Topic 11: Taxtation & Subsidies

• Perfectly Elastic – Only the producer gains
• Taxation can be classified into two categories: direct and indirect taxation.
• Direct taxation is a taxation on income which includes taxes like income tax, profits tax, and wealth taxes on inheritance.
• Indirect taxation is a taxation on expenditure which includes taxes like VAT, excise duties (tax on cigarettes, alcohol etc.).
• Indirect taxation is a tax on spending.
• Specific tax is a fixed amount of tax placed on a particular good, also referred to as a per-unit tax, and the tax will depend on the quantity sold (not price).
• Deadweight loss, also known as excess burden, is a measure of lost economic efficiency when the socially optimal quantity of a good or a service is not produced.
• The vertical distance between the new equilibrium and the old supply curve is the full amount of the tax.
• The tax adds to the cost of production as it is the producer’s responsibility to ensure that it is paid.
• Equilibrium price increases and quantity demanded falls.
• Consumers are not paying all the tax.
• The total vertical distance is the tax revenue for the government.
• Ad-Valorem Tax is a tax charged on the price of the product where the percentage is always the same, it is a value added tax like the GCT, and it is shown as a non-parallel shift where the higher the price the bigger the shift.
• If demand is perfectly inelastic the consumer pays all of the tax.
• The subsidy (the cost to the government) is the vertical distance between the new equilibrium and the old supply curve.
• If demand is more inelastic than supply then the consumer pays more of the tax.
• If demand is more elastic than supply then the producers pay more of the tax.
• Ultimately elasticity determines the burden of the tax.
• Subsidies are a negative tax as they are money given by government to encourage the production and consumption of certain goods and services.
• The consumer benefits from the lower price but the producer also keeps some of the subsidy.
• The greater proportion of the tax is paid by the consumer.
• Incidences of Indirect Tax refers to the distribution of the burden of tax between sellers and buyers.
• The producer benefits more as he is selling more at the lower price.
• When there is a subsidy the entire amount is not passed on to the consumer, the producer keeps some of the subsidy for himself.
• Perfect inelasticity means only the consumer benefits (same quantity at a lower price).
• Subsidies decrease production cost causing a decrease in price and an increase in quantity demanded.
• The decrease in the cost of production as a result of the subsidy cause the supply curve to shift to the right; increasing supply.
• Who gains more from the subsidy is determined by the elasticity of the demand and supply curves.
• If demand is perfectly elastic then the producer pays all of the tax.
• The consumer benefits more from the lower price when demand is more inelastic.
• When price is higher, the percentage value of the tax is more.
• Government offers subsidy to increase production, increase domestic jobs, protect strategic industries (agriculture and housing), and promote the use of technology.
• The vertical shift in the supply curve due to the subsidy is equal to the amount of the subsidy.
• Price falls and output increases.