(a) What is a specific tax? (2 marks)
(b) Explain with the aid of diagrams, the effects of specific tax on a commodity that has a:
(i) perfectly elastic demand; (6 marks)
(ii) perfectly inelastic demand
(c) State two differences between a direct tax and and an indirect tax. (6 marks)
Explanation
(a) A specific tax is a tax that is levied at a fixed rate per unit of output.
(b)(i) A specific tax is a post of production, the effect is a reduction in supply from S\(_{1}\)S\(_{1}\) to S\(_{2}\)S\(_{2}\) by the amount of tax as the diagram below. A reduction in supply cannot ad to an increase in price because the demand for the commodity is perfectly price elastic. The entire burden of a specific tax falls on the producer who is unable to increase his price. Equilibrium quantity falls from q\(_{2}\) to q\(_{1}\) while price remains the same.
(ii) A specific tax will make the market price of a commodity that has a perfectly inelastic demand to rise by the full amount of the tax. Since the demand is perfectly inelastic, quantity demanded will remain the same i.e. Q\(_{1}\). while the price of the commodity will increase by the full amount of the tax e.g. from P\(_{1}\) to P\(_{2}\).
(c)(i) A direct tax is levied on an individual's income or property while an indirect tax is paid indirectly when an individual purchases goods and services.
(ii)A direct tax can be evaded while indirect tax cannot be evaded.
(iii) A direct tax can serve as a disincentive to work while indirect tax may not.
(iv) A direct tax can be progressive while indirect tax is usually regressive.
(v) Generally, indirect tax is more convenient to collect than direct tax.