1.2.9- Indirect taxes and subsidies

• Indirect tax


  A tax on expenditure where the person who is ultimately charged the tax is not the person responsible for paying the sum to the government
• Types of indirect tax

  • Ad valorem tax
  • Specific tax
• Ad valorem tax


  The tax payable increases in proportion to the value of the good
• Specific tax


  An amount is added to the price, the tax increases with the amount bought rather than the value of goods
• With a £2 tax, if the business charges £5 they only get £3 as £2 is passed onto the government
• Incidence of tax


  The tax burden on the taxpayer
• Factors affecting incidence of tax

  • If demand curve (PED) is perfectly elastic, or supply curve (PES) is perfectly inelastic, supplier pays all tax
  • If demand curve is perfectly inelastic, or supply curve is perfectly elastic, all tax passed on to consumer
  • The more elastic the demand curve, or the more inelastic the supply curve, the lower the incidence of tax on the consumer
• The more inelastic the demand curve, the higher the revenue of tax for the government
• Subsidy


  A grant given by the government, an extra payment to encourage production/consumption of a good or service
• impacts of specific tax

  1. supply shifts from S1 to S2- increase in cost of production
  2. rise in prices from P1 to P2
  3. fall in output from Q1 to Q2
  4. consumer sees higher prices and suffers tax burden (orange area)
  5. producer sets rise in costs and fall in output and suffers tax burden (grey area)
  6. government gains tax revenue of shaded areas (AB x Q2)

  size of tax is vertical distance between S1 and S2 (AB)

  
• impacts of ad valorem tax

  same as specific but supply curve shifts and tilts so gap between S1 and S2 grows- tax is a % of the value

  vertical distance between curve represents size of tax, distance grows since tax grows

  
• impacts of a subsidy

  1. Supply increases from S1 to S2- producer sees fall in production costs
  2. Output rises from Q1 to Q2
  3. Price falls from P1 to P2
  4. Consumer subsidy is the orange box
  5. Producer subsidy is the grey box
  6. Total shaded area is government spending (AB x Q2)