AS Level Economics 9708: Regressive Indirect Tax. Petrol Excise Duty

Silverport's government levies a fixed excise duty of $0.80 per litre on petrol, added to the pump price. Marco earns $16,000 a year and buys 1,000 litres of petrol during the year. Elena earns $64,000 a year and also buys 1,000 litres of petrol during the year.

(a) Calculate the total excise duty paid by Marco and by Elena, and calculate each driver's average rate of this tax as a percentage of their income. [4]

(b) State and explain whether Silverport's petrol excise duty is progressive, proportional or regressive with respect to income, using your answers to part (a). [2]

(c) Explain why a fixed-rate indirect tax of this kind, charged at the same $0.80 per litre to every driver, tends to be regressive with respect to income even though everyone pays the identical rate per litre purchased. [3]

Part (a): Duty paid and average rate for each driver

Both Marco and Elena buy 1,000 litres of petrol at a duty rate of $0.80 per litre, so the excise duty each pays is:

$\text{Duty} = 0.80\times1000 = 800$

Both Marco and Elena therefore pay $800 in excise duty over the year. The same dollar amount, because they bought the same quantity of petrol.

Their average rates of tax (ART), however, differ because their incomes differ:

$ART_{Marco} = \frac{800}{16000}\times100 = 5\%$

$ART_{Elena} = \frac{800}{64000}\times100 = 1.25\%$

Part (b): Progressive, proportional or regressive?

Marco, on the lower income of $16,000, pays an average rate of $5\%$ , while Elena, on the higher income of $64,000, pays a much lower average rate of $1.25\%$ . Because the average rate of tax falls as income rises, Silverport’s petrol excise duty is regressive with respect to income. (A proportional tax would leave the average rate unchanged, and a progressive tax would see the average rate rise, as income rises.)

Part (c): Why a flat-rate indirect tax tends to be regressive

An indirect tax like this excise duty is charged per unit of the good bought, not as a percentage of income, so it does not automatically adjust to how much a taxpayer earns. If drivers with very different incomes end up buying a similar quantity of petrol (because, for example, their daily commuting distance is similar regardless of how much they earn) then they pay the same dollar amount of duty. That fixed dollar amount is a much smaller proportion of Elena’s $64,000 income than of Marco’s $16,000 income, which is exactly why the average rate falls as income rises. This is a general feature of fixed-rate indirect taxes on goods that are not strongly linked to income: because the tax tracks quantity consumed rather than ability to pay, it tends to fall more heavily, in relative terms, on lower-income taxpayers.

Final answers

(a) Marco: duty $=$ $800, ART $=$ 5%; Elena: duty $=$ $800, ART $=$ 1.25%
(b) Regressive. The average rate falls from 5% to 1.25% as income rises
(c) The tax is levied on quantity bought, not income, so an identical dollar amount of duty takes a smaller proportion of a higher income than of a lower one