16- Indirect Taxes

Question 1

What is an indirect tax?

Answer 1

A tax on consumption

Question 2

Examples of indirect taxes?

Answer 2

VAT and Excise duties

Question 3

Taxation definition

Answer 3

The medium through which governments finance their spending and control the economy.

Question 4

What is an ad valoerm tax?

Answer 4

A tax based on the value of the good being sold. They increase the price by a fixed percentage.

Question 5

What is a specific tax?

Answer 5

A tax paid by unit. They increase the cost of production by the tax amount on each unit and leads to a decrease in supply.

Question 6

What is a direct tax?

Answer 6

A tax based on wealth and income.

Such as income tax, interest rates and profits

Question 7

What is the incidence of tax?

Answer 7

It measures the burden of tax upon the tax payer.

Question 8

What factor determines the incidence of tax?

Answer 8

The elasticity of demand

Question 9

Link between elasticity of demand and incidence of tax?

Answer 9

The more inelastic demand, the more of the tax is passed onto consumers, and less is absorbed by firms.

Question 10

Impact of indirect taxes on governments

Answer 10

Indirect Taxes generate revenue for the government. These revenues can then be spent on capital investment (e.g hospitals for the NHS) or transfer (welfare) payments.

Question 11

Impact of indirect taxes on consumers

Answer 11

• If demand was perfectly inelastic, then the demand curve would be vertical - so the quantity demanded wouldn’t change but price would.
• The burden of the tax would fall completely on the consumer.
• If demand was perfectly elastic (horizontal demand curve) then the burden would fall completely on the producer.

Question 12

Impact of indirect taxes on producers

Answer 12

• If demand is inelastic, then the consumers bear the whole burden of an indirect tax
• If demand is elastic, the producers bear the whole burden of an indirect tax

Question 13

What is consumer incidence of tax?

Answer 13

The proportion of total tax revenue paid by consumers (for indirect taxes)

Question 14

Wprophat is producer incidence of tax?

Answer 14

The proportion of total tax revenue paid by producers (for indirect taxes)

Question 15

What is a progressive tax?

Answer 15

A tax that takes a higher proportion of income as income rises
E.g UK tax brackets

Question 16

What are the UK tax brackets?

Answer 16

£0-12,500- personal allowance
£12,501- 50,000 - 20% income tax
£50,001- 150,000- 40% income tax
£150,001+ 45 % income tax

Question 17

What is a Regressive tax?

Answer 17

A tax that takes a higher proportion of income as income falls
E.g Indirect ad valoerm taxes like VAT.
A smoker on a lower income will spend a larger % of income on VAT for cigarettes as someone who earns more.

Question 18

What is a proportional tax?

Answer 18

A tax that takes the same proportion of income regardless of the level of income.
E.g like in some US states

Question 19

What is a proportional tax?

Answer 19

A tax that takes the same proportion of income regardless of the level of income.
E.g like in some US states

Question 20

What does the right tax rate allow?

Answer 20

The tax rate, in theory, allows the socially optimal quantity to be achieved

Question 21

Why is it hard to set the right tax rate?

Answer 21

Because in reality it is virtually impossible to measure the value of externalities.

Question 22

What is the problem with the cost of tax collection?

Answer 22

If a tax is difficult/expensive to collect , then it may not be worth imposing it.

Question 23

Points in favour of a sugar tax?

Answer 23

• External costs of sugary drinks I.e cause of market failure
• Information failures- people underestimate long term costs
• Sugar tax raises revenue- perhaps ringfenced for other projects such as school sports
• Tax encourages producers to re-formulate drinks- healthier

Question 24

Points against sugar tax?

Answer 24

• Might be regressive on lower income families/households
• Other policies might be more effective in cutting consumption
• People might simply switch to other sugar products
• Risk of lost jobs in pubs and shops that rely on drink sales