15 terms

Indirect Tax

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Indirect Tax- Definition
A Tax placed upon the expenditure on a good or service.
Specific Tax
Also known as flat rate or per-unit tax, a fixed amount charged per unit of the good. Shift of the supply curve is parallel.
Ad Valorem
Fixed percentage tax on a good or a range of goods. The higher the price of the good, the higher the amount of tax to be paid.
Reasons Govt. Imposes Indirect Tax- Revenue
It is a source of Government Revenue.
Reasons Govt. Imposes Indirect Tax- Discourage Harmful Goods
It is a method to discourage the consumption of harmful goods. Taxing demerit goods such as cigarettes makes them more expensive. The success of this type of tax depends on the PED.
Reasons Govt. Imposes Indirect Tax- Re-Distribution of Income
Some excise taxes focus on luxury goods and this reduces the after-tax income of these consumers. This narrows the difference in incomes with the lower-income earners.
Reasons Govt. Imposes Indirect Tax- Allocative Efficiency
Indirect taxes can be used as a method to improve the allocation of resources by correcting negative externalities because they can motivate firms to be more allocatively efficient in order to avoid the taxes. Negative externalities cause an overallocation of resources, if the govt taxes the good then the firm treats it as a cost of production and decreases supply.
Effect on Consumers
Worse off because the tax causes the price of the product to increase and the quantity available in the market to decrease.
Effects on Producers
Worse off because of decrease in revenue as the quantity available in the market has decreased and costs of production have increased.
Effects on Workers
Worse off because output has decreased and less workers are needed by firms which leads to unemployment.
Effect on Government
Better off because of increase in revenue.
Effect on Society
Worse off because of underallocation of resources to the production of the good.
Tax Incidence
It is a measure of the consequences of the tax on all affected parties. After the supply curve shifts left who pays the majority of the tax varies.
Tax Incidence When PED>PES
Since PED is elastic, consumers are more responsive to changes in price. Therefore, the producer needs to bear most of the tax burden. There is more deadweight loss, the market size reduces and unemployment increases. Additionally, the govt. revenue is smaller.
Tax Incidence When PED<PES
Since PED is inelastic and consumers are not very responsive to changes in price, producers are able to pass on the majority of the tax burden to them in the form of higher prices. There is less deadweight loss, the market reduces less significantly, and the govt. revenue is greater.