1.2.9 Indirect taxes and subsidies

What is an indirect tax?

A tax on goods and and services (on spending)

Give an example of indirect taxes

• VAT (value added tax)

• Taxes on cigarettes

What is a direct tax?

Taxes on income (e.g corporate tax and income tax)

Give 2 reasons as to why governments set taxes?

1. Increase cost of production, reduce supply, increase prices and therefore reduce consumption

2. Raise revenue for the government

Explain why the government impose specific taxes on many goods and services

• The government impose specific taxes on good and services to increase their revenue. For example a specific tax such as VAT will increase the amount of money the government earns and therefore can spend on better welfare for the country. This can be done through increased funding from hospital for example

• The government also impose specific taxes on goods and services to dissuade people from purchasing certain goods. For example the government may impose a specific tax on tobacco, this will increase the price of tobacco and so by the law of demand it will cause a reduction in demand, and therefore less people purchasing tobacco. This will lead to improved health if there are less people smoking and also less pressure on the NHS.

What does the word “levied” mean which is often used when describing taxes

means imposed

Who do the government tax and why?

firms/ consumers → mostly on producers of demerit goods e.g producers of alcohol/ cigarettes.

What are the two types of indirect taxes?

• Specific taxes

• Ad Valorem taxes

What are specific taxes and what do they look like on a graph?

• Taxes which are fixed amounts per unit. E.g UK air passenger- duty

• The inwards shift will be parallel to the original curve

What is an ad valorem tax and what do they look like on a diagram?

• A percentage amount of the price of a good (e.g VAT)

• the curve is divergent between the original supply curve and the new one

How and why are taxes usually set to discourage consumption/ production? And draw this in a diagram

The producer would want to pass all the tax onto their consumer but the price elasticity of demand will determine how much of the tax they an afford to pass on. E.g for tobacco the producers can afford to pass on most of the tax because the price elasticity of demand is very inelastic.

What is the incidence?

the difference between the new equilibrium and the same point downward of the supply curve. - calculate the area of the full triangle

What is the incidence of tax on the consumer - how is it calculated?

Is it the upper rectangle - calculate the area of the rectangle

What is the incidence of tax on the producer - how it is calculated?

it is the lower rectangles - calculate the area of this triangle

What would a diagram look like for the tax on a product with elastic demand?

How would you calculate:

• The incidence tax

• How much tax the producer pays in comparison to the consumer

• Government revenue

• Total revenue

What would a diagram look like for the tax on a product with elastic demand?

How would you calculate:

• The incidence tax

• How much tax the producer pays in comparison to the consumer

• Government revenue

• Total revenue

What is a subsidy?

Grants given by the government to firms in order to reduce costs of production

Why do governments give subsidies?

To reduce the costs of production to allow firms to have increased profits

What is the main aim of subsidies given by the government?

To reduce costs of production, increase supply, decrease prices and therefore increase production and demand

Use a diagram to show how subsidies are given to encourage the consumption of a good?