Indirect Taxes

Indirect taxes: a levy imposed by the government on the expenditure of goods and services. ( A levy is a charge on spending)

An indirect tax is a tax that is not imposed on a persons income.

It is the firms that are required to pay the tax to the government. Every time the business produces another unit they must pay the tax. Firms may choose to pass the tax onto consumers.

Examples of indirect tax:

• Cigarettes

• Sugar

• VAT

• Petrol

Why do governments introduce taxes?

• To raise tax revenue to spend

• To reduce consumption of a product e.g. cigarettes

An indirect tax represents a cost for a firm. Supply shifts up (left) by the value of the tax.

A set value tax per unit shifts the curve up by the value of the tax. Known as the specific tax.

Percentage (ad valorem) tax → for each unit produced the firm pays a percentage of the price to the government.

Consumers

• Fall in demand due to an increase in price, shifts along demand curve.

• Income effect and substitution effect is seen.

• For neccesities/ addictive products, a change in price will not reduce consumption as inelastic.

• For low income earners this will impact them the hardest, perhaps increasing poverty/ inequality.

• Potentially, consumers made healthier, but not many giving up. The could switch to another unhealthy alternative.

Producers

• Will recieve less revenue as a result of the tax. As quantity has fallen.

• Producers facing elastic demand will have the greatest fall in revenue as they cannot increase price easily.

• They will have a higher tax burden than consumers.

• As a result, prducers either pay most of the tax or they will change the product to reduce the tax.

• If inelastic, no change as the consumer pays most of the tax.

Government

• The government recieves tax revenue by imposing a tax , this can be used for government spending e.g. NHS.

• It can also be used to create negative advertisement, shifting demand to the left.

• It can also subsidise substitutes to further decrease demand.