Indirect taxes and subsidies 1.2.9

What is an indirect tax?

A tax imposed by the government that increases the supply costs of producers

What is a unit tax?

A set amount of tax per unit sold

What is the effect on demand of an indirect tax?

It will increase the price of a product which reduces quantity demanded.

What is an ad valoram tax?

A percentage tax based on the value added by the producer

What is the most important ad valoram tax?

VAT (20% in UK)

What are excise duties in the UK?

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

What are some justifications for using indirect taxes?

• Pay for overall government spending

• Change consumer and producer behaviour- sugar/carbon taxes alter demand for goods/services

• Helps to address examples of market failure

• Import duties can be used to improve a countries trade balance

What are some arguments against indirect taxes?

• The sugar tax might be regressive on lower-income families

• Other policies might be more effective in cutting consumption of high sugar products in the long run, such as behavioural nudges and regulation

• People might simply switch to other high-sugar products

• Risk of lost jobs in pubs and shops that rely heavily on drink sales for their revenue

When is most of the burden of the indirect tax absorbed by the supplier?

If the co-efficient of price elasticity of demand > 1 (elastic)

When is most of the burden of the tax passed on to the consumer?

If the coefficient of price elasticity of demand < 1 (inelastic)

What is a regressive tax?

A tax imposed by a government which takes a higher percentage of someone’s income from those on low income.

What is a subsidy?

Any form of government support- financial or otherwise offered to producers and (occasionally) consumers

What is the effect of a subsidy on producers?

They reduce the marginal cost of supply. It usually leads to an increase in the output sold of a good or service at a lower market price.

What are some justifications for subsidies?

• Helping poorer families with food and childcare costs, particularly during a crisis

• Improved nutrition can lift labour productivity and reduce the burden on health services

• Encourage output and investment in sectors

• Protect jobs in loss-making industries hit by recession and by economic shocks

• Improve housing and transport affordability to improve geographical mobility of labour

• Reduce the cost of training and employing workers

• Encourage the arts and other cultural services which have social benefits

What are some disadvantages of subsidies?

• Producers can become ‘subsidy dependent’

• Subsidies can distort resource allocation

• Subsidies can lead to excess production/ surpluses

• Environmental risks from excessive production

• Government failure arising from political lobbying

• Subsidies can be very expensive- taxpayers bear the cost