Indirect taxation

Indirect tax

A tax on expenditure/ consumption e.g. VAT

Imposed by gov that increases the supply costs of producers but can be transferred to consumers via high prices

Unlike direct taxes, indirect taxes are typically collected by businesses at the point of purchase/consumption

Most indirect taxes are either specific taxes or ad valorem taxes

Direct tax

A tax on income e.g. corporation tax

Tax revenue

Revenue received by gov from the tax (tax per unit x quantity)

Producer revenue

Income from sales (price x quantity)

Consumer tax burden

Difference between original market price and new market price x quantity

Producer tax burden

Tax revenue minus consumer tax burden

Specific tax

A fixed tax per unit regardless of price

E.g. all wine has a specific tax of £2 per bottle

Ad valorem / percentage tax

A tax which is a % of the price, the higher the price the higher the tax

Why do we have taxes?

• To fund public services e.g. NHS

• To curb consumption of ‘demerit'' goods e.g. cigarettes because they are bad for society

How is tax shown on a diagram?

By the vertical distance between pre- and post-tax supply curves

Because of the tax - less will be supplied to the market at each price level

Are VAT + Ad valorem the same thing?

No - VAT is a specific type of ad valorem tax + VAT is a direct tax - ad valorem is indirect

So all VATs are ad valorem but not vice versa

Examples of main indirect taxes in UK?

• Air passenger duty - environmental impact

• Alcohol duties

• Tobacco duties

• Soft drinks industry levy - sugar tax

What are excise duties?

Indirect taxes levied on 3 major categories of goods - alcoholic drinks, tobacco products + road fuels

If PED>1 then most of the burden of an indirect tax will be absorbed by? demand

The supplier/producer

If demand is price elastic - firms have less scope to raise price after a tax - producers pass on a much smaller proportion of the tax to consumers (+ pay the rest themselves)

If PED<1 then most of the burden of an indirect tax will be absorbed by? demand

The final consumer

If demand is price inelastic - producers pass on a much higher proportion of the tax to consumers (+ pay the rest themselves) e.g. cigarettes

How does an ad valorem indirect tax differ from a specific tax?

Ad valorem - depends on its value - usually expressed as a percentage

Specific tax - regardless of the price tax stays the same

But are both indirect taxes

How do you represent ad valorem tax on a diagram?

Must pivot curve to show that the higher the price, the higher the tax

How do you show specific tax on a diagram?

Shift supply curve left or upwards (same thing)

This shows that it doesn’t matter how many bottles of wine you purchase - they all have the same tax of £2 per bottle

What does a specific indirect tax look like on a graph?

This

If PES>1 then most of the burden of an indirect tax will be absorbed by? supply

Consumers bear more of the tax

When supply is elastic - firms can easily adjust production levels

This means that firms can pass most of the tax to consumers by raising prices

If PES<1 then most of the burden of an indirect tax will be absorbed by? supply

Producers bear most of the tax

When supply is inelastic - firms can’t easily change their production levels

Since consumers are still somewhat responsive to changes in price - firms absorb most of the tax as they can’t instantly adjust supply