Indirect Tax

A payment that is levied on a good / service by the government.

Positives

  • Generates revenue for the government to spend on solving market failure -> Hypothecation
  • Encourages consumption of other products that have less of a negative impact - Such as more sustainable fashion or healthier food
  • Financial intervention tends to be more effective than other methods such as advertising, since people change their purchasing decisions based on price signals.
  • if set correctly, the tax will solve the market failure and internalise the negative externality (The 1st and second party will pay the externality) and create a socially optimal outcome.

Negatives

  • If set incorrectly, can be government failure
  • Penalises people who don't over consume
  • Indirect taxes are regressive. This means low income earners pay more tax, as a % of their income compared to high income earners.
  • An indirect tax will be less effective on inelastic products.
  • Difficult to place monetary values on MEC, this involves using judgements. If set incorrectly

Depends upon / Judgments

  • The PED of the product. If the PED is inelastic, then a change in price won't cause much of a change in demand, and so the tax will be ineffective.

Incidence of tax

Elastic

Elastic demand, tax burden falling mostly on the firm

When demand is elastic, consumers are sensitive to price changes, so the firm pays most of the tax, in order to maximise their profits.

Inelastic

Inelastic demand, tax burden falling mostly on the consumer

When demand is inelastic, consumers are insensitive to price changes, so the firm pushes the tax onto consumer to maximise profit.