1.2.9 Indirect taxes and subsidies

• Incidence of a tax:

  Refers to the burden of an indirect tax on consumers and producers.

  E.g. the incidence of a tax on consumers is how much of an indirect tax is paid by consumers.
• How does PED affect the incidence of a tax?

  The more elastic the PED, the greater the incidence on producers and the lower the incidence on consumers.

  If PED is perfectly elastic, then the incidence of the tax will fall entirely on producers.
• How does PES affect the incidence of a tax?

  The more elastic the PES, the greater the incidence on consumers and the lower the incidence on producers.

  If PES is perfectly elastic, then the incidence of the tax will fall entirely on consumers.
• How indirect taxes effect consumers

  -Leads to ↑ prices -> ↓ CS

  -Incidence of the tax on consumers depends on PED and PES

  -Could benefit consumers if the good is currently being overconsumed due to info failure (e.g. sugary drinks).

  -Indirect taxes are regressive - they have a disproportionate impact on lower-income households.
• How indirect taxes effect producers

  -↑ costs -> ↓ profits

  -If they pass on higher costs to consumers through ↑ prices, they may lose sales and revenue (esp if PED is elastic).

  -The incidence of the tax on producers depends on the PED and PES.
• How indirect taxes effect the government

  -Tax revenue ↑ which can be spent on education, healthcare, infrastructure, etc.
• How subsidies effect consumers

  -↓ prices -> ↑ CS

  -If the good being subsidised is an essential good, then this may reduce poverty.
• How subsidies effect producers

  -Reduces production costs and makes it more profitable to increase supply.

  -Results in ↓ prices -> makes it easier for the subsidised firm to compete against foreign rivals.

  -However, firm may become complacent and inefficient as a result of the subsidy as they have less of an incentive to reduce costs.
• How subsidies effect the government

  -Opportunity cost. Govt will either have to cut spending elsewhere, ↑ taxes or ↑ borrowing in order to fund the subsidy.