March 21, 2018 

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ADVERSE SELECTION: When a negotiation between two people with different amounts of information, that is, asymmetric information, restricts the quality of the good traded. This typically happens because the person with more information is able to negotiate a favorable exchange. This is frequently referred to as the "market for lemons."

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The official entry in the National Income and Product Accounts maintained by the Bureau of Economic Analysis for sales taxes. Indirect business taxes are one key difference between national income (the resource cost of production) and gross (and net) domestic product (the market value of production). Indirect business taxes (IBT) is generally less than 10 percent of gross domestic product (7 to 8 percent is common).
Indirect business taxes is the official term used in the National Income and Product Accounts for sales taxes. They are termed INDIRECT sales taxes because the business sector has the DIRECT responsibility of paying these taxes to the government sector, but the business sector really acts as the "collection agency" for the government, collecting the taxes from the household sector. The taxes are paid INDIRECTLY by the household sector.

The business sector does the deed of collecting the taxes from the household sector FOR the government sector. The household sector is considered the ultimate payer of the taxes. Other taxes paid by the business sector to the government sector are considered DIRECT business taxes. These include corporate profits taxes, property taxes, and franchise taxes.

In general, sales taxes drive a wedge between the price buyers pay for production (demand price) and the price sellers receive for production (supply price). The demand price IS the market value of production measured by gross domestic product. The supply price is the opportunity cost of the resources used in production, which is factor payments and income earned by the factors (that is, national income). To the extent that sales taxes increase the demand price above the supply price, gross domestic product is greater than national income.

For example, suppose Maurice Finklestein decides to buy a Wacky Willy Stuffed Amigo from the local MegaMart Discount Warehouse Super Center that carries a "shelf price" of $10. However, Maurice needs more than $10 to complete this purchase. The reason, of course, is that the local sales tax is 5 percent. Any purchase made at the MegaMart Discount Warehouse Super Center includes the "shelf price" plus 5 percent. His total expense is thus $10.50.

This means that Maurice must obtain at least $10.50 worth of satisfaction from his Stuffed Amigo. If he receives less than $10.50, then he would not by this Stuffed Amigo. He would spend his $10.50 on a good that DID provide $10.50 worth of satisfaction. This is the essence of what gross domestic product seeks to measure. And from the expenditure approach to measuring GDP, this $10.50 is included in its entirety.

Now consider the income approach to measuring GDP. The income generated from the production of this Amigo is not $10.50, but only $10. The opportunity cost of using the four factors of production to supply this Stuffed Amigo is $10. To see why all that is needed is ask the question: "What is the minimum price MegaMart Discount Warehouse Super Center would except for this Stuffed Amigo WITHOUT SALES TAXES?" The answer, of course, is $10. This $10 covers all production cost, which is another way of saying that the factors of production (labor, capital, land, and entrepreneurship) need a total of $10 in income to produce and supply this Stuffed Amigo.

As such, the $10.50 revenue received by the MegaMart Discount Warehouse Super Center is divided in two ways. The first $10 is used to pay the factors of production, which is then included in national income. The remaining $0.50 is used to pay sales taxes.

In the same way, gross domestic product includes the total revenue generated in production, which is then divided among national income and indirect business taxes.


Recommended Citation:

INDIRECT BUSINESS TAXES, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 21, 2018].

Check Out These Related Terms...

     | national income and gross domestic product | national income and net domestic product | capital consumption adjustment | net foreign factor income | business transfer payments | statistical discrepancy | government subsidies less current surplus of government enterprises |

Or For A Little Background...

     | national income | gross domestic product | gross domestic product, income | production | product markets | National Income and Product Accounts | Bureau of Economic Analysis | National Bureau of Economic Research |

And For Further Study...

     | factor payments | circular flow | business cycles | gross domestic product, expenditures | gross domestic product, ins and outs | gross domestic product, welfare | gross national product | real gross domestic product | government functions | net domestic product | personal income | disposable income | gross domestic income |

Related Websites (Will Open in New Window)...

     | Bureau of Economic Analysis |

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