1.4.1 Indirect Taxes Flashcards
what is an indirect tax
a tax on expenditure
what is the difference between an ad valorem and a specific tax
ad valorem - percentage
specific - flat rate
what is the result of an indirect tax (externalities)
increases costs to the producer which internalises the externality - the market now produces at the social equilibrium position and social welfare is maximised
the tax increases MPC to equal MSC at all output levels
how do indirect taxes reduce market failure
consumption of the good with the negative externality will fall
what is a hypothecated tax
the hypothecation of a tax is the dedication of the revenue from a specific tax for a particular expenditure purpose
what are the pros of indirect taxation
- reduce supply and consumption of demerit goods
- raises revenue for government
- holds the first party responsible for their actions
- raises awareness
- internalises external costs
explain how indirect taxation reduces supply and consumption of demerit goods
increases costs, reduces supply and therefore reduces consumption of demerit goods/goods with negative externalities to the socially desirable level
explain how raising revenue for the government is a benefit of indirect taxation
raises government revenue so they can be hypothecated and used to further reduce market failure
explain how raising awareness is a benefit of indirect taxation
raises awareness of higher private costs and negative externalities associated with the product, thereby overcoming some information failure
explain how internalises external costs is a benefit of indirect taxation
taxes work with market forces as they internalise the external costs and enables the socially optimum output level to be attained
what are the cons of indirect taxation
- regressive tax
- hard to measure externalities
- can reduce competitiveness of UK firms
- excess burden of tax
- unintended consequences may arise e.g smuggling
explain how regressive tax is a con of indirect taxation
indirect tax is a regressive tax, meaning those on lower incomes pay a higher proportion of their income than higher earners and this is unfair
explain how hard to measure externalities is a con of indirect taxation
taxation requires a reliable method to value the externality. This is known as shadow pricing but is complex and subjective in reality
explain how indirect taxes reduce the competitiveness of UK firms
some taxes on external costs can reduce the competitiveness of UK firms as prices increase and lead to a fall in export sales. It may also encourage firms to relocate to outside the UK to avoid the tax
explain how excess burden of tax is a con of indirect taxation
there is an excess burden of tax - an area of consumer and producer surplus that is lost and not reclaimed in government tax revenue
what does the impact of indirect taxes depend on
- PED
- size of tax
- reliability of shadow pricing
how does PED affect the impact of an indirect tax
if a product is very price inelastic, a tax will make little difference to the quantity consumed, hence little correction to market failure
how does size of tax affect the impact of an indirect tax
a large tax causes prices to rise significantly so may have more of an impact
how does reliability of shadow pricing affect the impact of an indirect tax
if the external cost is not valued correctly, the tax may not be large enough. hard to achieve as subjective
