4.5.2 taxation Flashcards
what is meant by taxes
taxes are used to pay for the number of goods and services that the government provides.
can also be used to correct market failure and maange the economy and redistribute income
what are progressive taxes
where those who are on higher incomes pay a higher marginal rate of tax. e.g. income tax
what are regressive taxes
where the proportion of income paid in tax falls as the income of the taxpayer rises.
most indirect taxes are regressive
what are proportional taxes
where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes.
what are the impacts of tax changes on incentives to work
- high marginal rates of tax will discourage ppl from working
- high taxes on high incomes could encourage them to move abroad and taxes on the poor may lead to a poverty trap
- high income tax reduces incentives more than high VAT. a switch from direct to indirect taxes may increase incentives
- however there is no hard evidence for the link between income tax and incentives
- 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 to work
what are the impacts of tax changes on tax revenues
- the laffer curve shows that a rise in the tax rate does not necessarily increase tax revenue.
- tax revenue will initially rise as tax increases but after the point where revenue is maximised then tax revenue wil decrease as taxes increase due to reduction in motivation to work. there will be a fall in output and increased incentive to use tax avoidance and tax evasion.
- revenue from indirect taxes can be uncertain as they depend on consumer spending patterns
what are the impacts of tax changes on income distribution
- a progressive tax system will increase the equality of income distribution as more money is proportionally taken away from the rich than the poor. a regressive one will increase income inequality.
- inheritance taxes are hte most progressive form of taxation. high corporation taxes take money from shareholders, who tend to be very well off, and give the to the government to spend on the poor
- using tax to redistribute income does not give the poor anything so the system needs to be supported with benefits.
what are the impacts of tax changes on real output and employment
- some taxes affect AD whilst others affect AS. a rise in direct taxes will reduce spending and hence AD. this could also cause less profits for businesses and hence a fall in investment. the effect this has on output will depend on whether the economy is at full employment or not
- higher indirect taxes and NIcs increase costs for firms and this will decrease SRAS. this impact will again depend on where the economy is producing.
- can be argued that income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive.
what are the impacts of tax changes on the price level
- taxes can impact LRAS, SRAS, and AD. these changes will impact price depending on where the economy is producing
- indirect taxes, particularly VAT often cause cost push inflation
what are the impacts of tax changes on the trade balance
- a rise in taxes will decrease income and therefore decrease consumption. this also means consumers spend less on imports, which in the UK are highly income elastic. as a result the trade balance will improve in the SR
- in the LR AD will reduce business’ need to invest and this could reduce competitiveness meaning that exports decrease
what are the impacts of tax changes on FDI flows
- 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, eventually resulting in a fall in revenues for all countries.
