A good example of how taxes can influence the face of markets is demonstrated by remembering the 1988 budget when the excise duty on a gallon of 4 star petrol increased by 10p, unleaded was left unchanged. This was the start of a price difference between the two types of petrol of 10p. Over 12 months sales of leaded petrol fell by ¼.
The consumer bears the 10p price difference from £1.90 to £2.00, as the short-term supply curve for petrol is perfectly elastic. Unleaded petrol is a very good substitute for leaded petrol and therefore the demand curve is price elastic. This is different to the point made earlier where it was stated that price is demand inelastic. That referred to petrol as a whole and not different types of petrol. We have a 5% increase in price leading to a 25% fall in sales. The result was that the consumer paid this increase while petrol companies kept on supplying for a constant £1.90 a gallon. Unleaded petrol suddenly became more popular and the transition of many cars to unleaded began, subsequently changing the face of petrol sales from then on. Taxation affected the structure of the petrol market and made it almost compulsory for car suppliers to change the engine on cars so that leaded petrol was no longer needed.
Taxation has other profound effects, as was seen in the media recently. The UK experienced a petrol shortage, meaning that transportation of goods was limited. If the Chancellor increases the excise duty on petrol it will cost more to carry goods via transportation, as all vehicles need petrol-it is a necessity. If a firm is not located near to its raw materials or its market then transportation costs are of huge importance. If a company has to pay more for transportation then it would seem to follow that profits will decrease if the higher petrol prices are not reflected in the price of the good the company wants to sell.
It will be strongly evident, therefore, that many of the smaller manufacturing firms will find it hard to cope with the increasing costs of transportation. In order to compensate for this, prices for the goods sold will have to increase and be passed on to consumers. However, the British manufacturing industry has been in decline over the last 30 years. One reason is its failure to compete on world markets. If the Chancellor of the Exchequer decides to keep on increasing the excise duty on all forms of petrol then the result could be a further reduction in its’ share of world exports and therefore a subsequent decline in output. A decline in output would lead to unemployment and a cycle of deprivation. This is, of course, a generalization. However, some truth does come out of this statement
It would be unwise for the statutory incidence of tax to be on the producer of a good as excise duty is raised (on average) by 6p a year. We can say that for any given product there is a distribution of the tax burden after the imposition of an indirect tax:
Consumers’ share of tax burden = Elasticity of Supply
Producers’ share of tax burden = Elasticity of Demand
It is possible to say for petrol that if the supply is more elastic than demand, the consumers’ share of the tax burden will exceed the producers’ share.
The simple economic theory dictates that an increased cost to make a product leads to an increase in its price. Profit is everything in the competitive world and any company which does not take petrol increases to mind will be left feeling the cost. During the crisis a Yorkshire firm called “Beacon’s Hauliers” had to close their company due to the inability to carry out their service. Taxation of petrol is similar as people will go looking elsewhere for companies offering better prices due to larger economies of scale.
The recent petrol crisis in the UK demonstrated the price differences of petrol around the country. An increase in petrol duty will raise prices. However, there is variation depending on the size of the petrol retailer. A Tesco or a Shell outlet will try to keep prices as low as possible. They can do this due to their large economies of scale. A small independent outlet will not be able to keep their prices as low as the big retailers. Customers will be prepared to ‘shop’ around for better prices in the local area and a subsequent loss of business will occur. In a way the big supermarkets and large petroleum companies dominate and control the market and its structure.
In the UK duties on tobacco, petroleum and alcoholic drinks accounts for almost 30% of government revenue. The high excise duties mirror the presumption that increased consumption would be detrimental to the health of the community. An increase of 4p a gallon (which occurred in March of this year) had, of course, revenue consequences. Such an increase means that tax receipts swelled up by a considerable £170 million.
The price of unleaded petrol at the start of November 2000 was 62p a litre; the duty rate was 47p. The increase in excise duty is required to be handed over to the government. As a result of this tax, the supply of petrol decreases and the supply curve shifts leftward. The difference between the two supply curves is the amount of tax:
The grey triangle is a “measure of the total loss of both consumer and producer surplus.” An excise duty will create a deadweight loss due to the creation of inefficiency in the market. There is a consumer surplus that equals the area of the small blue triangle.
The recent public discontent at yet another increase in petrol duty has put the question of alternative energy in the minds of people. By increasing petrol taxes the government hopes to change the face of car running, either by looking for cleaner alternatives or using public transport. However, the revenue that excise duties creates for the government leads many to wonder if the government are doing all they can to adopt cleaner alternatives to petrol.
The high excise duty on petrol can be used to correct externalities in the market. Cars emit poisonous fumes that pollute the atmosphere. Therefore, external costs are created for the environment and the people who breathe in the fumes. The high tax on petrol still allows the market to operate (as demand is so high) but it also forces companies to look at the social cost. Moreover, by taxing leaded petrol even more consumers are encouraged to find cleaner ways of producing. The higher tax on leaded petrol acts as an incentive over the long run for people to change cars and therefore reduce pollution.
It is not enough for governments to simply tell people to use a different form of transport; one that is kinder to the environment. People need cars to communicate and until public transport becomes more reliable and cheaper then the public has no other alternative than to use their car. It is a necessity. The government can impose excise duties on petrol and get away without demand for petrol decreasing by a significant amount.
Excise duties, therefore, are levied on imported goods (and domestic goods) with the aim of raising revenue. Of the duties on tobacco and alcohol a lot is raised by taxing petrol. The large sums raised from sales of petrol indicate that demand for them is relatively inelastic. It is true to say that in the last year increases in price caused by higher excise duty have had little impact on consumption. An increase in the taxes on petrol will influence the type of petrol people buy but will not affect the demand for petrol overall. Petrol prices affect haulage markets. They need to be competitive due to the threat from Europe (including cheaper petrol prices) but how much of the price increase they absorb, as discussed, will depend on economies of scale. The government needs to take into consideration the cost to society of petrol. It is harmful so needs to be taxed but the revenue raised is substantial. This can go towards expenditure like NHS funding (which was £54 billion last year. Either way an increase in petrol duties will have profound effects above and beyond a person paying a few pounds more at the petrol pump.
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as at 11/2000
as at 11/2000