Taxes and Subsidies
Define Tax:
Taxes are compulsory payments made to the government.
Different types of Taxes:
Direct:
These are taxes taken from income and wealth
(e.g. income taxes, wealth taxes, and profit taxes)
Indirect:
These are taxes imposed on goods and services. Hence, they are taxes on spending or expenditure.
(e.g. VAT and excise taxes)
Why are Taxes Imposed:
- Decrease in consumption of harmful goods
- Increase in Government revenue
- Increase the equality in the distribution of income in a country
Burden of Taxation:
The burden of taxation refers to how the tax is divided between consumers and producers.
Consumer Burden:
The part/proportion of tax paid by the consumer. It is the increase in price to the consumer due to a tax.
Producer Burden:
It is part/proportion of the tax paid by the producer. It is the decrease in price received by the producer due to a tax.
Tax Revenue:
Income from taxation received by the government.
Taxes on Goods:
- When a tax is imposed, the S curve will shift to the left to “S + Tax”.
- Prices will increase at “consumer tax burden” and will decrease at “producer tax burden”
- Consumer tax burden > Producer tax burden
Define Subsidy:
A subsidy is a grant from the government to the firms to increase the supply of a product.
Purpose of a Subsidy:
- The “grant” is a form of financial aid.
- This helps to reduce the costs of production from the firm.
- Subsidies are usually provided to firms that supply goods that are necessities like food and medicines.
- It is provided to firms that produce merit goods – goods that benefit the consumer and the society such as education and healthcare.
- Subsidies are provided to firms to encourage research and development of new technologies such as environment-friendly methods of production.
- Masks, PPE Kits, and the production of vaccines have been subsidized by governments to tackle the pandemic.
Subsidy Presented on Supply Curve:
When a subsidy is provided the cost of production for the firm decreases. As a result, the supply curve will shift to the right to S2. The supply curve will shift by the amount of per-unit subsidy. As a result price decreases to P2 and quantity increases from QE to QS. Therefore, there is a higher quantity in the market at lower prices and goods become more affordable and in larger quantities.
