Specific Tax: A Simple Guide to Per-Unit Taxes
What is a Specific Tax?
Imagine you buy a pack of gum. The government says, "For every pack of gum sold, we collect an extra 25¢." That extra 25¢ is a specific tax. It is a direct, fixed cost added to the production or sale of each unit. It's also called a per-unit tax or excise tax.
$P_{consumer} = P_{producer} + T$
Where:
• $P_{consumer}$ is the price buyers pay.
• $P_{producer}$ is the price sellers receive (after paying the tax to the government).
• $T$ is the specific tax amount per unit (e.g., $2).
This tax creates a "wedge" between what consumers pay and what producers keep. If a consumer pays $5 for a product with a $1 tax, the producer only gets $4. The government collects that $1 difference.
How a Specific Tax Shifts the Supply Curve
To understand the tax's effect, we use supply and demand graphs. The supply curve[3] shows how much producers are willing to sell at different prices. A specific tax increases the cost of production for every unit. To make the same profit as before, sellers now need a higher price from consumers.
This causes the entire supply curve to shift upwards by exactly the amount of the tax ($T$). Visually, if the original supply curve is $S_0$, the new supply curve with the tax is $S_1$, and $S_1 = S_0 + T$.
Who Really Pays the Tax? The Burden of Tax Incidence
One of the most important questions is: who bears the cost? It’s not always the person who physically hands the money to the government. Tax incidence analyzes how the burden of a tax is split between buyers and sellers.
The split depends on price elasticity[4], which measures how sensitive quantity demanded or supplied is to price changes.
| If Demand is... | If Supply is... | Then the Tax Burden Falls More Heavily on... |
|---|---|---|
| Inelastic (e.g., medicine, gasoline) | Elastic | Consumers |
| Elastic (e.g., luxury goods, candy) | Inelastic | Producers |
| Equally Elastic | Equally Elastic | Split evenly |
Simple Rule: The side of the market (buyers or sellers) that is less sensitive to price changes (more inelastic) will bear a larger share of the tax burden. They have fewer alternatives and cannot adjust their behavior as easily.
Applying a Specific Tax: The Soda Tax Example
Let's walk through a complete, step-by-step example using a hypothetical tax on sugary soda.
Step 1: The Initial Market. Suppose before any tax, the equilibrium price of a 2-liter soda bottle is $1.50, and the equilibrium quantity sold is 1000 bottles per week in a small town. At this point, supply meets demand.
Step 2: Imposing the Tax. The government introduces a specific tax of $0.50 per bottle. By law, sellers (the soda company) are responsible for sending this tax to the government.
Step 3: The Supply Shift. For sellers to be willing to supply the same 1000 bottles as before, they now need to receive $1.50 + $0.50 = $2.00 from consumers to cover their costs and profit. The supply curve shifts up by $0.50 at every quantity level.
Step 4: Finding the New Equilibrium. The new, higher supply curve ($S_1$) intersects the unchanged demand curve at a new point.
• New Consumer Price ($P_c$): Let's say it rises to $1.80.
• New Producer Price ($P_p$): Sellers receive $1.80 - $0.50 = $1.30.
• New Quantity ($Q_1$): The quantity sold falls to, say, 850 bottles per week.
Step 5: Analyzing the Burden.
• Consumers pay $0.30 more per bottle ($1.80 - $1.50).
• Producers keep $0.20 less per bottle ($1.50 - $1.30).
• The total tax per bottle is $0.50, which is the sum of the consumer's and producer's burden ($0.30 + $0.20).
• Government Revenue: $0.50 × 850 = $425 per week.
Step 6: The Deadweight Loss. Notice that 150 fewer bottles are sold. These were transactions that benefited both buyers and sellers before the tax, but no longer happen. This loss of economic activity is called deadweight loss[5]. It represents value that is simply lost to society because of the tax.
Important Questions
A specific tax is a fixed amount per unit (e.g., $2 per pack). An ad valorem tax[6] is a percentage of the price of the good (e.g., 10% of the sale price). Sales tax is a common example of an ad valorem tax. With a specific tax, the government's revenue per item stays the same even if the price changes. With an ad valorem tax, the government's revenue changes with the price.
Yes, in cases of negative externalities. This is when a product's consumption causes harm to others not involved in the transaction (like second-hand smoke from cigarettes or health costs from pollution). A specific tax on such goods increases their price, discourages consumption, and can help pay for the damage caused. This use is often called a "sin tax" or "Pigouvian tax." The goal here is not just to raise revenue, but to improve public welfare by reducing harmful consumption.
Almost never. The final price increase for consumers depends on tax incidence. If demand is very elastic (buyers can easily switch to alternatives) and supply is inelastic, producers may be forced to absorb most of the tax, and the consumer price might rise by less than $3, perhaps only $1. The tax creates a wedge, but how that wedge is split determines the final consumer price change.
A specific tax is a powerful and clear-cut tool in economics. By adding a fixed cost to each unit sold, it directly alters market dynamics, shifting supply curves and creating a gap between the price consumers pay and producers receive. Understanding who ultimately bears the cost—the tax incidence—is crucial and depends on the relative responsiveness, or elasticity, of buyers and sellers. While these taxes generate government revenue, they also reduce the overall quantity of goods sold, leading to a deadweight loss. Whether applied to raise funds or to discourage the use of harmful products, the specific tax offers a concrete example of how policy directly interacts with the fundamental forces of supply and demand.
Footnote
[1] Market Equilibrium: The point where the quantity of a good demanded by consumers equals the quantity supplied by producers. The price at this point is the equilibrium price.
[2] Tax Incidence: The analysis of who bears the final economic burden of a tax. It examines how the cost is distributed between buyers and sellers.
[3] Supply Curve: A graph showing the relationship between the price of a good and the quantity of that good sellers are willing and able to produce and sell.
[4] Price Elasticity: A measure of how much the quantity demanded or supplied of a good changes in response to a change in its price. If quantity changes a lot, it is elastic. If it changes very little, it is inelastic.
[5] Deadweight Loss (DWL): The loss of economic efficiency that occurs when the equilibrium for a good is not achieved or is not Pareto optimal. In taxation, it is the value of the transactions that do not occur because of the tax.
[6] Ad Valorem Tax: A tax levied as a percentage of the value or price of a good or service. "Ad valorem" is Latin for "according to value."