the return and hands over the money, but the economic burden usually falls on consumers.

Indirect taxes are the counterpart of the direct tax, which is levied on a person's income, profits or wealth. Together they make up most of a government's taxes. Indirect taxes are attractive to governments because they are hard to avoid and cheap to collect, but they weigh more heavily on poorer households, who spend most of what they earn.

Picture a toll booth at the entrance to a market. Every lorry bringing goods in pays the toll, and the traders quietly add it to the price of what they sell. Shoppers never meet the toll collector, yet they end up paying the toll in the price of their rice and soap.

That is how an indirect tax works. The government collects from a few businesses rather than millions of shoppers, and the tax travels down the chain into the shelf price. People pay it without filling in any form, often without knowing how much of the price is tax.

• Value added tax (VAT). A tax charged at each stage of production and sale on the value added at that stage. Each business charges VAT on its sales and deducts the VAT it paid on inputs, so the full tax ends up on the final consumer price. More than 170 countries use a VAT or a similar goods and services tax.
• Sales tax. A tax charged once, usually at the retail stage, as with most US state sales taxes.
• Excise duties. Specific taxes on particular products such as fuel, cigarettes, alcohol, sugary drinks or mobile phone services, often set per unit.
• Customs duties and tariffs. Taxes on imported goods, collected at the border; they also shape international trade.
• Stamp duties and transaction taxes. Charges on documents, property transfers and some financial transactions.

VAT collected at each stage equals tax on sales minus tax already paid on inputs:

• $\text{Sales}$ is the value of the business's sales before tax.
• $\text{Purchases}$ is the value of taxable inputs it bought.
• $r$ is the VAT rate, written as a decimal.

Worked example at a 10% rate: a farmer sells cotton to a mill for 100 and pays 10 in VAT. The mill sells cloth to a tailor for 250, charges 25 and pays $25 - 10 = 15$. The tailor sells a shirt to a customer for 400, charges 40 and pays $40 - 25 = 15$. The government receives $10 + 15 + 15 = 40$, exactly 10% of the final price, and the customer bears all of it.

Who bears an indirect tax depends on how buyers and sellers respond to price changes. When demand is inelastic, as for fuel, medicine or staple foods, sellers can pass almost the whole tax to consumers. When demand is elastic, sellers may absorb part of it in lower margins. This is why excise taxes are placed on products people keep buying even when prices rise.

Indirect taxes are usually regressive: a poor family spending all its income pays a larger share of that income in VAT than a rich family that saves much of its income. Many countries soften this by exempting or zero-rating food, medicine and education. Indirect taxes also raise measured prices, so a VAT increase shows up as a one-off jump in the Consumer Price Index (CPI) and in inflation, and reduces households' purchasing power.

Their advantages are real too. They are hard to evade once goods pass through registered businesses, they reach people in the informal economy who pay no income tax, and they do not directly penalise saving or investment. Smuggling, under-invoicing and fake input claims are the main ways they leak.

Pakistan relies heavily on indirect taxes. At the federal level the Federal Board of Revenue (FBR) collects sales tax on goods under the Sales Tax Act 1990, at a standard rate of 18%, along with federal excise duty and customs duty. Since the 18th Constitutional Amendment of 2010, sales tax on services is levied by the provinces through their own revenue authorities. According to FBR's provisional figures for FY2024-25, sales tax brought in about Rs 3.9 trillion, federal excise about Rs 1.3 trillion and customs about Rs 0.8 trillion, together roughly half of FBR's collection.

Many of Pakistan's withholding taxes on transactions, although booked as withholding tax under income tax, are passed into prices and behave like indirect taxes. Changes in sales tax, petroleum levies and duties are watched closely because they move the weekly Sensitive Price Indicator (SPI) and the monthly Wholesale Price Index (WPI). Duties on imports also interact with the exchange rate: when the Pakistani Rupee (PKR) weakens, duty charged on the rupee value of imports rises with it. Heavy reliance on these taxes helps fund government spending but is often criticised for its burden on lower-income households.

• Federal Board of Revenue (Pakistan)
• Pakistan Economic Survey 2024-25 (Finance Division)