Taxation

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Taxes:a) Based on the information provided, adviseis higher than when we tax the cigarettes.b) The
the Minister which one of the two products she shoulddecision to impose the indirect tax may still be
tax. Explain and justify your advice.unpopular with consumers and/or suppliers, depending
Taxation is one source of government revenue, thereon which product is taxed; the Minister needs to be
exist two types of taxes which are direct taxes andprepared for any potential negative political reaction.
indirect taxes, direct taxes are those taxes that areFor both products, advise the Minister where potential
imposed directly on products or even personal incomenegative reaction to the tax may come from.
tax. Indirect taxes are taxes imposed on good andThe decision to impose taxes on products may result
services. When a direct tax is imposed then both theto negative reactions, when taxes are imposed on a
sellers of the products and the buyer faces the burdenproduct it is likely that the products demand decreases
of tax.and as a result the profits obtained by the producers
On the decision to decide which product to impose theof these products will decline due to low demand that
tax we will have to consider the incidence of tax andleads to low sales.
this will be determined by the elasticity of demand.Tax on Bilos:
Because the country has no indirect tax thenBilos are used in almost all offices, schools and
that’s why the indirect tax is preferred, thecolleges, an increase in their price will lead to a
effect of an indirect tax on a good is demonstratednegative reaction by almost the entire population
below:because every other person uses and purchases
When the tax is imposed on the seller then the priceBilos. As a result of the tax on Bilos therefore the
rises and this is shown in the diagram where the pricewhole population will term this tax as unpopular.
moves from P to P+T, these price increase shift theThe other negative reaction will come from the
supply curve upwards from supply curve 1 to supplyproducers of the Bilos, the producers will experience a
curve 2 as shown above.decline in sales level and therefore they will record
A tax will lead to a reduction in the producer surpluslower profits. The lower profits will lead to the
and at the same time the consumer surplus, further thecompanies wanting to cut off on expenses by laying
tax also results to dead weight loss, the diagramoff workers, therefore in this case there will be a
below shows the consumer surplus and the producernegative reaction that will result from the companies
surplus:and also the laid off workers from these companies
From the above diagram it is clear that the produceras a cost reduction measure.
surplus is reduced and also the consumer surplus, theThe other issue is that Bilos, papers and books are
loss in consumer surplus and producer surplus goes tocomplementary goods, when the price of Bilos rise and
the tax and also the dead weight loss. Therefore atheir demand rise it is highly likely that the demand for
tax will lead to a loss which is referred to as the deadits complementary will also decline. For this reason
weight loss.therefore there will be a negative reaction coming
In our case we have two good to consider: bilos andfrom the producers of books and papers regarding
cigarettes, the elasticity of demand for bilos is 2.00,this tax. The decline in demand for papers and books
while for the cigarettes the price elasticity of demandwill lead to a decline in the profits for the producers of
is equal to 0.05. Given the elasticity levels then it isthese products and as a result there will be a rise in
clear that bilos have a higher elasticity level and thisunemployment as a result of the increased lay off of
means that a change in their prices by imposing a taxthese companies wanting to cut on the cost of
will reduce the demand by a very large quantity. Forproduction in order to maintain high profits.
the cigarettes the elasticity level is lower and thereforeTax on cigarettes:
an increase in price will not reduce demand by a largeWhen taxes are imposed on cigarettes the prices will
margin. The diagrams below show the effect of a taxrise, however because the elasticity of demand in this
on the two goods:case is low the demand will not decline at the same
From the above diagram it is clear that when the taxrate as that for the Bilos, therefore the prices will rise
is imposed on either of the goods the level of price willand demand will fall, smokers will react to the price
raise and the supply curve shifts upward, the diagramincrease while in the same case the producers will
assumes that the price for both goods is equal andexperience a decline in profit and therefore they will still
that the tax imposed increases the price to the samehave a negative reaction to the tax.
level.Unemployment will rise and therefore this will be an
The demand curve bilos is elastic while that ofunpopular tax imposition by the government, the
cigarettes is inelastic, therefore if we choose the bilosunemployment will be caused by the cigarette
to impose the tax the incidence of tax is that theproducing companies whereby they will lay off
burden will be both to the producer and the customers,workers in order to maintain high profits whereby they
however if we choose the cigarettes the greatestwill try to reduce the costs of production.
burden will be on the buyers.The other issue regarding cigarette tax is that the
The best option therefore will be to impose a tax ontaxes will only target a certain group in the economy,
cigarettes. Cigarettes are luxuries as compared to thethis target group is the smokers, this may be a tax that
bilos which are more productive. The other reasonwill target this group of consumers only and the taxes
why we would choose the cigarettes is that a priceproduced will result to the free rider effect. This means
increase will not affect the demand for them by athat the revenue collected will be used to provide
greater degree as compared to the bilos.public goods to the population but some of the people
The other reason is the issue of incidence of tax, forwho enjoy the goods will not have paid for the taxes.
the cigarettes the greater tax burden is to the buyersTherefore the free rider effect on the economy will
and for this reason we will achieve higher revenuelead to negative reaction form the target group.
without affecting the demand in the market. ForA positive reaction however will come from non
healthy issues this tax imposed on cigarettes will besmokers who advocate for a tobacco free economy,
viewed as a way in which we are discouraging peoplethe increase in prices of cigarettes will lead to a decline
to smoke and therefore the decision to impose tax onin the number of cigarettes produced in the economy,
cigarettes will not be viewed negatively by theas a result of this therefore there will be a decline in
population.the diseases associated with smoking and also some
Further the dead weight loss in the cigarettes is lowersmokers will stop the habit, therefore the tax on
than the loss in the Bilos tax. Therefore it would becigarettes will lead to positive vote regarding the health
advisable to tax the cigarettes instead of the Bilos. Forand health expenses on the diseases and ailments
these reason therefore the proportion of tax collectedcaused by smoking.
with regard to the decline in producer and consumer