Budget 2026: What is indirect tax, how is it different from direct tax, how does it work?

Union Finance Minister Nirmala Sitharaman will present the Union Budget for FY2026–27 in Parliament on Sunday (February 1) at 11:00 am. Indirect taxes are likely to form a big part of this year's budget presentation as West Bengal, Kerala, Tamil Nadu, Assam, and Puducherry are slated to go to polls this year. 

What is indirect tax?

An indirect tax is a type of tax that is not paid directly to the government by the person who ultimately bears its cost. Instead, it is first collected by an intermediary such as a manufacturer, producer, or retailer and then built into the price of a good or service. As a result, the consumer ends up paying the tax indirectly when purchasing that product or service.

Indirect taxes are widely used by governments as a steady source of revenue because they are relatively easy to collect and are embedded in everyday transactions. Common examples include import and export duties, excise duties on products such as fuel, alcohol, and cigarettes, carbon emission fees charged at the production level, and certain types of sales taxes.

How do indirect taxes differ from direct taxes?

The key feature that distinguishes an indirect tax from a direct tax is the difference between legal liability and economic burden. In the case of indirect taxes, the party legally responsible for paying the tax (for example, a manufacturer paying excise duty) is not the same party that actually bears the cost. That burden is shifted forward to consumers through higher prices. This contrasts with direct taxes like income tax, where the individual earning the income both pays the tax and bears its cost.

How do indirect taxes work? 

When a tax is imposed at the manufacturing, production, or distribution stage, businesses usually incorporate that cost into the final selling price. Consumers may not see the tax listed separately, but they still pay it as part of the total price.

Indirect taxes are often described as regressive because they apply equally to all consumers, regardless of income level. This means lower-income individuals may spend a larger proportion of their income on these taxes compared to higher-income individuals, even though the tax amount is the same.