A2.04.02: Indirect Taxes

Question 1

Define indirect taxes

Answer 1

An expenditure tax that increases costs of production for firms but can be transferred to consumers in the form of higher prices

Question 2

Provide 2 examples of indirect tax

Answer 2

GST or VAT

Question 3

Define direct taxes

Answer 3

Tax on income that can’t be transferred

Question 4

Provide 2 examples of direct taxes

Answer 4

Income taxes or corporation taxes

Question 5

State 2 main reasons why govs impose indirect taxes

Answer 5

• To raise gov. revenue (VAT)
• To solve market failures (reducing consumption of alc, cigs, fuel duty)

Question 6

State the 2 natures of indirect taxes and explain their meaning as well as an example for each of them

Answer 6

• Specific indirect taxes: Tax per unit (alc duty - $2.33/bottle)
• Ad Valorem indirect taxes: Tax as a percentage of the price being charged (20% VAT in the UK)

Question 7

Explain and illustrate a specific indirect tax curve

Answer 7

This shifts the supply curve upwards (labelled S1 + Tax) —> This is because the vertical distance between the 2 supply curves represents the value of the tax per unit.

Question 8

Explain and illustrate an ad valorem indirect tax curve

Answer 8

This pivots the supply curve to the left (labelled S1 + tax). This is because the vertical distance between the 2 supply curves is the same at any of the 2 points and represents the value of the tax per bottle.

• However, the value of tax at a higher price represents a higher amount of tax revenue collected as opposed to at a lower price

Question 9

Explain the economic theory behind how consumers are affected according to a specific indirect tax on a diagram

Answer 9

• Price increases thus, consumers pay greater amounts and output is decreased thus, lowering choice for consumers; Lowering CS
• Consumer burden increases as a result of the indirect tax being regressive in their nature; this is because they take a larger proportion of the income of low-income households than high-income households
• Although, to what extent is dependent on the elasticity of demand

Question 10

Explain the economic theory behind how producers are affected according to a specific indirect tax on a diagram

Answer 10

• Producer revenue falls due to producers absorbing the indirect tax if demand for the goods and services produced is price elastic; Lowering PS
• Producer burden increases as a result of the indirect tax as labour is a derived demand thus, with a lower output, there is less need for workers to produce therefore, less profit being made by producers.

Question 11

Explain the economic theory behind how Governments are affected according to a specific indirect tax on a diagram

Answer 11

• Governments benefit as indirect taxes raise their revenue and potentially also solve market failures due to increases in price
  However, there may be unintended consequences:
• Producers may shut down due to them not making enough supernormal profit to stay in business thus, governments lose out on the tax revenue that they could have obtained
• There may be possible creation of black markets which can create affect the value of the real GDP as they will not be taken into consideration due to them being hidden