Microeconomics - AS Indirect Tax and Subsidies

 AS Indirect Tax and Subsidies

Writing Skills -                                 Example 1

In 2018 the Government of Uganda introduced an indirect tax on mobile internet usage. The aim was to raise tax revenue. Consumers had to pay a tax of 200 shillings per day to use services including Facebook,  Twitter and Instagram. In the six months that followed the introduction of the tax, mobile internet usage decreased from 47.4% to 35% of the population. 

Evaluate the likely microeconomics effects of the introduction of this indirect tax. 

(Source - Edexcel AS Economics October 2021)

Possible answer -

Before I evaluate the case let me first mention the brief understanding on the term indirect tax.

Indirect tax is the tax on goods and services or the expenditure by the households. Indirect tax could be two types such as specific tax and ad valorem tax. Specific tax where an specific amount is imposed as tax on the price of goods and services. Whereas ad valorem tax is the tax in terms of percentage imposed on the price of the goods and services.

In the case study, Uganda government has imposed a tax of 200 shillings is an example of specific tax. This imposition of specific tax will cause parallel shift in the supply curve to the left from Supply 1 to Supply 2 on the Figure 1 below. As a result, price of the mobile internet usage will increase from P1 to P2 and quantity will decrease from Q1 to Q2 (Figure 1). 

Indirect tax

The shift in the supply curve to the left will be due to the increase in the tax burden on the producers as the imposition of 200 shillings tax will increase the cost to the producers. This is evident from the case above that the tax of 200 shillings has caused the price to increase leading the quantity demanded for the mobile internet usage to decrease from 47.4% to 35% (Figure 1, Q1 to Q2).

Though the price of the good will increase but it would not be an absolute increase in price as the tax of 200 shillings will be shared by the mobile internet users and the internet service providers as it is mentioned on the Figure 1. Part of the DB = EG tax is shared by the sellers. Sellers are likely to share FG amount of the per unit tax, whereas, users of internet services would have shared EF amount of the per unit tax. The share of the tax burden would depend on the elasticity of the demand of the mobile internet services. If it is inelastic then buyers will share the tax more and sellers would share less, vice-versa.

The imposition of the tax will also affect the consumer and producer surplus in the market. Consumer surplus is the price benefit that consumers enjoy due to the difference between the price that consumers are willing to pay and the price that consumers actually pay. Whereas, producer surplus is the price benefit that producers enjoy due to the difference between the price they actually receive and the price they are willing to receive. Imposition of tax causes the consumer and producer surplus to decrease from ABC to AEI. Consumer surplus decreased from ABP1 to AEP2. The loss of consumer surplus is P2EBP1. The producer surplus has decreased from P1BC to P2EI.  The loss of producer surplus is P1BGH. The part of the consumer and producer surplus lost are converted into the government tax revenue P2EGH and the deadweight loss EBG on the graph.

Due to the loss of producer surplus (because of the imposition of the tax), producers could be discouraged to start up a new business in the industry or to operate the existing one efficiently as there is a less probability to make same amount of profit like before. 

The reason for decrease in profitability could be due to the increase in costs at the same time decrease in number of mobile internet users in the country. This may have negative impact on the employment as firms like Facebook, Twitter or Instagram may not like to hire people anymore. This could be an unintended consequences of the tax imposition in the mobile internet service market leading to government failure. Unintended consequences may also include people not being able to access the necessary information to run their daily lives.

In case of firms like Facebook, Twitter and Instagram leaving the market means internet users may not have many options left in the future. This may cause inconvenience for the mobile internet users. 

The tax imposition may also cause rise in external costs on advertising firms as less internet connections will cause commercial firms not to advertise like before. As a result of that many advertising companies may become obsolete. 

Nonetheless, in order to collect the tax from the mobile internet service providers, government has to set up a department to cross check the number of users that each of the mobile internet service providers has to collect the right amount of tax. This may increase the administration costs. 

From the above information it is clear that government of Uganda has imposed tax on mobile internet services to increase the tax revenue. Though they have increased the tax theoretically but it does not make sure that the government would actually be able to increase the tax revenues. Tax revenue would increase or not that would depend on the elasticity of the demand of mobile internet services. If the demand is highly elastic then imposing tax would cause decrease in the government tax revenues as the higher price led by tax would cause decrease in huge number of users in the country. As a result, government of Uganda may not be able to achieve their objective.

On the other hand decrease in huge number of users would also cause inconvenience for the mobile internet service providers as they would lose a huge number of customers leading to fall in their revenues vis-e-vis profits. As a result, they will pay lower taxes to the government than before. This may again mean government of Uganda might not be able to enhance their tax revenues.

Though there are many adverse effects of imposing tax on the mobile internet service market but not without some positive effects. Let me explain those below.

The imposition of tax will definitely decrease the consumer and producer surplus but the benefit is that the Uganda government would be able to charge tax on each person using the mobile internet usage up to 200 shillings per day. This may result in massive increase in the tax revenue for the Uganda government. 

Though the collection of the tax depends on the elasticity, the tax of 200 shillings may not be a big amount for mobile internet users in Uganda compare to their income leading to continue using the internet services despite of the tax. This might not affect the tax revenue collections negatively. 

Instead, considering the fact that the use of mobile internet services have become part of the daily lives of the people around the world may mean the demand for mobile internet services in Uganda is inelastic. This means that the imposition of the tax will not decrease the number of users leading to higher tax collections. 

Though the objective of the government of Uganda mentioned in the case is to increase tax revenue, but there may have other objectives too to impose tax on mobile internet services, one of them could be to decrease the external cost of mobile internet services on the third parties. The externality may occur due to the availability of the cheap data usage that some disturbing groups may use to spread misinformation to create chaos in the country. To control the spread of misinformation government may choose to make the availability of the data costly. Thus tax can be used to solve the externality problem. Tax on mobile internet services will make the availability of the information costly to everybody leading to have a control on the spreading of the misinformation across the country. Thus, presenting it as a good solution.

To conclude, I must say that, though the possible assumptions are made above but the true evaluation could have been done if more data was available on the minutes or hours that people have spent in consuming the data.