1.4.1: Government Intervention in Markets (Indirect Taxation)

Question 1

What is indirect taxation?

Answer 1

• A tax levied on goods or services rather than on individuals or the company.

Question 2

When does the government introduce indirect taxation on goods?

Answer 2

• When the good has a negative externality, the government can introduce indirct taxation to prevent market faiure.

Question 3

What are advantages of indirect taxation?

Answer 3

• It internalises the externality; the market now produces at the social equilibrium position and social welfaire is maximised.
• It raises government revenue, which could be used to solve the externality in other ways such as through education; this may help goods to bvecome more elasic in the long run.

Question 4

What are the disadvantages of indirect taxation?

Answer 4

• It is difficult to know the size of the externality and so it is difficult to target the tax.
• There could be conflict between the government goal of raising revenue and solving the externality
• It could lead to the creation of a black market
• If demand for the good is inelastic, then the tax will be ineffective at reducing output.
• They are regressive, meaning they the poor spend a larger proportion of their income on indirect taxes than the rich do.