Indirect Taxation and Subsidies (Pack 12)

• What is the definition of 'indirect tax'?

  Tax that is put on goods and services, not on income.
• How does a specific tax affect a product with price inelastic demand?

  • Diagram shows tax imposed
  • Price remains relatively stable
  • Total revenue raised significantly increases
  • Incidence of tax on producer is lower
  • Incidence of tax on consumer is higher
• How does an ad valorem tax affect a product with price elastic demand?

  • Diagram shows tax imposed
  • Price changes significantly
  • Total revenue raised may decrease
  • Incidence of tax on producer is higher
  • Incidence of tax on consumer is lower
• How do taxes correct market failure caused by negative externalities?

  They internalize external costs into market prices.
• What are the benefits of using a tax to correct market failure?

  1. Generates government revenue
  2. Discourages harmful consumption
  3. Encourages alternative behaviors
  4. Can fund public goods and services
• What are the drawbacks of using a tax to correct market failure?

  1. Can be regressive
  2. May lead to black markets
  3. Administrative costs can be high
  4. Potential for tax avoidance
• What is the step-by-step effect of a subsidy on a market?

  Increases supply, lowers prices, boosts consumption.
• How does Price Elasticity of Demand (PED) affect the effectiveness of a subsidy?

  • Higher PED means greater consumption increase
  • Lower PED means smaller consumption increase
  • Effectiveness varies with demand sensitivity
• What are the benefits and drawbacks of a subsidy?

  Benefits:

  1. Lowers prices for consumers
  2. Encourages production
  3. Supports new industries

  
  

  Drawbacks:

  1. Can be costly for government
  2. Risk of dependency
  3. May distort market signals
• What is the definition of ‘specific tax’?

  A type of indirect tax where the tax rate is a fixed amount per unit of the taxable good or service
• What is the definition of ‘ad valorem tax’?

  A type of indirect tax where the tax rate is a percentage of the value of the taxable good or service e.g. VAT
• How does a specific tax affect a product with price elastic demand?

  • Diagram shows tax imposed
  • Price remains relatively stable
  • Total revenue raised increases
  • Incidence of tax on producer is higher
  • Incidence of tax on consumer is lower
• How does an ad valorem tax affect a product with price inelastic demand?

  • Diagram shows tax imposed