Indirect tax is a tax placed on producers by the government for goods such as diesel and petrol. Petrol and diesel are classed as de-merit goods as the products have more overall costs than the consumers realise. This results in an indirect tax being placed on the products in order to discourage consumption, thus correcting the market failure. However, government intervention sometimes leads to a more inefficient allocation of resources than the free market, hence government failure .
Indirect tax will internalise the external costs of petrol and diesel. The government will place a tax on the producers, thus increasing their production costs. The size of this tax should be equal to the size of the external costs associated with the product, thus enforcing the ‘polluter pays principle.’ If this were to occur, the diagram below shows what would happen in the market.

As there is an increase in production costs, there is a leftward shift in supply from S to S1. This causes an increase in price of the petrol and diesel from P to P1, as the business pass on a "consumer burden" to consumers in an attempt to cover their costs by. The consequence of this is a contraction in demand from Q to Q1, as the high prices discourages some consumers. It could be argued that the indirect tax on petrol and diesel in the UK should be reduced, for various reasons. Firstly, the current tax placed on producers by the government is very high meaning producers pass on large "consumer burdens" to cover their good. As most means of transport rely on these fuels, the product is deemed "a necessity". High prices of the product mean consumers have less disposable income and result in high costs of living. In order to satisfy and maximise consumer welfare, it could thus be argued that indirect tax levels are reduced. Furthermore, a reduction in indirect tax