1.2.9. Indirect taxes and subsidies

• What is an indirect tax?

  An indirect tax is a tax on expenditure where the person charged is not the one paying the government.
• What are the two types of indirect taxes?

  Ad valorem tax and specific tax.
• How does an ad valorem tax work?

  It increases in proportion to the value of the good, being a percentage of the cost.
• How does a specific tax work?

  A specific tax adds a fixed amount to the price, increasing with the amount bought.
• If the initial equilibrium price is £5 and a £2 tax is imposed, what price does the business receive when charging £5?

  The business receives £3 after the tax is passed to the government.
• What is the incidence of tax?

  • The incidence of tax is the tax burden on the taxpayer.
  • If demand is perfectly elastic or supply is perfectly inelastic, the supplier pays all the tax.
  • If demand is perfectly inelastic or supply is perfectly elastic, the consumer pays all the tax.
• How does elasticity affect the incidence of tax on consumers and suppliers?

  • More elastic demand or inelastic supply means lower incidence of tax on consumers.
  • Suppliers pay more tax in such cases.
  • More inelastic demand leads to higher tax revenue for the government.
• What is a subsidy?

  • A subsidy is a grant given by the government to encourage production or consumption.
  • It is the opposite of a tax.
  • Subsidies can be given for necessities or to keep businesses competitive.