Tax and Subsidies -A-Level Economics
Direct and Indirect Taxes
A tax is a compulsory charge by the government on goods, services, income or capital.
The government use tax revenue to provide services such as healthcare, defence, policing and education.
A direct tax is levied directly on an individual or organisation. The taxpayer pays the tax directly to the government, so tax liability cannot be passed on to someone else.
Examples of direct taxes include income and corporation taxes.
An indirect tax is a tax levied on expenditure on a good or service. The tax is imposed on producers, but they are able to pass on the liability of the tax to the consumer (in the form of higher price) if they wish.
There are two types of indirect tax: specific tax and ad valorem tax.
Indirect Taxes: 2 Types
Definitions
Specific tax (unit tax) is charged as a fixed amount per unit.
For example, a specific tax on cigarettes will mean a fixed tax is charged per unit bought.
Ad valorem tax (% tax) is charged as a percentage of the price of a good.
For example, VAT is an ad valorem tax-‐ the tax amount is equal to 20% of expenditure.
Shifts in Supply Curve
The imposition of a tax increases the price of a good and causes the supply curve to shift. A specific tax causes a parallel shift of the supply curve to the left.
An ad valorem tax causes a pivotal rotation of the supply curve to the left. The reason for this is that the amount of tax increases as the price rises.
Incidence of Taxation
The burden of an indirect tax can be shared with the consumer. The amount of tax passed on to the the consumer depends on the price elasticity of demand-‐ the more inelastic the demand, the more of the tax passed down.
When demand is price inelastic, the consumer pays more tax:
When demand is price elastic, the consumer pays less tax:
Subsidies
A subsidy is a grant given to producers by the government, to encourage suppliers to increase production of a good or service, leading to a fall in price.
A subsidy is paid directly to producers, but as they respond by increasing output, the market price falls, increasing benefit for consumers. The more inelastic demand is the greater the price fall, and the greater the benefit to the consumer.
The primary purpose of taxes is to raise revenue for the government to fund public goods and services, such as healthcare, education, and infrastructure.
There are several types of taxes, including income tax, corporate tax, value-added tax (VAT), excise tax, and property tax.
Progressive taxation is a system where the rate of tax increases as the income of the taxpayer increases. This means that people who earn more pay a higher percentage of their income in taxes than those who earn less.
A subsidy is a payment made by the government to encourage or support certain economic activities or industries. A tax, on the other hand, is a compulsory payment made by individuals or businesses to the government.
The advantages of subsidies include promoting economic growth, creating jobs, and supporting important industries. However, the disadvantages include the cost to taxpayers, the potential for market distortions, and the risk of encouraging inefficiencies.
Taxes and subsidies can have a significant impact on market outcomes by affecting the supply and demand for goods and services. For example, a tax on a product will increase its price, while a subsidy will decrease its price.
The Laffer Curve is a graphical representation of the relationship between tax rates and tax revenue. It shows that there is an optimal tax rate where the government can maximize revenue, beyond which increasing tax rates will actually decrease revenue.
Taxes and subsidies can affect income distribution by redistributing income from higher-income groups to lower-income groups. For example, progressive taxation can help reduce income inequality by taxing the wealthy more heavily than the poor.
The incidence of taxation refers to who ultimately bears the burden of a tax. Depending on market conditions and the elasticity of supply and demand, the burden of a tax can fall on either the producer or the consumer.
Taxes and subsidies can affect economic efficiency by creating distortions in the market that can lead to inefficiencies, such as deadweight loss. However, they can also be used to correct market failures and promote more efficient outcomes.
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