Indirect Tax

Question 1

Define the term “Indirect tax”

Answer 1

A tax on goods and services

Question 2

Name, define and give examples of indirect taxes

Answer 2

Specific Tax-a fixed amount charged per unit of a good/service
-excise, alcohol,tobacco duty
-fuel duty

Ad Valorem Tax- a percentage of the price of the good/service
VAT

Question 3

What is one drawback of an ad valorem tax

Answer 3

It is regressive because lower-income earners spend a higher proportion of income compared to higher-income earners

Question 4

Go on sketchpad and draw the effects of a specific tax on price and equilibrium quantity
(show consumer and producer incidence)

Answer 4

Have you shown
1.Size of tax
2.Vertical shift upwards by size of the tax
3.Consumer incidence on top
4.Producer incidence on the bottom
5.Incidences are separated by the line which starts from the original equilibrium
6.Increase in price
7.Decrease in equilibrium quantity
8.Use arrows to show shift
9. Middle triangle is the deadweight welfare loss

Question 5

Go on sketchpad and draw the effects of an ad valorem tax on price and equilibrium quantity
(show consumer and producer incidence)

Answer 5

1.New supply curve should start from the same point as the original supply curve
2.Curve should be getting steeper at higher prices
3.Consumer incidence on top
4.Producer incidence on the bottom
5.Incidences are separated by the line which starts from the original equilibrium
6.Increase in price
7.Decrease in equilibrium quantity
8.Use arrows to show shift
9.Middle triangle is the deadweight welfare loss

Question 6

Advantages of indirect taxation

Answer 6

-raise govt revenue
-internalises the external costs
-reduce negative externality

Advantages:
Discourages negative externalities: Indirect taxes, like carbon taxes or sin taxes (e.g., on cigarettes), can reduce harmful behavior (e.g., smoking, pollution) by increasing the cost of harmful goods.

Revenue generation: Indirect taxes provide a stable source of government revenue that can be used to fund public services or mitigate the impact of negative externalities.

Encourages efficiency: By taxing goods with negative externalities, the government can encourage firms and consumers to find more efficient or less harmful alternatives.

Question 7

Disadvantages of indirect taxation

Answer 7

-regressive in nature
-difficult to calculate
-reduction in competitiveness due to higher prices
-could lead to black markets
-Can have little effect on goods and services with inelastic PED

Regressive nature: Indirect taxes are typically regressive, disproportionately affecting lower-income individuals who spend a larger percentage of their income on taxed goods.

Inelastic demand impact: For products with inelastic demand (e.g., tobacco, fuel), consumers may not reduce consumption despite higher prices, limiting the effectiveness of the tax.

Encourages tax evasion: High taxes can lead to black market activities and tax evasion, undermining the policy’s intended effects.