1.8 Government intervention - indirect taxes

2 main types of taxes in government intervention to the market

• direct taxes

• indirect taxes

direct taxes

imposed directly on income

reduce consumers income = decrease in demand

indirect taxes

tax added to the price of a good or service, collected by the firm selling the good or service and then paid to the government.

affects supply as they are raise the costs of producing the product - taxes collected from producer

Types of indirect tax

1. Specific

2. Ad valorem

Specific taxes

a fixed amount of tax per unit aded to the price of a good

Ad valorem taxes

fixed percentage tax added to the price of a good such as value added tax

as selling price of the product rises => the tax amount rises as the price rises

why does the government impose indirect taxes?

1. discourage production and consumption of harmful products

2. generate government tax revenue to finance other government spending (healthcare, education)

Reasons of government intervention

1. raise revenue to pay for public services - indirect taxes

2. support to producers - farming is supported by the government as they are important to the overall welfare of society - food supply. - subsidy

• making food affordable for people on low income - subsidy (increased supply, decreased prices)

• help businesses involved in healthcare, education, infrastructure etc. - subsidy

3. support for households on low income

• drive: reduce income inequality, improve equity

• how: subsidising healthcare, housing etc.

=> improves health, help employment levels progress

4. influence the level of production in a market

• negative social welfare impact - decrease (indirect taxes)

• positive social welfare impact - increase

• (Subsidies)

5. influence the level of consumption in a market (harmful products) - indirect taxes

importance of elasticity

the PED/S will affect the size of tax revenue received by the government and the incidence (who pays more of the tax?)of tax paid by the consumers and the producer

why does the government favour taxing goods with price inelastic demand ?

the revenue collected is high, tax incidence falls more on consumer than producer

Burden of tax on producer cause

• result in output cut, which could cause unemployment

• tax revenue could lower if output falls significantly

When is consumer incidence greater than producer incidence ?

when the PES > PED

→ supply is more elastic than the tax = consumers bear more of the tax burden (higher consumer incidence )

When PED > PES

→ demand is more elastic than supply = producers bear more of the tax burden

indirect tax impact on stakeholders

1. consumers

• pay higher price for a taxed goods = reduces consumer surplus (satisfaction decreases as they gain less benefit per unit)

• taxes on goods with social costs (higher price) = improve welfare in long term

2. producers

• must pay part of the tax incidence = reduces producer surplus = less profit = les investment = job losses

3. government

• receive more revenue to spend on public services

• negative political consequences from an industry badly affected by tax

4. welfare

• when tax is applied to a good it will change the allocation of resources in the market

• => consumer welfare loss

• => Producer welfare loss

welfare

overall economic well-being and satisfaction (social and producer surplus)

consumer welfare loss

Higher prices → lower demand → lower consumer surplus

Leads to DWL

producer welfare loss

Higher costs → lower supply → lower producer surplus

DWL (total lost benefit to society)

Consumer incidence

Tax (or subsidy) burden that tax (or benefit of the subsidy) consumers face

Producer incidence

Tax (or subsidy) burden that tax (or benefit of the subsidy) producers face