Indirect taxes are imposed by the government on producers - but the burden of the tax can be passed onto consumers depending on the price elasticity of demand and elasticity of supply for the product. Therefore in most cases, consumers end up paying some (or all) of any indirect tax introduced into a market.
example of this is the air passenger duty of £12 per flight for domestic
flights. Most airlines pass this straight onto the consumer when the final
price is published.
Indirect taxes raise a firm's variable costs and therefore cause an upward shift in the firm's supply curve. This means that less can be supplied at each price.
A unit tax (or specific tax)
will cause a parallel shift in
the supply curve. The vertical distance between the supply curves shows the
amount of tax per unit.
An ad valorem or percentage tax will cause the supply curve to tilt or pivot to the left. This is because the size of the tax increases with price. For example a 17.5% tax on ten pounds is smaller than the same tax on £1,000.
The diagram above shows the effect of a specific tax, the diagram below shows the effect of an ad valorem tax
The burden of an indirect tax can be passed onto the consumer by the producer - but not all of it. The ability to pass the burden of the tax depends on price elasticity of demand and price elasticity of supply. When demand is inelastic, most of the tax is passed onto the consumer. When demand is elastic, the producer must carry most of the burden of the tax - they risk losing a large slice of total demand if they pass the tax onto the consumer in the form of higher prices.
effect of indirect taxes on goods and services also depends on the degree
of competition between producers in a market. In some industries - particularly
those for luxury goods where the demand is relatively elastic - intense price
competition between producers may limit the extent to which a firm is prepared
to pass on any extra taxes to consumers.
Indirect Taxes in the UK
Value added tax
- VAT standard rate 17.5%
- VAT domestic fuel rate 5%
- Beer (pint) 26p
- Wine (75cl bottle) 116p
- Spirits (70cl bottle) 548p
- 20 cigarettes Specific duty 181p Ad valorem (22% of retail price) 87p
- Petrol (litre) 51p
- Unleaded petrol (litre) 49p
- Diesel (litre) 49p
Air passenger duty
- Low rate (for destinations within the EU) £10
- High rate (for destinations outside the EU) £20
Betting and gaming duty
- General betting duty (applies only to Off-course bookmakers) 6.75%
- Pool betting duty 17.5
Insurance premium tax
- Standard rate 5%
- Higher rate (for insurance sold accompanying certain goods and services) 17.5%
TAXATION AND GOVERNMENT REVENUE
The Government would rather place indirect taxes on inelastic commodities because the tax causes a small fall in the quantity consumed and as a result the total revenue from the tax will be greater. A good example of this is the high level of duty on cigarettes and petrol.
Demand for both products changes little when a few extra pence are added to the price of a packet of cigarettes or a litre of fuel. Rising prices and higher taxes leads to a sharp rise in total government tax revenue. Cigarette and alcohol taxes provide some of the largest sources of tax revenue for the government every year.
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