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AS Micro: Indirect Taxes & Subsidies
Indirect Taxes
Indirect Taxes in Markets
• An indirect tax is a tax imposed by the government that increases the supply costs faced by producers.
• The amount of the tax is always shown by the ver<cal distance between the two supply curves.
• Because of the tax, less can be supplied at each price level. • The result is an increase in the market price and a contrac>on in
demand to a new equilibrium output. 1. A specific tax is a set tax per unit e.g. a £5 tax per unit sold. 2. An ad valorem tax is a percentage tax e.g. 20% on the unit price. • The main UK indirect tax is VAT -‐ genera>ng £110bn annual tax • Fuel du<es generate £27bn and tobacco taxes £10bn each year • Taxes such as air passenger duty bring in £3bn of tax each year Exam Tip: Use clear analysis diagrams to show the impact of an indirect tax
Examples of Indirect Taxes in the UK Economy
VAT Landfill Tax Fuel Du>es
Alcohol Du>es Tobacco Du>es Air Passenger Duty
Standard rate = 20% £80 per tonne for waste Taxed at 58p per litre
Bands based on distance £3.76 per pack + 17% VAT Beer tax = 41.5p per pint
Indirect Tax When PED = 0 and PES = infinity
Price
Qty
P2
Demand
P1
Q1
S1
S1 + tax
Total Tax Revenue
(paid by the consumer)
Price
Qty
Demand
S1
S1 + tax
Q1 Q2
P2
P1
Total Tax paid by the consumer
Perfectly Inelas<c Demand All of the tax is paid by the consumer
Perfectly Elas<c Supply All of the tax is paid by the consumer
Tax Per Unit
Indirect Taxes with Different Coefficient of PED
If the co-‐efficient of price elas<city of demand >1, then most of the burden of an indirect tax will be absorbed by the supplier
Price
Qty
P2
D
Q2
S1
S1 + tax
Q1
P1
P3
Paid by consumer
Paid by supplier
If the co-‐efficient of price elas<city of demand <1, most of an indirect tax can be passed on to the final consumer
Price
Qty
P2
Demand
P1
Q2
S1
S1 + tax
Q1
P3 Paid by consumer
Paid by supplier
Tax Per Unit
Ad Valorem (Indirect) Taxes
Value added tax (the standard rate in the UK is 20%) is an example of an ad valorem tax.
Quan>ty
P2
Demand
P1
Q2
S1
S1 + tax
Q1
Price
• The effect of an ad valorem tax is to cause a pivotal shi` in the supply curve
• This is because the tax is a percentage of the unit cost of supplying the product.
• So a good that could be supplied for a cost of £50 will now cost £60 when VAT of 20% is applied whereas a different good that costs £400 to supply will now cost £470 when the same rate of VAT is applied
• The absolute amount of the tax will go up as the market price increases
Tax Per Unit
Evalua<on Arguments when Assessing Indirect Taxes
• Does an indirect tax achieve the specified aims? • Are there unintended consequences of introducing / changing a tax?
Effec>veness of a tax and unintended consequences
• Does an indirect tax generate substan>al tax revenues? • How is the tax revenue used – perhaps for par>cular projects?
How much tax revenue is raised? How is it used?
• Might there be a possible loss of jobs and/or capital investment? • Will an indirect tax nega>vely affect compe>>veness and trade?
What is the impact on businesses / compe>>veness?
• Is the tax regarded as equitable / fair? • Who are the main winners and losers? • Does a tax have a regressive effect on lower income groups?
Consequences for equity / the distribu>on of income
Government Subsidies
Government Subsidies for Producers and Consumers
A subsidy is any form of government support—financial or otherwise—offered to producers and (occasionally) consumers
Biofuel subsidies for farmers
Solar Panel “Feed-‐In Tariffs”
Appren>ceship Schemes
Aid to businesses making losses
Subsidies for wind farm investment
Food / fuel subsidies for consumers
Child Care for working families
Subsidies to the rail industry
Basic Subsidy Diagram – For Producers Price
Quan>ty / output
Market Supply pre subsidy
P1
Q1
A subsidy per unit of output causes an outward shi` of the market supply curve leading to a lower equilibrium price
Market Demand
Market Supply post subsidy
P2
Q2
Subsidy
Subsidy per unit is shown by the ver>cal distance
Showing Total Government Spending on the Subsidy Price
Quan>ty / output
Market Supply pre subsidy
P1
Q1
Total spending on the subsidy is equal to the subsidy per unit mul>plied by the level of output – shown by the shaded area
Market Demand
Market Supply post subsidy
P2
Q2
P3
Producer receives this price
Consumer pays this price
Jus<fica<ons for Subsidies for Producers
Subsidies are a form of government interven>on. They are introduced for a number of economic, social & poli<cal reasons
Help poorer families e.g. food and child
care costs
Encourage output and investment in fledgling sectors
Protect jobs in loss-‐making industries e.g. hit by recession
Make some health care treatments more affordable
Reduce the cost of training & employing
workers
Achieve a more equitable income
distribu>on
Reduce some of the external costs of
transport
Encourage arts and other cultural
services
Effects of Subsidies with Different Price Elas<city
Inelas<c market demand Subsidy has a larger effect on the new
equilibrium price
Price
Qty
Price
Qty
P1
Q1
Elas<c market demand Subsidy has a stronger effect on the
new equilibrium quan>ty
D1
P2
Q2
S1
S2
S1
S2 D1
Q1 Q2
P1 P2
Subsidy Subsidy
Evalua<on Arguments when Assessing Subsidies
• Will they achieve the desired s>mulus to demand / consump>on? • Is a subsidy sufficient? Might other incen>ves be needed?
Are the subsidies effec>ve in mee>ng their aims?
• Subsidies for investment and research can bring posi>ve spillovers • But firms may become dependent on state aid / financial assistance
Will a subsidy affect produc>vity / efficiency?
• Is a subsidy part self-‐financing? Will it create more tax revenue? • Or does a subsidy create an expensive extra burden for taxpayers?
How much does the subsidy cost and who benefits?
• For example – do more people find work with child care subsidies? • Or does a subsidy lead to undesired / unintended consequences?
Does the subsidy help to correct a market failure?
AS Micro: Indirect Taxes & Subsidies
