Difference between Net Indirect Taxes and Subsidy

This article will help you to learn about the difference between net indirect taxes and subsidy.

Difference between Net Indirect Taxes and Subsidy

Money value of final goods and services can be estimated in two ways—at Factor Cost (FC) and at Market Price (MP). Briefly, the difference between FC and MP is ‘net indirect tax’.

And net indirect tax is the difference between indirect tax and subsidy.

(i) Factor cost refers to all factor payments made by the producing unit (firm) to the factors of production for rendering productive services in the production of goods and services. It is called factor cost because it is cost to the producer (firm) who pays to factors in the form of rent, wages, interest, etc. and profit to himself.

(ii) Market price is the price at which a commodity is sold and purchased in the market. It is the price what the buyers pay actually, not what the producers actually get. The point to be noted is that when a product goes to the market for sale, government levies indirect taxes (like sales tax, excise duty, etc.) which is added to the factor cost of the commodity.

Consequently market price becomes higher than factor cost. Similarly, sometimes government gives subsidy on sale of certain goods (like sugar, rice, LPG cylinder) which is subtracted from factor cost. As a result, MP becomes lower than Factor Cost (FC).

The difference between indirect tax and subsidy:

(a) Indirect Taxes:

Taxes which are levied by the government on production and sale of commodities are called indirect taxes, e.g., excise duty, sales tax, customs duty, octroi, etc. These are called indirect taxes because buyer of a taxed commodity pays the tax indirectly which in fact is included in the price. Leaving aside the aims of the government in levying indirect taxes, we study here the effect of an indirect tax on the price of a commodity on which tax is levied.

What is the effect of indirect tax on the price of a commodity on which it is levied? The effect of indirect tax is that it increases the price of a commodity. Let us take the example of electrical appliances on which government has levied Central Sales Tax @ 10% in Delhi. A ceiling fan, which was being sold at Rs 1,000 before levying of sale tax, will now be sold at Rs 1,100 (= 1,000 + S. Tax 100).

Similarly at present, the price of Maruti (Standard) car in Delhi is Rs 1,84,000 without Sales Tax but with Sales Tax @ 12% the price has gone up to Rs 2,06,080. In short, an indirect tax on a commodity increases its price. The market price of a commodity which does not include indirect tax (or subsidy) is called at factor cost. The price is called at Factor Cost (FC) because

It is the cost incurred by the enterprise which it pays to the factors of production for their contribution in the production of a commodity. Thus, in the above example, the market price of a ceiling fan is Rs 1,100 whereas the price at FC is Rs 1,000.

(b) Subsidies:

These are cash grants given by the government to the enterprises to encourage production of certain commodities or to promote exports or to sell goods at prices lower than the free market prices. Subsidies are opposite of indirect taxes.

What is the effect of a subsidy on the price of a commodity on which it is granted? The effect of subsidy is fall in the price of a commodity. For example, Delhi Milk Scheme sells 1 litre poly bag of toned milk for Rs 30.00 whereas the same costs it 31.00.

The difference or loss of Rs 1.00 is made good by the government by granting subsidy of Rs 1.00 per litre on toned milk. Thus, the market price of a subsidised commodity becomes lower than its factor cost when subsidy is granted.

Significance of Net Indirect Taxes:

Net Indirect Tax is the difference between the Indirect tax and subsidy. To find out Market Prices (MP), indirect taxes are added and subsidies are subtracted from Factor Cost (FC) as explained above.

Symbolically:

Market Price = Factor Cost + Indirect taxes – Subsidies

= Factor Cost + Net indirect taxes

In short, MP includes net indirect tax whereas FC does not. Thus, FC becomes MP when net indirect taxes are added to FC. In the absence of indirect taxes and subsidies, MP and FC are the same.

Why subsidies are added and indirect taxes are deducted from domestic product at MP to arrive at domestic product at FC?