Why a specific tax shifts supply up by the tax, why the price rises by less than the tax, and how to show revenue, who pays and the deadweight loss.
In April 2018 the UK brought in the Soft Drinks Industry Levy, the "sugar tax". It started at 18p a litre for drinks with at least 5g of sugar per 100ml and 24p a litre for 8g or more. Since April 2025 the rates have risen each year: from April 2026 they are £2.08 and £2.78 per 10 litres. From January 2028 the threshold falls to 4.5g and milkshakes are brought in.
The firms pay the levy. So who really pays it: the firms, or the people buying the drinks?
Sources: HMRC, Check if your drink is liable for the Soft Drinks Industry Levy (updated March 2026); HM Treasury, Changes to the Soft Drinks Industry Levy (July 2026).
A direct tax is a tax on income or wealth, such as income tax. An indirect tax is a tax on spending. The seller pays it to the government, but can try to pass it on to buyers in a higher price. There are two kinds:
Governments use indirect taxes to raise revenue and to cut consumption of goods that harm people, such as sugary drinks, tobacco and alcohol.
The model assumes a competitive market with normal supply and demand curves, and that only the tax changes (ceteris paribus).
A £3 tax is put on every crate of a fizzy drink.
The drinks firms pay the tax to the government. Before the tax, a crate sold for £6.
What is the most likely new price of a crate?
The price rises, but usually by less than the tax. Firms try to pass the tax on, but at a higher price people buy fewer crates, so firms end up absorbing part of it. Who pays how much is the big idea of this lesson.
Start with the market before the tax: a sugary drink, priced per crate. Supply and demand set the price at P1, £6, and the quantity at Q1.
The tax is £3 a crate, paid by the firms. To supply any quantity, firms now need £3 more per crate than before, because £3 of it goes to the government. So supply shifts vertically up by the tax. A specific tax is the same at every quantity, so S + tax is parallel to S.
Check: Why does a £3 specific tax shift supply up by exactly £3 at every quantity?
For any quantity, firms now need £3 more per unit to be willing to supply it, because £3 goes to the government. So the whole curve moves up by the tax. A fixed tax per unit gives a parallel shift.
The new equilibrium is where S + tax crosses demand. The price consumers pay rises from £6 to P2, £8, and the quantity falls from Q1 to Q2. The price rose by £2, not the full £3.
Firms collect £8 but send £3 to the government, so they keep £5. Read it off the original supply curve straight below the new equilibrium: P2 minus the tax. That point is on S because £5 is what firms need to supply Q2 without the tax.
Check: Consumers now pay £8 a crate. How much of that does the firm keep?
The firm pays £3 to the government out of the £8, so it keeps £5. That is less than the £6 it got before the tax.
Tax revenue is the tax per unit times the number of units sold after the tax: £3 × Q2. On the diagram it is the rectangle between P2 and P2 minus the tax, out to Q2. Use the new quantity, Q2, not the old one: the tax is only paid on units that are still sold.
Now split the revenue rectangle at the old price, P1. Above P1 is the part paid by consumers: £2 a crate more than before. Below P1 is the part paid by producers: they keep £1 a crate less. Who really bears a tax is called its incidence. The firms hand over the tax, but consumers bear most of it here.
Check: Who pays most of this tax?
Consumers pay £2 more per crate; producers keep £1 less. So consumers bear two thirds of the tax, even though producers pay it to the government.
The tax also means some crates are no longer traded at all.
Check: Between Q2 and Q1, buyers valued each crate at more than it cost to make, but those crates are no longer sold. What happens to that value?
Those crates are not traded, so nobody gets the value they would have created. That lost welfare is the deadweight loss.
One more area. Between Q2 and Q1, buyers valued each crate at more than it cost to make, but those crates are no longer traded because of the tax. That lost welfare is the deadweight loss, the triangle between Q2 and Q1. Nobody gets it: not consumers, not firms, not the government.
Firms had two years’ notice of the levy before it started in 2018.
Check: Before the levy started, most firms cut the sugar in their drinks below 5g per 100ml. What did that do to the revenue the levy raised?
Drinks below 5g per 100ml pay no levy, so the more firms reformulated, the fewer litres were taxed and the less revenue came in.
Back to the sugar levy. Its main aim was not revenue but less sugar. Before it started, most firms cut the sugar in their drinks below 5g per 100ml, so those drinks pay no levy at all.
They shifted supply down, so their price falls and the quantity rises. A tax adds to firms’ costs, so supply shifts up (to the left), not down.
Explain, using a diagram, the effect of a specific tax on the market for sugary drinks.
A specific tax is a fixed amount charged on each unit sold, such as the sugar levy, which is set in pence per litre. Producers pay it to the government.
[Diagram: D and S crossing at P1 and Q1. S + tax drawn parallel to S, above it by the tax. New equilibrium at P2 and Q2. P2 − tax read off S below Q2. Revenue rectangle and DWL triangle shaded.]
The tax raises firms’ costs by the same amount on every unit, so supply shifts vertically up by the tax, parallel to the original curve. At the old price there is now excess demand, so the price rises from P1 to P2 and demand contracts from Q1 to Q2.
The price rises by less than the tax. Consumers pay P2 instead of P1, and producers keep P2 minus the tax, which is less than P1. So the burden is shared: consumers bear the part of the revenue rectangle above P1 and producers the part below it. The government raises the tax per unit times Q2.
The units between Q2 and Q1 are no longer traded, even though buyers valued them at more than they cost to make, so there is a deadweight loss.
How the burden is split depends on the price elasticities of demand and supply: the more inelastic side bears more of the tax. However, the deadweight loss is only a true loss if the free market quantity was right. If sugary drinks harm people more than they realise, cutting consumption from Q1 to Q2 may raise welfare.
Sugar levy rates and changes: HM Revenue and Customs and HM Treasury (gov.uk), 2018 to 2026. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.