economics chap13

There are two main types of indirect taxes:

• Ad valorem taxes are a proportion or percentage of the price charged by the retailer. VAT in Kenya or Mauritius or a GST as charged in Canada and New Zealand are typical examples. The final price paid by consumers is inclusive of such taxes. The tax element may be included in the published retail price or, in cases where the GST is on everything, added to the price at the final transaction stage.

• Specific taxes are in the form of a fixed amount per unit purchased. For example, specific taxes are widely used to tax fuel. The tax is based on a measurable quantity, such as per litre. The final price includes this tax.

  Indirect taxes are widely used to discourage the production and consumption of demerit goods such as cigarettes and high-sugar sports drinks. These taxes tend to be passed on to consumers through increased prices in the market, although technically they are imposed on the producer.

  When an indirect tax is imposed, this tax must be paid to the government by retailers, wholesalers, manufacturers and other providers of taxable goods and services. This means that a business requires a price that is higher than the original price by the amount of the tax. With a specific tax, this is represented by a shift to the left of the supply curve by the amount of the tax.

• The extent to which the producer is able to pass on the tax by raising price depends on the price elasticity of demand for the product. The more price inelastic the demand, the easier it is for the seller to pass on the tax to the consumer in the form of higher prices. This explains why essential products, like petrol, are heavily taxed in most economies. If demand is price elastic, then consumers will invariably buy less of the product as price rises, resulting in the producer having to absorb a greater part of the indirect tax