“The use of indirect taxation to solve failure will inevitably result in ”. To what extent is this statement true? Indirect taxation is the imposition of a on goods and services rather than on income or Starting an essay with clear, accurate and profits (i.e. direct taxation). Indirect tax is paid when consumers make purchases. Indirect succinct definitions is a are associated with to ‘internalise the externalities’ of consumption or safe but effective way to start. production. They are used to raise revenue for government to provide public and merit goods and to redistribute income. This essay will show that government failure is highly Introducing the key likely following the imposition of indirect taxes, although not inevitable. thesis i.e. conclusion, in the opening A common type of market failure tackled using indirect taxes are externalities which are paragraph is great way of building up costs or benefits borne by a third party not involved in an economic transaction. For towards a example, some external costs caused by road transport include pollution and congestion. substantiated judgement, which is an Roads are a quasi-public good due to difficulty in excluding users and the consequent rivalry essential quality of a at peak periods, as most roads are free to use. The external costs of congestion, such as top-grade essay. increased emissions of pollutants, excess consumption of fuel, and lost productivity are There is lots of evidence of sound significant, and so governments may introduce indirect taxes to try and reduce road use. economic analysis The UK government levies a tax on petrol and a tax on the ownership of cars, it also here, using technical language and implements a congestion charge in Central London during peak periods. Such taxes make explanations including road users pay for the external costs associated with their use and raises the market price examples. so they limit or switch to substitute goods such as rail, bus and bikes. This limits congestion and flowing traffic produces fewer external costs. The same rationale applies to other interventions to prevent degradation of the environment such as taxes on coal-fired power stations, plastic bags, landfill, and air passenger transport.

Governments use indirect taxes to reduce sales of goods that are harmful and have consumption externalities such as tobacco and alcohol. These goods are known as demerit goods – they are over-consumed due to information failure, as consumers don’t realise the true private and external costs of their consumption. These “sin” taxes are paid by the This is a sound explanation of how producer per unit of output. Like road taxes, they internalise the externality and reduce indirect taxes work in consumption and production of theory, and there is a nice link to the the good to a socially efficient diagram in the written level. Indirect tax distorts the analysis. market to raise the costs of production for firms who then raise price (to P + tax) to protect profit, the response of demand depends on price elasticity. Most recently there have been calls for this kind of tax on products with high fat or sugar content. All indirect taxes raise revenue, which can then be used to redistribute income through the welfare state, or provide infrastructure to help tackle factor immobilities e.g. transport networks and educational facilities. In other words, tax revenue from one market can be used to reduce other market This is a really great point, as the candidate failures too, assuming an efficient tax system along the lines of Adam Smith’s ‘canons of considers the broader taxation’. impact on market

failure of indirect taxes. Government failure (i.e. when intervention leads to a less efficient allocation of resources) suggests either too much or too little is still produced following the tax imposition.

Measurement of the size of a tax required can be compromised by information failure; this Candidates often is particularly prevalent with environmental taxes where often the size of the tax does not struggle with the concept of government reflect the contribution to degradation. Science is unsure as to the true cost of C02 emissions failure, so it is pleasing and specifically how much more an airplane contributes to global warming than a car. Even to see it accurately defined here. if economists were able to calculate the external costs, there is inequity as the biggest contributor to global warming i.e. meat and dairy production, remains tax free. Food is left untaxed as it is a basic need and a tax would increase levels of poverty so a solution in one Using an extended market would cause a failure in another. The extent to which market failure is tackled, example as part of the evaluation is an therefore, appears to depend on how narrowly the market is defined. effective technique.

An effort to redistribute income is behind the lack of VAT on unprocessed foods, books and children’s clothes and at a much lower rate on heating fuel. VAT and Stamp Duty attempt to redistribute income by imposing greater rates on luxury items and expensive houses respectively. Tax revenue can then contribute to the provision of public and merit goods. However, many of the items that incur VAT can be seen as basic needs in today’s world, such Using the current as TV’s, internet, mobile phones and fast food. This, together with the burden of sin taxes, context of consumption patterns that are similarly price inelastic goods, means lower income groups ration other items, is important for reducing output in these markets which may have positive externalities, such as educational showing examiners that candidates can resources or healthy food. This is clearly government failure. think ‘beyond the textbook’. Indirect taxes can also lead to unintended consequences that produce more inefficient outcomes, for example, a tax on cigarettes may see consumers switch to smoking marijuana, an illegal and more harmful substitute. Consumers may also try to avoid a tax, which results It is important that in a rise in black markets that require extra policing (e.g. cigarette smuggling). The cost of candidates consider a policing and administration on both government and firms means a tax has to be at a certain range of reasons for government failure in level to be efficient and recoup its costs of collection, and this argument has been behind questions on this topic the UK’s reluctance, until recently, to tax plastic bags. e.g. information failure, administration

costs, unintended Finally, the difference in indirect tax regimes across the globe suggests that there is no consequences etc. consensus as to the true social costs and social benefits of many of the markets that are

‘adjusted’ by the system. To this end, I agree that the imposition of indirect taxes is likely to cause government failure due to information failure and the subjective nature of estimating the external costs and benefits. On the other hand, although the outcome following an indirect tax may not be perfectly efficient it can be argued that it is a more efficient outcome than if left to the .