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Indirect taxation consumer impact
Consumers pay a share of the tax P1P2BE due to
higher prices from P1 to P2, reducing their consumer surplus. The poor will suffer proportionately more
than the rich. As indirect taxes are regressive, meaning they take a greater proportion of the
poor’s income than they do of the rich which could widen income inequality in society.
Consumers are burdened even more if the demand for the product is price inelastic due
to the good being addictive in nature perhaps. In this sense, producers know that they can transfer
more of tax onto consumers with there being a proportionately smaller decrease in quantity demanded
burdening low income consumers the most. The opposite is true where demand is price elastic. In this
case, the burden of the tax will fall more heavily on producers knowing that increases in price would
lead to large falls in total revenue.
Consumers suffer short term pain from this tax but there may be a long term gain if such
taxes generate enough revenue for there to be greater spending on social goods and services in the
economy such as education, healthcare and infrastructure which would improve the lives of poor in
particular who rely m o r e heavily on these services.
If the government is looking to discourage consumption of a de-merit good, in this sense
solving a market failure, it can be argued that burdening consumers is a weak argument as this is the
exact intention of the policy. Reducing consumption, production and thus quantity in the market from
Q1 to Q2 could well be reaching the socially optimum level of output increasing welfare in the market
and not generating a welfare loss as the diagram suggests.
EVAL
Indirect taxation on producers
Producers suffer as this tax raises their costs of production where they have
to pay a share of the tax to the government indicated by the rectangle PECD, leading to a fall in
revenue from P1AQ10 to CDQ20. This could mean reducing the size of their workforces due to the lower
quantity produced in the market to reduce their costs and remain profitable impacting on workers by
increasing unemployment.
EVAL
This argument is very strong if demand is price elastic. However if demand is price inelastic,
producers can transfer most of the tax burden onto the consumer without suffering such a large
decrease in revenue. Workers may also not lose their jobs as quantity in the market will not decrease
significantly.
Indirect tax impact on government
The government will impose an indirect tax for two reasons, either to raise
revenue of P2BCD or to solve a market failure where over-production exists. In
this sense the tax is in the government’s interests, benefiting in both ways. This allows for long term
spending on key areas of the economy such as health, education and infrastructure. If this tax is
implemented to solve market failure, the revenue could be used to further reduce consumption through
advertising campaigns or subsiding the production of better alternatives.
EVAL
By burdening both consumers and producers so heavily, there is a net loss of both consumer
and producer surplus in the market leading to an overall deadweight welfare loss of society surplus
indicated by the triangle ABC. If the market was working efficiently, initially allocating scarce resources
as socially desired, the government is now distorting that efficient allocation generating a welfare loss
causing government failure if the value of the loss exceeds the tax revenue gained. This argument is
reduced however if the government has solved a market failure given a pre-existing misallocation of
resources. In this sense, the government in reducing quantity in the market will increase society surplus
improving welfare in the market and the allocation of resources.
Benefit of subsidy on consumer
-Lower prices= increased consumer surplus
-Now purchase Q1 units as before but at lower price leading to savings of P1P2XY
-Quantity increased form Q1 to Q2 = increased output and choice
EVAL
