1.2.9 Indirect Taxes and Subsidies Flashcards
What are indirect taxes?
- A tax on expenditure where the person who is ultimately charged the tax is not the person responsible for paying the sum to the government.
- The business is required to pay the tax but the customer is charged instead
What are the two types of indirect taxes?
- Ad Valorem tax
- Specific tax
What is Ad Valorem tax?
- Where the tax payable increases in proportion to the value of the good
- The tax is a percentage of the cost of the good
Give an example of Ad Valorem tax
VAT
What is specific tax?
- Where an amount is added to the price
- The tax increases with the amount bought rather than the value of goods
Give an example of a specific tax
Excise duties on alcohol, tobacco and petrol
What causes supply to shift from S1 to S2?
The introduction of tax causes supply to shift because it leads to an increase in the cost of production.
What is the knock on effect after the shift from S1 to S2?
- Leads to a rise in price from P1 to P2
- A fall in output from Q1 to Q2
What do the consumers see?
- Higher prices and suffers from a tax burden of the orange area
What do the Producers see?
- A rise in costs and a fall in output, suffering from the tax burden of the grey area
What is the government tax revenue?
Area of shaded areas (ABxQ2)
What is the size of the tax?
The vertical distance between S1 and S2, shown by the line AB
Shown is an ad valorem tax diagram.
What’s the difference between a specific and Ad Valorem tax diagram?
- The effects are the same but the supply curve shifts and tilts
- This is so that the hap between S1 and S2 grows
Why does the gap between S1 and S2 grow?
- Because its an Ad Valorem tax
- The tax is a percentage of the value
- When the price is small, the tax will only be a small amount but when the price is high, the tax will be a large amount
What is the incidence of tax?
The tax burden on the taxpayer
What happens if the demand curve is perfectly elastic?
- The supplier will pay all the tax
What happens if the supply curve is perfectly inelastic?
- The supplier will pay all the tax
What happens if the demand curve is perfectly inelastic?
- All the tax will be passed on to the consumer
What happens if the supply curve is perfectly elastic?
- All the tax will be passed on to the consumer
In general, the more elastic the demand curve, or the more inelastic the supply curve….
The lower the incidence of tax on the consumer (meaning the supplier has to pay more)
Ceteris Paribus, the more inelastic the demand curve…
- The higher the tax revenue for the government because quantity demanded falls less and the more goods that are bought, the higher the tax revenue
What is a subsidy?
A grant given by the government and is the opposite of a tax.
What is the reason for a subsidy?
To encourage production/consumption of a good or service
Give examples of subsidies occurring.
- Given to necessities, e.g. bread
- Companies employing disadvantaged workers
- Those manufacturing in the UK to keep them competitive with imported goods
What causes supply to shift from S1 to S2?
The producer sees a fall in production costs due to the subsidy
What is the knock on effect after the shift from S1 to S2?
- There is a rise in output from Q1 to Q2
- A fall in price from P1 to P2
What is the consumer subsidy?
Orange box
What is the producer subsidy?
Grey Box
What is the producer subsidy?
Grey Box
What is the government spending?
- The total shaded area (ABxQ2)
