Table of Contents

Stealth Taxes: What They Are, How They Work

By

Julia Kagan

Updated January 31, 2024

Reviewed by

Michelle P. Scott

Fact checked by

Michael Logan

What are Stealth Taxes?

Stealth taxes are an indirect form of taxation that goes unnoticed by the party who ultimately pays it. The defining feature of a stealth tax is that a formal taxpayer passes tax costs along to others in the form of higher prices or lower dividends. In such cases, the final payer of the tax is unaware that they are shouldering the burden.

Governments use stealth taxes to increase revenue without raising the ire of taxpayers. Stealth taxes can also arise from government regulations that do not directly raise any tax revenue, but still increase the cost of doing business.

Key Takeaways

Stealth taxes are a form of taxation that isn't immediately obvious to the party paying it.
Stealth taxes are typically levied on businesses, which then pass them along to shareholders, customers, workers, or other parties.
For instance, stealth taxes are often built into a product's price, in which case consumers may be unaware of how much of a price is going toward tax costs.
Stealth taxes can occur without any formal tax getting paid to the government.

Understanding Stealth Taxes

Stealth taxes are commonly built into product prices, leaving consumers unware of exactly how much tax they are paying. While personal income taxes and property taxes are visible, stealth taxes are less so, and therefore attract less scrutiny.

Governments find stealth taxes easier to collect than other types of taxes because they are imposed at the point of sale and do not depend on a taxpayer's income level. Stealth taxes can also refer to the removal of existing tax breaks.

The most common stealth tax is an income tax imposed by a government on a business's profits. In this case, the government levies a tax against a business rather than individuals who patronize the business. The business may pay the tax first, however it passes along the tax cost to other parties, such as its customers in the form of higher prices. Another common example of a stealth tax is that which might be paid by shareholders in the form of lower returns. Stealth taxes can also affect employees in the form of lower wages and benefits.

This occurs even though the government initially charges the business. Because the business functions as a pass-through to organize economic activity and distribute the income that results, the burden actually falls on parties other than the business itself.

Stealth taxes can vary, depending on the kind of tax, specific tax provisions, and the ability of various parties to avoid or shift the tax onto others. Stealth taxes can vary by jurisdictions and often overlap, such as when states, counties, and municipalities each levy their own taxes. A common example of this practice is value added tax (VAT), which is common in Western Europe.

Stealth taxes are usually levied against some kind of business entity or organization that is situated to pass the tax onto someone else. They can take the form of business income taxes, sales taxes, property taxes, fees, surcharges, business licensing and permitting costs, among others.

What Is An Example of a Stealth Tax?

Most taxes are not explicitly defined as stealth taxes. However, some taxes may appear to have the qualities of a stealth tax, such as when tax costs are passed along to consumers.

In New Mexico, for instance, there isn't an outright sales tax. However, the state does have a gross receipts tax, which it imposes on people doing business in the state. Frequently, people doing business will pass the cost of this tax onto consumers, such as by rolling it into the sale price. In such a scenario—where a consumer is not aware of how much a product price is meant to cover tax costs—this can be a form of a stealth tax.

What Is Tax Drag?

Tax drag refers to a reduction in potential income due to taxes. It's commonly used when discussing returns on investments. A tax drag is evident when comparing returns in tax-sheltered investment vehicles, like a Roth IRA, versus an unsheltered account.

Is There Anything in the U.S. That Isn't Taxed?

While most forms of income and purchases of goods and services are taxed, there are certain categories that are exempt from taxation. A common example is the value of employer-provided health coverage. This is not included as income and not taxable. For the most part, life insurance payouts aren't taxed. In a handful of states, earned income is not taxed at the local level. Income from investments in tax-sheltered accounts, such as a Roth IRA, are also not taxed.

The Bottom Line

Stealth taxes are a form of indirect taxation, in which the party that ultimately bears the tax burden isn't fully aware of it. This happens in commerce when a business passes tax costs to other parties. For instance, a business may roll the cost of its own taxes into the price tag it charges consumers for goods and services. A company might reduce the dividends that it pays shareholders to make up for its tax burden. An employer might shrink benefits for workers if it encounters an increase in taxes. In such cases, the cost of taxes are ultimately borne by a party that isn't the formal entity responsible for it.

Article Sources

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Taxation & Revenue New Mexico. "What Is New Mexico's Sales Tax Rate?"

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