2.11 Government Intervention

Question 1

What is an indirect tax?

Answer 1

A charge paid to government based on the spending on a good or service

Question 2

What is a specific tax (unit tax)?

Answer 2

A certain fixed sum charge per unit of the good or service

Question 3

What is an “Ad valorem” tax?

Answer 3

A tax applied “according to value”, such as a percentage of the selling cost of the good or service

Question 4

What are the advantages of using an indirect tax to correct market failure?

Answer 4

• Is a market-based measure to reduce production and consumption of demerit goods/products that result in negative externalities - may be a more efficient intervention than alternatives
• Use of a tax collects revenue for government which can be used to increase spending on other economic activities to correct market failure

Question 5

What are the disadvantages of using an indirect tax to correct market failure?

Answer 5

• Indirect tax is regressive in nature - takes a greater proportion of income from those on low income
• It is very difficult to determine the correct level of tax
• Price inelastic demand will require tax to be very high to discourage consumption
• Burden of taxation

Question 6

What is a hypothecating tax?

Answer 6

A tax which is collected where the revenue is designated for a specific purpose

Question 7

What are some evaluation points for use of indirect tax?

Answer 7

• The size of the tax imposed
• The PED of the good/service
• Other factors affecting the market - all else may not stay the same
• Costs associated with the intervention (opportunity cost)
• Equity