1.2.9 - indirect taxes and subsidies Flashcards
What is an indirect tax?
An indirect tax is a tax levied on expenditure on goods or services where the individual who is ultimately charged the tax is not responsible for paying the sum to the government [consumer burden + producer burden], raising the cost of a good.
Who pays an indirect tax, and who bears the cost?
The business is required to pay the tax but the customer is charged instead.
How does an ad valorem tax work?
Ad valorem tax is where the tax payable increased in proportion to the value of the good. The tax is a percentage of the cost of the good.
How does a specific tax work?
Specific tax is where an amount is added to the prices. The tax increases with the amount bought rather than the value of goods.
What does tax incidence refer to?
The incidence of tax is the tax burden on the taxpayer.
How does tax incidence change when demand for a good is price elastic and the supply is inelastic?
If the demand for a good is price elastic, then the tax will fall mainly on the producer as they will be unable to put up prices without losing a lot of demand. If the supply of the good is inelastic, the producer cannot easily reduce quantity supplied, so they bear even more of the tax burden.
How does tax incidence change when demand for a good is price inelastic and the supply is elastic?
If the demand for a good is price inelastic, then the tax may fall mainly on the consumer as the producer can put up prices without losing a lot of demand. Despite the higher tax revenue for the government, the tax is ineffective at reducing output for certain goods (e.g. cigarettes, fuel). If the supply is elastic, producers can adjust production more easily, further shifting the burden of the tax onto consumers.
What is a subsidy?
A subsidy is a grant given by the government, the distance between S1 and S2 (AB), an extra payment to encourage production/consumption of a good or service, lowering the cost of a good.
Why might the government provide subsidies for certain goods?
This government spending [consumer gain + producer gain] could be given to necessities in the UK to keep them competitive with imported goods.
How does tax incidence change when demand for a good is price elastic?
If the demand of a good is price elastic, then the subsidy will mainly benefit the producer as they will not have to cut price much to gain more demand.
How does tax incidence change when demand for a good is price inelastic?
If the demand for a good is price inelastic, then the subsidy mainly benefits consumers as the producer has to put prices down a lot to gain a small increase in demand. Despite it being cheaper for the government to impose, it is ineffective at increasing output and government have to pay subsidy on less goods.
