Discuss Whether Indirect Taxes on Petrol and Diesel Fuel in the UK should be reduced
The main reason that a government imposes a taxes on fossil fuels is to try and correct for the negative externality (pollution) which is produced when they are consumed. Without the tax there would be a market failure as drivers would be over consuming petrol as they are not being charged for the damage to the environment. In order to order to answer this essay as to whether the tax should be reduced, I am going to focus on 3 aspects; those that lose from a reduction, those that gain from a reduction and finally at what level the overall price for petrol was BEFORE the tax reduction. In my conclusion I will show that this is key to deciding whether the tax should be lowered or not.
The major argument for maintaining the level of taxation on petrol and diesel is to protect the environment. When the social costs of consuming a good are higher than the private costs, there is said to be a negative externality. As an individual consuming fuel is polluting the environment for all, then it can be seen that fuel produces a negative externality. This is illustrated in diagram 1 below. This shows that without any government intervention, the market equilibrium would consume Qp at price Pp. This is higher than the social equilibrium, Qs, meaning there has been a welfare loss to society of (shade triangle). Government fix this by imposing an indirect tax on producers, which effectively raises their costs of production, shifting their supply curve inwards. If they have set the tax at the right level, this internalises the externality and the new private cost curve looks exactly like the social cost curve, and the market “chooses” to consume Qs after the tax. This is shown as level Q2 on the diagram below. Importantly, as a result of the tax, the welfare loss triangle has disappeared. This