1.2.9 Indirect taxes and subsidies Flashcards
Indirect taxes
A tax levied on goods/ services rather than on an individual or company.
An indirect tax is collected by one entity in the supply chain, such as a manufacturer or retailer, and paid to the government. However, the tax is passed onto the consumer by the manufacturer or retailer as part of the purchase price of a good or service. The consumer is ultimately paying the tax by paying more for the product.
- An indirect tax is 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. There are two types of indirect tax:
1) Ad valorem
2) Specific
Ad valorem - indirect taxes
Where the tax payable increases in proportion to the value of the good. The tax is a percentage of the cost of the good, for example VAT.
Specific tax - indirect taxes
Where an amount is added to the price. The tax increases with the amount bought rather than the value of goods. For example, excise duties on alcohol, tobacco and petrol are a specific amount (e.g. 10p a litre).
Impact of tax on: Consumer
Higher prices and suffers from a tax burden of the orange area.
Impact of tax on: Producer
The producer sees a rise in costs and a fall in output, suffering from the tax burden of the grey area.
Impact on tax on: Government
The government gains tax revenue of the shaded areas.
Incidence of tax
The incidence of tax is the tax burden on the taxpayer.
Incidence of tax on consumers and producers
• If the demand curve (PED) is perfectly elastic, or the supply curve (PES) is perfectly inelastic, the supplier will pay all the tax. If the demand curve is perfectly inelastic, or 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.
• This means that, all other things being equal, the more inelastic the demand curve, the higher the revenue of tax for the government because quantity demanded falls less and the more goods that are bought, the higher the tax revenue.
Subsidies
A subsidy is a grant given by the government and is the opposite of a tax, an extra payment to encourage production/consumption of a good or service.
- They could be given to necessities e.g. bread, companies employing disadvantaged workers or those manufacturing in the UK to keep them competitive with imported goods.
Impact of subsidies on consumers, producers and the government
Taxes and subsidies - Synoptic point **
Taxes and subsidies can have macroeconomic effects. For example, subsidies can be used to encourage exports or protect domestic industries whilst indirect taxes can be regressive.
Both will have implications on the government budget.
