4.5.2 Taxation

Question 1

What is tax

Relate this to a microeconomic and macroeconomic level

Answer 1

Tax is used to pay for the number of goods and services that the government provides

On top of this, tax can be used to correct market failure at a microeconomic level

and to manage the economy and redistribute income at a macroeconomic one.

Question 2

What are the UK Government’s current aims of tax

Answer 2

keeping the burden of tax low, improving incentives, using equitable taxes, correcting market failure

Question 3

What is a processive tax

Answer 3

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

Direct taxes tend to be progressive, for example income tax

Question 4

What is Regressive tax

Answer 4

is 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

Most indirect taxes are regressive, for example everyone pays the same rate of VAT

Question 5

What is a proportional tax

Answer 5

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

Question 6

How do tax changes affect the incentives to work

Answer 6

• high marginal rates of tax will discourage individuals from working - however this may depend on the elasticity of supply of labour
• High taxes on high-income earners could encourage them to move abroad and taxes on the poor may lead to a poverty trap
• It is income tax that is important: high-income tax reduces incentives more than high VAT. Thus, a switch from direct to indirect taxes may increase incentives.

Question 7

Why would changes in taxation, not always affect the incentives to work

Answer 7

• no hard evidence for the link between income tax and incentives.
• Nordic countries have high taxes and welfare benefits but have similar rates of growth compared to lower tax and government spending countries like US and UK
• It can be argued that higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work

Question 8

How can changes in levels of taxation affect tax revenues

Answer 8

• Laffer curve shows that a rise in the tax rate does not necessarily increase tax revenue
• If people were taxed at 100%, they would not do any work and this means that tax revenue is 0 at both 0% and 100%
• Tax revenue will initially rise as the tax rate is increased but it will come to a point where revenue is maximised
• Then, motivation and drive will fall so there will be a fall in output and there is an increased incentive to use tax avoidance and tax evasion

Question 9

How can levels of taxation affect income distribution

What is the problem with this

Answer 9

• progressive tax system will increase the equality of income distribution as more money is proportionally taken from the rich than from the poor
• a move from indirect to direct taxes will improve equality
• high corporation taxes take money from shareholders, who tend to be very well off and give them to the government to spend on the poor
  
  • The problem with this is using tax to redistribute income is that it does not give the poor anything, so the system needs to be supported with benefits

Question 10

How does levels of taxation affect real output and employment

Answer 10

• Some taxes affect AD whilst others affect AS
• rise in direct taxes will cause a fall in their spending and thus a fall in AD
• higher indirect taxes and NICs increase costs for firms and this will decrease SRAS - (depends on spare capacity of the economy)
• argued income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas

Question 11

How can levels of taxation affect price levels

Answer 11

Indirect taxes, particularly VAT, often cause cost-push inflation

Depends on spare capacity of the economy

How will taxation effect LRAS, SRAS and AD

Question 12

How will levels of taxation affect trade balance

Answer 12

a rise in taxes will decrease income and mean consumers spend less on imports (Imports in the UK have been found to be highly income elastic)

High taxation my make exporting firms less competitve

Tariffs will allow protection over domestic industries - decreasing imports

Question 13

How will levels of Taxation affect FDI flows

What is the problem with this

Answer 13

• Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return
  
  • The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment