2.11 Government Intervention (Indirect Tax and Subsidy) Flashcards
What is an indirect tax?
A charge paid to government based on the spending on a good or service
What is a specific tax (unit tax)?
A certain fixed sum charge per unit of the good or service
What is an “Ad valorem” tax?
A tax applied “according to value”, such as a percentage of the selling cost of the good or service
What are the advantages of using an indirect tax to correct market failure?
- 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
What are the disadvantages of using an indirect tax to correct market failure?
- 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
What is a hypothecating tax?
A tax which is collected where the revenue is designated for a specific purpose
What are some evaluation points for use of indirect tax?
- 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
What is a subsidy?
A payment by government to producers (or consumers) to encourage an increase in the production and consumption of a good or service
What are the advantages of using a subsidy to correct market failure?
- A subsidy is a market-based measure and may be a more efficient intervention than alternatives
- Subsidies are progressive in nature -> reduces inequality and may be seen as being more equitable/fair
What are the disadvantages of using a subsidy to correct market failure?
- It is difficult to determine the correct level of subsidy
- There is an opportunity cost associated with the use of government spending
- May lead to high cost producers becoming less efficient in production due to the protection the subsidy offers them
- Price inelastic demand will mean a subsidy may need to be very high to encourage consumption
- Using subsidies may encourage corruption
What are some evaluative points for the use of subsidies?
- The size of the subsidies paid
- The PED of the good/service
- Other factors - everything else may not stay the same
- How the subsidy payments are funded (opportunity cost)
- Effectiveness of the intervention in improving efficiency in the allocation of resources
What is government failure?
When government intervention leads to less total social welfare than if the market was left to operate without government intervention
