IGCSEEconomicsEdexcelRevision NotesBusiness EconomicsGovernment InterventionGovernment Intervention: Taxation & Subsides

Government Intervention: Taxation & Subsides (Edexcel IGCSE Economics)

Revision Note

Steve Vorster

Expertise

Economics & Business Subject Lead

Government Intervention To Deal With Externalities

  • To correct externalities, a government can use taxation or subsidies to influence the level of consumption or production of a good or service

    • Indirect taxes increase the cost of production which is then passed on as an increase in price. Taxes are useful to address externalities where goods are over-provided

    • Subsidies lower production costs and therefore increase output of the product. Subsidies are useful to address externalities where goods are under-provided or under-consumed

Taxation

  • Indirect taxes are levied by the government on producers, increasing the cost of production for firms

    • Higher prices may reduce the quantity demanded (QD) and discourage the consumption of specific goods or services that generate negative externalities

Example

  • A sugar tax was levied on sugary drinks in the UK (2018)

    • The aim was to reduce consumption of sugary drinks

    • The consequence of poor health and obesity caused by excess sugar intake are paid for by third parties,

    • In this case, the third party is the taxpayer, who funds the healthcare provided by the UK National Health Service

Evaluating the use of indirect taxes to reduce negative externalities

Stakeholder

Advantages

Disadvantages

Consumers

  • Reduced consumption of goods with external costs, leading to lower costs to third parties

    • E.g. Cigarette tax (excise duty) leads to higher priced cigarettes, which reduce s consumption and therefore less passive smoking for third parties

  • "Sin Taxes" often affect low-income consumers disproportionately, worsening inequality

  • The effectiveness of the tax depends on the price elasticity of demand (PED)

    • Many consumers who purchase products that are price inelastic in demand such as cigarettes and alcohol will continue to do so, not reducing consumption

Producers

  • Producers are forced to pay for external costs associated with emissions from production of harmful goods

  • E.g. Air pollution is fined, increasing the cost of production and therefore internalising the externality

  • Producers may be forced to make some workers redundant as output falls due to the higher costs of production

  • This is particularly the case if the producer cannot pass on the higher costs as higher prices

Government

  • Raises revenue for government programs

  • Could be used to fund healthcare and education initiatives about the consumption of goods with external costs

  • It may create illegal markets as consumers seek to avoid paying the taxes

Subsidies

  • Subsidies attempt to increase the output and consumption of specific goods or services that have external benefits

    • A subsidy is a payment to a firm that reduces the costs of production and encourages an increase in the output of a good or service

Example

  • The UK government provides subsidies to firms producing renewable energy equipment

    • The subsidy lowers the cost of production of air source heat pumps and loft insulation

    • Consumers demand more of of these energy saving devices at a lower price, therefore using less fossil fuel to heat their homes

    • This reduces the negative externality associated with the use of fossil fuels

Evaluating the use of subsidies to promote products with positive externalities

Stakeholder

Advantages

Disadvantages

Consumers

  • Lowers prices and increases demand for goods with positive externalities

  • It helps to change destructive consumer behaviour over a longer period of time, e.g. subsidising electric cars makes them affordable and increases demand

  • Subsidies may disproportionately benefit higher income consumers, e.g. on electric vehicles

Producers

  • Can be targeted so as to help specific domestic industries

  • Subsidies can discourage firms from becoming more efficient or competitive, as they become reliant on financial assistance from governments

Government

  • It helps achieve environmental aims

  • It helps reduce carbon emissions and improve air quality

  • There is an opportunity cost associated with government expenditure; could the money have been better used elsewhere?

Exam Tip

In Paper 1, you may be given a scenario and asked to assess the impact of the taxation or subsidy. Make sure you have a balanced argument and consider how effectively the intervention impacts the consumption or production of that good/service (e.g. subsidy may increase consumption of positive externality goods but also have an opportunity cost)

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    Steve Vorster

    Author: Steve Vorster

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.