Indirect taxes
- 1. Indirect Taxes EdExcel Economics 1.2.9
- 2. 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 ver7cal 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 contracBon 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 -‐ generaBng £110bn annual tax • Fuel du7es 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
- 3. Examples of Indirect Taxes in the UK Economy VAT Landfill Tax Fuel DuBes Alcohol DuBes Tobacco DuBes 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
- 4. UK Tax Revenues from Value Added Tax 0 20000 40000 60000 80000 100000 120000 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 VAT receipts in £ million
- 5. 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 Inelas7c Demand All of the tax is paid by the consumer Perfectly Elas7c Supply All of the tax is paid by the consumer Tax Per Unit To ensure that suppliers receive the required minimum price a_er an indirect tax, the market price must rise by the full amount of the tax.
- 6. Indirect Taxes with Different Coefficient of PED If the co-‐efficient of price elas7city 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 elas7city 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
- 7. Ad Valorem (Indirect) Taxes Value added tax (standard rate in the UK is 20%) is an example of an ad valorem tax. QuanBty 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 • 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
- 8. Evalua7on Arguments when Assessing Indirect Taxes • Effect of a tax depends in part on coefficient of elasBcity of demand • Problems in sedng the tax rate at the right level to achieve aims • Are there unintended consequences from a tax? EffecBveness of a tax and unintended consequences • Does an indirect tax generate substanBal tax revenues? • How is the tax revenue used – perhaps for parBcular 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 negaBvely affect compeBBveness and trade? What is the impact on businesses / compeBBveness? • Who are the main winners and losers? • Does a tax have a regressive effect on lower income groups? Consequences for equity / the distribuBon of income
- 9. Indirect Taxes EdExcel Economics 1.2.9