Indirect Taxes

Question 1

Indirect tax

Answer 1

Indirect taxes are taxes on expenditure. An indirect tax is imposed on producers so a tax increases the costs of a business causing an inward shift in the supply curve. The original pre tax equilibrium is P1Q1

An indirect tax is charged on producers of goods and services and is paid by the consumer indirectly.

• Examples = VAT, excise duties (cigarette and alcohol tax) and import levies

Question 2

Why impose indirect taxes - micro

Answer 2

To change (a) the level of demand of (b) the pattern of demand for different goods and services

(A) - to deter and reduce the consumption of goods and services considered to be harmful (demerit goods)

(B) - To encourage the longer term conservation of scarce economic resources (e.g fuel)

Question 3

Why impose indirect taxes - macro

Answer 3

• To raise Tax revenue to fund government spending
• To help manage the macroeconomy - impact on consumption (AD) and cost on producing (AS)
• Changing the distribution of income and wealth

Question 4

Indirect taxes in markets

Answer 4

• An indirect tax is a tax imposed by the government that increases the supply costs faced by producers
• The amount of tax is always shown by the vertical distance between the two supply curves
• A specific tax is a set tax per unit - parallel supply curves
• An ad valoren tax is a percentage tax - diverging supply curves
• Because of the tax, less can be supplied at each price level
• The result is an increase in the market price and a contraction in demand to a new equilibrium output

Question 5

Specific tax

Answer 5

Question 6

Effect of elasticity

Answer 6

Question 7

Arguments against indirect taxes

Answer 7

Question 8

Evaluation arguments

Answer 8

Question 9

PED = 0 and PES = infinity

Answer 9

Question 10

AD valorem tax

Answer 10

Is a tax that is based on the value of an item. This means that the amount of tax you pay is proportional to the value of the item.

• The tax is usually expressed as a percentage
• For example, in the UK, VAT is charged at 20% on most goods offered for sale.

Question 11

AD valorem tax diagram

Answer 11

Question 12

Excise duties

Answer 12

Excise duties in the UK are indirect taxes levied on three major categories of goods – alcoholic drinks, tobacco products and road fuels. Generally, excise duties are charged a flat (or specific) rate: a certain number of pence per pint, per litre, per packet - though tobacco is subject to an additional ad valorem tax.

Question 13

What are the main justifications for governments to intervene using indirect taxes?

Answer 13

• A key source of tax revenue to pay for overall government spending
• Can be used to change consumer and producer behaviour such as the sugar tax or carbon taxes – this might alter the pattern of demand for goods and services
• Helps to address examples of market failure – an example is the landfill tax (to encourage recycling) and the sugar tax to combat diabetes and control health costs
• Indirect taxes such as import duties can be used to improve a country’s trade balance

Question 14

What impact do indirect taxes have on the level of income inequality?

Answer 14

• A regressive tax is a tax imposed by a government which takes a higher percentage of someone’s income from those on low incomes. This means that those with lower incomes pay more in tax relative to their income.
• If we look at indirect taxes paid as a share of household disposable income, then they are regressive
• The highest percentage is paid by families in the poorest quintile of the income distribution
• However, indirect taxes measured as a share of household spending shows a broadly proportional impact