Taxes

• Taxes are involuntary payment of funds to the government by a household or firm for which the household or firm receives no good and services in return.
• Specific tax is a fixed amount of tax that is charged per unit sold
• An indirect tax is a levy imposed by the government upon the sale of goods/services, and are paid to tax authorities, not by consumers, but indirectly by producers.
• Ad valorem tax is a percentage of the price of the good/service or value-added at each stage of production.
• The immediate effect of an indirect tax would be to increase the marginal cost of production and therefore, decrease the supply.
• When a tax is imposed,

  Government tax revenue: d a c Pt

  Consumer expenditure: 0 Qt c Pt

  Producer revenue: 0 Qt a d

  
• If the market is efficient to begin with, indirect taxes distorts price signals and lead to a loss of allocative efficiency.
• When a tax is imposed on a good, the change in market price and quantity of said good are in opposite directions, hence the final effect on consumer expenditure depends on the PED.
• After a specific tax is imposed on a good,

  Consumer surplus: Pt d e

  Producer surplus: a b g

  Government tax revenue: g b d Pt

  Deadweight loss: b c d

  
• Indirect taxes tend to be regressive in nature leading to greater inequity.
• With the implementation of taxes on certain goods, black markets illegally selling those goods without paying taxes, and fierce resistance against these taxes by political groups may arise.
• When demand is price elastic, DDe:

  • Price increases from P0 to Pe
  • Quantity demanded decreases from Q0 to Qe
  • Since change in price < change in quantity demanded, consumer expenditure decreases

  
• When demand is price inelastic, DDi:

  • Price increases from P0 to Pi
  • Quantity demanded decreases from Q0 to Qi
  • Since change in price > change in quantity demanded, consumer expenditure increases

  
• If the objective of an indirect tax is to discourage consumption, the policy will be more effective with a more price elastic demand.
• If the objective of the indirect tax is to raise tax revenue, the policy will be more effective with a more price inelastic demand.