Key terms
- Tax incidence
- Tax incidence is the way the burden of a tax is divided between the consumers and the producers of the taxed good.
- Tax wedge
- The tax wedge is the gap a tax opens between the price consumers pay and the price producers receive, equal to the tax per unit.
Types of indirect tax
Can you name the two types of indirect tax?
The type decides how the supply curve moves.
Definition
A specific tax is an indirect tax of a fixed sum on each unit sold, whatever the price of that unit.
Can you think of an example?
Example
A £1 tax on every bottle of wine adds £1 to a £5 bottle and £1 to a £50 bottle, so supply shifts up by £1 at every quantity.
Definition
An ad valorem tax is an indirect tax charged as a percentage of the price of a good, so it takes more in pounds from a dearer unit.
Can you think of an example?
Example
A 20 per cent tax adds £1 to a £5 bottle of wine and £10 to a £50 bottle, so the gap between the old and new supply curves widens as the price rises.