Direct & Indirect Taxes (AS/A LEVELS/IB/IAL)
Direct & Indirect Taxes (AS/A LEVELS/IB/IAL)
Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
Taxes
A tax is a compulsory charge on the price of goods and services. Taxes are also charged on incomes and capital.
- Taxes will make the price of a good higher and shift the supply curve to the left.
- Taxes are collected by the government to provide public goods to society such as street lighting, the police force, dams and roads etc.
There are two types of taxes:
- Direct taxes
- Indirect taxes
Direct Tax
Definition
A direct tax is paid directly to the government. It is levied on individuals or companies.
Direct Tax – Examples
- Income tax is a direct tax on an individual’s income. It normally comes out of their pay before they receive their payslip.
- Corporation tax is also a direct tax on a company’s profit. The current rate of corporation tax in the U.K. (2016) is 20%.
Indirect Tax
Definition
An indirect tax is a tax on expenditure.
There are two types of indirect tax:
- Specific Tax
- Advalorem Tax
Specific Tax
- A specific tax is a fixed amount per unit of a good. E.g. cigarettes, wine and beer
- E.g. if a product was purchased for £10 and the specific tax on this product was £2. If the price of this product increased to £20 the tax on this product would still be £2. The tax amount stays fixed regardless of changes in price.
- A specific tax causes a parallel shift of the supply curve to the left as shown below.
Calculating the tax area:
Whole Tax = (£15 – £5) x £10 = £10 x £10 = £100
Consumer Tax = (£15 – £10) x £10 = £5 x £10 = £50
Producer Tax = (£10 – £5) x £10 = £5 x £10 = £50
Ad-valorem Tax
- An ad-valorem tax is charged as a percentage of the price of a good. E.g. VAT is 20% in the U.K. & air passenger duty
- If a restaurant meal costs £100. The VAT on this meal would be £20 and the total price of this meal would therefore be £120.
- As this is a percentage tax if the meal costs £200 instead. The VAT amount would be £40. Therefore the tax (VAT) increases with the price of the good or service.
- An ad-valorem tax always causes a pivotal rotation of the supply curve to the left as shown below.
Calculating the tax area:
Whole Tax = (£18 – £7) x £10 = £11 x £10 = £110
Consumer Tax = (£18 – £10) x £10 = £8 x £10 = £80
Producer Tax = (£10 – £7) x £10 = £3 x £10 = £30
Quick Fire Quiz – Knowledge Check
1. State the two types of taxes (2 marks)
2. Explain the impact of taxes imposed (2 marks)
3. Distinguish between a direct tax and an indirect tax (4 marks)
4. Identify two examples of a direct tax (2 marks)
5. Identify two examples of an indirect tax (2 marks)
6. Using a diagram, explain the effects of a ‘specific indirect tax’ imposed. In your explanation, please refer to an example. (6 marks)
7. Using a diagram, explain the effects of a ‘ad valorem indirect tax’ imposed. In your explanation, please refer to an example. (6 marks)
Next Revision Topics:
- Government Intervention
- Public & Private Goods
- Government Failure
- Maximum Prices (Price Ceilings)
- Externalities
A Level Economics Past Papers