Types of Taxes: Direct and Indirect

Study Notes

Direct tax: a tax levied on income and wealth, where the income receiver is directly liable to pay the tax.
Indirect tax: a tax paid by consumers when buying a product, but the seller is liable to pay the tax.
There are two types of indirect taxes:
- Specific tax: a per-unit tax of a fixed amount on quantity/volume/weight.
- Ad Valorem tax: a tax expressed as a percentage of the purchase price.

An excise tax shifts the supply curve to the left, indicating that producers require more revenue to cover the indirect tax.
The market price rises by the full amount of the tax if demand is completely price inelastic or supply is completely price elastic.

The proportion of the tax burden paid by consumers and sellers depends on the elasticity of demand and supply.
If the price elasticity of demand exceeds the price elasticity of supply, sellers' share of the tax burden exceeds buyers' share.
Conversely, if the price elasticity of demand is less than the price elasticity of supply, sellers' share of the tax is less than buyers' share.

A subsidy is a payment by the government to producers, reducing the costs of supplying a commodity.
The effect of a subsidy is to reduce the market price and increase the quantity supplied.
The supply curve shifts to the right, and the price buyers pay differs from the price sellers get.

A maximum price ceiling makes it illegal for sellers to charge more than a specific maximum price.
The effect of a maximum price ceiling is to create a shortage of supply relative to demand.
The extent of the shortage depends on the price elasticities of demand and supply and the difference between the market equilibrium price and the controlled price.
The ceiling price allows some people to buy at a lower price, but it reduces the total quantity supplied and creates a shortage.
The government may use non-price rationing devices such as "first come, first served" or favoured customers to allocate the limited supply.

The net effect on consumers' surplus can be positive or negative.
Producers lose producer surplus, resulting in a net loss of total surplus.
The loss to producers is not offset by the gain to consumers, resulting in a deadweight loss.

Rent controls limit the rent a landlord can charge tenants.
In the short run, the supply curve is very inelastic, but in the long run, the supply contracts as property is allowed to deteriorate or is sold to owner-occupiers.
The excess demand creates black market pressures, and landlords may evict existing tenants to collect new entrance fees.

A minimum price floor sets a price below which prices are not allowed to fall.
The consequences of setting a minimum price above the market equilibrium price are an excess supply and a shortage of accommodation.
The government has to restrict output, and the type of product is important in setting the minimum price.

The effect on the aggregate economic welfare of consumers and producers depends on the reaction of producers.
The possible effects of a price floor on consumers' surplus and producers' surplus are:
- Suppliers producing only what can be sold, avoiding a surplus.
- Suppliers increasing output levels, buying up the unsold output.
- Government buying up the unsold output.

The agricultural industry has experienced a long-run downward trend in agricultural prices compared to the prices of manufactured goods.
The Common Agricultural Policy (CAP) sets target prices to guarantee even the less efficient farmers of the EU a reasonable income.
The CAP ensures a minimum price for agricultural products, leading to a surplus of production.### The Common Agricultural Policy (CAP)
The CAP has advantages for farmers, including:
- Rising incomes through annual price increases
- Keeping farmers on the land, reducing rural unemployment and maintaining political support
The CAP has benefits for consumers, including:
- Increased food supplies and self-sufficiency in staple agricultural products
- Improved variety and choice of food products
However, the CAP has also led to:
- Higher food prices within the EU, above world prices
- Significant costs to finance, making up 49.3% of EU spending in 1993
- Subsidies for food surpluses sold on world markets

Producers are paid to take land out of production in 'set aside' schemes
Farmers may focus on more productive land, potentially mitigating the effects on crop yields
There is encouragement for environmentally friendly practices and financial help for farmers leaving the land
The aim is to reduce the CAP's share of the EU budget, freeing up funds for other purposes

Effective minimum wage laws must be set above the market equilibrium wage
This can lead to unemployment, as shown in Figure 4.13
The employment effects of minimum wage laws are mixed, but often reduce opportunities for teenagers
Minimum wage laws have a negligible effect on adults, as most earn above the minimum wage
Non-compliance and reduction of fringe benefits can also mitigate the effects on employment