Economics Shift from Direct to indirect tax ?? HelpWatch
A direct tax is a tax that is that is taken depending on a consumers income and wealth whilst an indirect tax is a tax on the producer of a good or service which results in an increase in manufacturing cost so less factors of production can be put towards the production of that good or service and therefore theoretically reduce the supply for a good. An example of this in use would be the taxation of a demerit good.
Shifting the taxation in the economy from direct to indirect means that supply of a good or service is going to decrease unless it is inelastic. If the indirect taxes were to be placed in an inelastic good such as alcohol or tobacco that can be addictive and are also income inelastic. The income elasticity of the good is a general trend that people on lower incomes are generally going to have had a low level of education and therefore are more likely to take part in risky behaviours such as drinking alcohol and smoking tobacco so the consumption of the demerit good ill be greatest on those household with the lowest incomes. The price inelasticity of the good means that increasing the indirect tax will not reduce demand that much as price effects it little. This would mean that the producers could pass off the cost of the taxation on to the consumers and still maintain a profitable revenue.The taxation of the inelastic good means that the producers will still be earning money and also the government will also gain from then indirect tax and could use the extra revenue gained on hypothecation or spent elsewhere within the economy. However the taxation of the inelastic good means that price for the consumers will go up shifting from price P to P2 which results in the reduction of the consumer welfare surplus from A to B.
This indirect tax leading to reduced consumer surplus means that people will start to have to pay more for their good and will start to fill less satisfied having an effect on peoples daily lives. The increase in price level due to the indirect placed upon a good such as tobacco or in the budgets case fruit juices means that living costs for the population in the lowest incomes will increase not in proportion to their income. This may lead to the further consumption of harmful demerit goods such as alcohol and tobacco which would increase the societal cost of the consumption of the good. However an indirect tax can also be a good idea and result in a positive outcome as if the government has increased the tax then they will be gaining higher tax revenues which means that they can incases aggregate demand which will lead to economical growth as government spending is a key contributor to total AD. (C+G+I+X-M) This economic growth could lead to further positives as it may attract FDI’s to the country and create more jobs which leading to reduced unemployment and a right shift in Aggregate supply.
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