Taxation
- There’s a wide range of taxes implemented by central and local governments on firms and consumers in the UK
- Here are two main kinds of tax:
- Direct taxes, such as income tax and corporation tax
- Indirect taxes, such as VAT and excise duties
- The burden of tax is roughly evenly split between direct and indirect taxes
- All forms of taxation are paid to the government, which in turn allocates tax revenue to various forms of public spending
- There is very little hypothecation
- As previously mentioned, a lot of tax revenue is needed to finance merit goods and public goods
- Indirect taxes are widely used to discourage the production of demerit goods and goods that produce negative externalities
- Although this tax is imposed on the producer, most forms of indirect tax tends to be passed on to consumers
- This obviously leads to an increase in prices
- In principle, the tax that’s imposed should equal; the value of the negative externality
- When this occurs, the producer is required to pay the tax in full
- Prices charged therefore take into account the cost of the negative externalities
- In this way, the external cost is internalised to the producer
- A tax such as this is consistent with the ‘producer pays principle’
- This is fine in theory, but difficult to apply in practise for four reasons:
- There are problems determining the exact amount of the tax, as it’s difficult to estimate the monetary cost of a negative externality
- Producers may not always pay the full amount of the tax, and it’s often shared with the consumer
- PED for many demerit goods is inelastic, meaning that consumption may not be reduced as much as intended, with the result that production is higher than intended
- Better quality information for consumers might also be used to further reduce consumption