Chapter Indirect Taxes P73-75 Chapter Indirect Taxes P73-75

Indirect Taxes Taxes on Goods rather than sources of IncomeTaxes on Goods rather than sources of Income Taxes on Goods - IndirectTaxes on Goods - Indirect Taxes on Income, Profits, Savings - DirectTaxes on Income, Profits, Savings - Direct

INDIRECT TAXES Specific and ad valorem taxesSpecific and ad valorem taxes –Specific : Just add T to the wholesale price to find the price charged for the good in the shops: e.g P c = P w +T

Effect of a tax on the supply curve S P Q O

S + specific tax S P Q O

Effect of a tax on the supply curve S + specific tax S amount of specific tax P Q O

INDIRECT TAXES Specific and ad valorem taxesSpecific and ad valorem taxes –ad valorem: Tax paid depends on the value of the of the good. Now we multiply the wholesale price by the tax rate (1+t) to get the price in the shops, i.e. P c = P w (1+t) –Value added tax is an ad valorem tax –(rate is 17.5% so to find the price we multiply the pretax price by = (1+.175)

Effect of a tax on the supply curve S + ad valorem tax S P Q O

INDIRECT TAXES Specific and ad valorem taxesSpecific and ad valorem taxes –Specific : e.g P c = P w +T –ad valorem: e.g. P c = P w (1+t)

What curve is affected: The demand curve or the supply curve?What curve is affected: The demand curve or the supply curve? Ans: Supply CurveAns: Supply Curve INDIRECT TAXES

Effect of a tax on price and quantity S P Q O P1P1 Q1Q1 D

Effect of a specific tax on price and quantity S + tax S O P1P1 Q1Q1 D P Q

Effect of a tax on price and quantity S + tax S O P 1 + tax P1P1 Q1Q1 D P Q

Effect of a tax on price and quantity S + tax S O P 1 + tax P1P1 Q1Q1 D P Q But at this price Supply exceeds demand

Effect of a tax on price and quantity S + tax S O P 1 + tax P1P1 P2P2 Q1Q1 Q2Q2 D P Q

INDIRECT TAXES Specific and ad valorem taxesSpecific and ad valorem taxes Effects on supply curveEffects on supply curve The incidence of taxationThe incidence of taxation –the producers' share –the consumers' share Elasticity and the incidence of taxation: Who Bears the Burden?Elasticity and the incidence of taxation: Who Bears the Burden?

Incidence of tax: inelastic demand S O P1P1 Q1Q1 D P Q

S + tax S O P1P1 Q1Q1 D P Q

Incidence of tax: inelastic demand S + tax S O P1P1 P2P2 Q2Q2 Q1Q1 D P Q

Incidence of tax: inelastic demand S + tax S O P1P1 P2P2 Q2Q2 Q1Q1 D CONSUMERS’SHARECONSUMERS’SHARE P Q

Incidence of tax: inelastic demand S + tax S O P 2 - t P1P1 P2P2 Q2Q2 Q1Q1 D CONSUMERS’SHARECONSUMERS’SHARE PRODUCERS’ SHARE P Q

Incidence of tax: elastic demand S + tax S O P1P1 Q1Q1 D P Q

S O P1P1 P2P2 Q2Q2 Q1Q1 D Incidence of tax: elastic demand P Q

S + tax S O P1P1 P2P2 Q2Q2 Q1Q1 D CONSUMERS’SHARECONSUMERS’SHARE Incidence of tax: elastic demand P Q

S + tax S O P 2 - t P1P1 P2P2 Q2Q2 Q1Q1 D CONSUMERS’SHARECONSUMERS’SHARE PRODUCERS’ SHARE SHAREPRODUCERS’ Incidence of tax: elastic demand P Q

Incidence of tax: inelastic supply S + tax S O P1P1 Q1Q1 D P Q

S O P1P1 P2P2 Q2Q2 Q1Q1 D P Q Incidence of tax: inelastic supply

S + tax S O P1P1 P2P2 Q2Q2 Q1Q1 D P Q CONSUMERS’ SHARE Incidence of tax: inelastic supply

S + tax S O P 2 - t P1P1 P2P2 Q2Q2 Q1Q1 D P Q CONSUMERS’ SHARE PRODUCERS’ SHARE Incidence of tax: inelastic supply

Incidence of tax: elastic supply S + tax P Q O P1P1 Q1Q1 D S

Incidence of tax: elastic supply S + tax P Q O P1P1 P2P2 Q2Q2 Q1Q1 D S

Incidence of tax: elastic supply S + tax P Q O P1P1 P2P2 Q2Q2 Q1Q1 D S CONSUMERS’SHARECONSUMERS’SHARE

Incidence of tax: elastic supply S + tax P Q O P 2 - t P1P1 P2P2 Q2Q2 Q1Q1 D S CONSUMERS’SHARECONSUMERS’SHARE PRODUCERS’ SHARE SHAREPRODUCERS’

Incidence of tax and elasticity of demand and supply (1) INELASTIC DEMAND (3) INELASTIC SUPPLY (2) ELASTIC DEMAND (4) ELASTIC SUPPLY

Summary The ‘Incidence’ of Tax: Who bears the burden?The ‘Incidence’ of Tax: Who bears the burden? Inelastic Demand or Elastic SupplyInelastic Demand or Elastic Supply –Consumer bears brunt of Tax Elastic Demand or Inelastic SupplyElastic Demand or Inelastic Supply –Producer bears brunt of Tax

INDIRECT TAXES Implications for tax policyImplications for tax policy If tax revenue is the objective then want a Q sold to remain high when tax is imposedIf tax revenue is the objective then want a Q sold to remain high when tax is imposed What kind of goods fulfill this objective?What kind of goods fulfill this objective?

Incidence of tax and elasticity of demand and supply (1) INELASTIC DEMAND (3) INELASTIC SUPPLY (2) ELASTIC DEMAND (4) ELASTIC SUPPLY

INDIRECT TAXES Implications for tax policyImplications for tax policy If tax revenue is the objective then want a Q sold to remain high when tax is imposedIf tax revenue is the objective then want a Q sold to remain high when tax is imposed What kid of goods fulfil this objective?What kid of goods fulfil this objective? –Cases 1 & 3: Goods in inelastic demand or supply  Demand - Cigarettes, Booze, Petrol  Supply - Utilities - (taxing profits).