VAT Worksheet - VAT - Who pays what?

This worksheet deals with how indirect tax changes will affect individuals and the level of income distribution. It also considers the impact that indirect taxes will have on the equilibrium price of a product and who bears the burden of the tax.

There is also a printable version of this worksheet available for classroom or personal use with spaces to fill in the answers.

Step 1 - The defining moment of tax

Try to find out definitions of the terms below and write them down. You may want to use your course notes or course book, or there is some information in the explanation of VAT and in the glossary of the Virtual Economy.

Per-unit tax

Ad-valorem tax

Regressive tax

Progressive tax

Direct and indirect taxes

Step 2 - Taxes, what taxes?

Use either your course materials or the resources available in the Virtual Economy to help you find out about all the indirect taxes that we have in the UK. Use this information to fill in the blanks in the table below. You may find the explanation of VAT and the input form of the model helpful in doing this.

Product?	Price?	Total tax?	Tax as a % of price?	Tax collected by?
Petrol
		718.8p		HM Customs & Excise
			29.8	HM Customs & Excise
Wine
	336p

Why does the government change the level of the per-unit taxes in each Budget, but not that of the ad-valorem ones?

Step 3 - The price of tax

When an indirect tax is imposed on a good, this will affect the equilibrium price and quantity in the market. There are further details about this in the VAT theory section. Use the figures in the table below for the supply and demand of a product to answer the questions underneath.

Supply (no. per week)	Demand (no. per week)	Price (£)
45	75	5
50	70	6
55	65	7
60	60	8
65	55	9
70	50	10
75	45	11
80	40	12
85	35	13

What is the initial equilibrium price and quantity?

What would be the equilibrium price and quantity in each of the following cases? (Fill your answers in in the relevant gaps in the table.)

	Equilibrium price	Equilibrium output
1...A per-unit tax of £2 on each unit
2...A maximum price of £6
3...A per-unit tax of £4 on each unit
4...A minimum price of £5 per unit
5...A per-unit tax of £6 on each unit

On the axes below, draw a diagram to show each of the five events in the table:

1...A per-unit tax of £2 on each unit

2...A maximum price of £6

3...A per-unit tax of £4 on each unit

4...A minimum price of £5 per unit

5...A per-unit tax of £6 on each unit

What would be the amount of tax revenue for the government in each of the following instances (assuming the same pattern of supply and demand as in the table above)?

A per-unit tax of £2 on each unit            Tax revenue £__________?

A per-unit tax of £4 on each unit            Tax revenue £__________?

A per-unit tax of £6 on each unit            Tax revenue £__________?

Step 4 - Taxing e l  a   s    t     i      c      or inelastic goods?

Goods with a high price elasticity (elastic goods) will respond far more to a change in price than goods with a low price elasticity (inelastic goods). This means that they will also react very differently to a tax imposed on them. There is more detail on this in the VAT theory section.

On the diagrams below, show the effect on equilibrium price and quantity of a per-unit tax:

What effect does the tax have on the equilibrium of the market for the elastic goods?

Would taxing elastic goods be an effective way of raising money for the government? Give reasons for your answer.

Write a short paragraph explaining the type of goods the government should tax if it wants to use the taxes to raise revenue. Justify your answer by reference to the actual taxes you found out about in Step 2 above.

Step 5 - Who gets hit hardest by taxes?

Look back to the definitions you found for progressive and regressive taxes in Step 1 and use them to decide whether the taxes below are progressive or regressive:

Tax	Progressive or regressive?
Income tax
VAT
Tax on cigarettes
Tax on beer
Council Tax

Let's now try some changes on the model and see the impact they have on families at different income levels. Go to the model (either click on the link at the top of the page or on the 4th floor in the side panel) and try the following:

• Increase the level of VAT by 2.5 percentage points (to 20%)
• Increase all other indirect taxes by a reasonable amount

Note down in the table below the effect of these changes on the families given. From the weekly change in income, calculate the annual gain or loss and also the percentage gain or loss for each family:

Family	Weekly gain or loss (£)	Annual gain or loss (£) weekly gain x 52	Percentage gain or loss (%) annual gain as % of income
Employed single parent, one child, £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children, £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two children, £100,000

Which family has lost the most as a percentage of their income?

Which family has lost the least as a percentage of their income?

What effect has this had on income distribution in the economy? Has it widened or narrowed it?

What indirect tax changes would you suggest to have the minimum effect on the less well-off in society? Justify your answer.

What effect would you expect on the economy if the government were to significantly increase the level of indirect taxes? Try to consider the following in your answer:

• the level of aggregate demand
• income distribution
• the level of consumer spending
• inflation and unemployment
• economic growth
• government tax revenue