• 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


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