3- Taxation

Question 1

Reasons for laffer curve

Answer 1

• Increased tax, reduces incentive, workers work less
• Emigration of most skilled workers (who contribute the most to tax Rev)
• Increased tax evasion and avoidance

Question 2

Uses of taxation

Answer 2

• To pay for goods and services provided by the government
• Correct market failure
• Manage the economy- redistribute income

Question 3

Progressive tax

Answer 3

A tax where those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax.

Question 4

Regressive tax

Answer 4

A tax where the proportion of income paid in tax falls as the income of the taxpayer rises. Those on higher incomes pay a smaller percentage of their
income on the tax.

Question 5

Proportional tax

Answer 5

A tax where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes

Question 6

Effects of changes in taxation on the incentive to work

Answer 6

• Higher taxes will discourage people to work
• Lower taxes promote work, promotion, more people in the work force and higher productivity,
• Taxes on the poor could lead to the poverty trap
• High taxes could lead to a brain drain
• BUT: higher income taxes, may incentivise work as more hours need to be work to maintain income.

Question 7

What types of tax causes more incentive?

Answer 7

• High income tax reduces incentive more than VAT.

- Therefore a switch from direct to indirect taxes may increase incentives.

Question 8

Does increase in taxes increase tax revenues?

Answer 8

Not always- laffer curve

Question 9

Effects of changes in taxation on income distribution

Answer 9

• Progressive taxes increase income equality
• Regressive taxes decrease income equality
• Since indirect taxes are more regressive and direct taxes are more progressive, a move to direct taxes may increase equality
• E.g. inheritance tax and cooperation tax- very progressive.
  BUT: It doesn’t give the poor anything without benefits

Question 10

Effects of changes in taxation on real output and employment

Answer 10

• Direct taxes cause a fall in AD- less income
• Indirect taxes cause a fall in SRAS- higher costs
• High taxes- low incentive to work- long run fall in LRAS
• BUT: depends on where the economy is producing (full capacity or not)

Question 11

Effects of changes in taxation on the price level

Answer 11

• Indirect taxes- cost push inflation

- Direct taxes- lower prices due to lower demand

Question 12

Effects of changes in taxation on the trade balance

Answer 12

• Higher direct taxes- lower income- less spent on imports (price elastic)- better trade balance
• Reduce long run competitiveness- less investment due to less demand- less exports

Question 13

Effects of changes in taxation on FDI flows

Answer 13

• Low taxes on profit- increased investment by businesses in the country- more rate of return
• However, race to the bottom, fall in revenues