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

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

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