What are Indirect Taxes?
- Also called Goods and services tax (GST), Value added tax (VAT), sales tax, or consumption tax.
- It is called excise tax (sales tax for specific products, such as cigarettes).
- Indirect taxes are taxes not designed to target a specific individual.
- They are applied to goods.
Two Types of Indirect Taxes
Specific Tax
- A fixed amount of tax per unit sold
- For example, for each beer sold $2 tax
Percentage Tax
- Also called Ad valoreum tax
- A fixed percentage charged on the selling of the good.
- For example, 20% tax on the price of cigarettes. The amount of tax increases as the amount purchased increases.
Purpose of Indirect Taxes
- Collecting revenue.
- Discourages consumption of certain goods.
- Redistributes wealth.
- Corrects allocative inefficiencies.
Graphing Indirect Taxes
Specific tax
- If there is an increase in tax, then the supply curve will shift to the left proportionally.
- This results in a reduce in supply, and a change in the equilibrium.
- The vertical distance between the old and new supply curves is the tax per unit.
- The new supply curve is called "S + tax".
Ad valorem Tax
- For an increase in tax, the supply will shift to the left proportionally and the curve will have a steeper slope.
- This not only results in reduced supply, but also a change in the elasticity of supply.
Variables
- Variables are the stakeholders relating to indirect taxes.
- The following occurs when indirect taxes are applied:
- Price: increase
- Quantity: decrease
- Government: Increase in revenue
- Producer: Decrease in revenue
- Consumer: Higher expenditure
- Community welfare: Decrease
- Allocative Efficiency: Inefficient
COST PAID BY SOCIETY
- Some products have additional costs that are not paid by the firms producing the products.
- For example cigarettes, who have costs on healthcare and the environment.
- These prices are externalities and are not represented in a price-demand graph.
- If these costs were paid the actual cost would be higher.