1.2.9a - indirect taxes

what is an indirect tax

a tax on expenditure

two main types of indirect tax

ad valorem = percentage
eg. VAT

specific/unit = fixed value
eg. excise duties

on whom are indirect taxes placed

the producer

effect of indirect tax

increase costs of production:

• supply curve shifts LEFT

• price RISES

• quantity [bought/sold] FALLS

show an indirect tax diagram for SPECIFIC TAX

BEFORE TAX:
- TE = TR (total expenditure = total revenue)

AFTER TAX:
- TE reduced (price up, demand down)
- TR reduced (some of TE went to government)
- consumers paid half, producers paid half

the more inelastic the demand…

…the more tax is passed onto the consumers

(+ vice versa)

(bc the ppl don’t care what price they’ll still buy the same)

the more inelastic the supply

…the more tax is passed onto the producers

(+ vice versa)

(bc they don’t care what price they’ll still supply the same)

difference between specific and ad valorem tax graphs

supply curve still shifts left but at a STEEPER GRADIENT

because…

…vertical distance between the curves shows the tax, so HIGHER PRICES means vertical distance gets BIGGER because the amount of TAX RISES (bc its a percentage)

what can you also do with indirect tax diagrams

add them into externalities diagrams to show the reduction in welfare loss

4 stakeholders and the effects of indirect taxation on them

consumers	producers	government	society
higher prices = some unwilling/unable to buy	loss of sales and revenue	will gain tax revenue	net welfare loss
loss in consumer surplus (welfare)	will pay a proportion of the tax (producer incidence)		less neg externalities
will pay a proportion of the tax (consumer incidence)