This document discusses indirect taxes and subsidies. It provides details on different types of indirect taxes, including VAT, fuel duties, and tobacco duties levied in the UK. It explains how indirect taxes increase producer costs and are passed onto consumers in the form of higher prices. The document also examines how the burden of an indirect tax is distributed between consumers and suppliers, depending on the price elasticity of demand. Finally, it discusses government subsidies to producers and consumers and some examples used in different markets.

1. AS
Micro:
Indirect
Taxes
&
Subsidies

2. Indirect
Taxes

3. 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

4. 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

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
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

6. 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

7. 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

8. 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

9. Government
Subsidies

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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?

16. AS
Micro:
Indirect
Taxes
&
Subsidies