Taxes and Subsidies

Define Tax:

Taxes are compulsory payments made to the government. 

Different types of Taxes:

These are taxes taken from income and wealth
(e.g. income taxes, wealth taxes, and profit taxes)

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

taxes on good graph.JPG

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. 

subsidy on supply graph.JPG