4.5.2 Taxation Flashcards
Taxation
The way in which governments raise taxation.
What are the Canons of Taxation?
(Context)
Taxation has been a source of controversy since it was force introduced.
Adam Smith wrote at length on the subject of taxation in his book ‘The Wealth of Nations’.
He argued that a good tax was one that had the four characteristics - the canons of taxation.
Canons of Taxation
1) The tax is affordable – those taxes must have the means to pay it
2) The timing of collection and the amount to be paid should be clear and certain.
3) The cost of collection should be as little as possible, and it should be a small proportion of the total tax collected.
4) The tax should be easy and convenient to pay.
What can tax systems be classified as?
- Progressive
- Proportional
- Regressive
Progressive taxes
As income rises, a larger percentage of income is paid in tax. This system is built around the idea of marginal tax rates.
UK examples of progressive taxes
- Income tax
- National insurance
- Corporation tax
- Capital gains tax
UK examples of regressive taxes
- Poll tax
- Air passenger duty – same amount paid by all passengers regardless of class (i.e. economy and first class pay the same).
Example of the use of proportional taxes
In Bolivia, the tax rate is 13% - regardless of income.
Regressive taxes
As income rises, a smaller percentage of income is paid in tax.
- Regressive taxes can have a big-impact on low-income households. In 2020 they represented 30% of income for the poorest 20% of households, but only 10% of income for the top 20% of households.
Proportional taxes
The percentage of income paid in tax is constant, no matter what the level of income.
- For example, tax paid irrespective of whether income is £10,000 or £100,000.
The main purposes of tax
- To pay for government expenditure
- To correct market failure such as externalities
- To manage the economy as a whole
- To redistribute income
[The main purposes of tax]
How is taxation used to pay for government expenditure?
Governments need to raise finance for their expenditure programmes. They can borrow a limited amount of money for this, but most of the finance must come from taxation if inflation is to be avoided.
[The main purposes of tax]
How is taxation used to correct market failure (such as externalities)?
o Governments can intervene in individual markets by changing taxes and thus changing demand.
- For instance, tobacco consumption can be reduced by raising taxes on cigarettes, pollution can be controlled by imposing pollution taxes, or sales of books can be increased by exempting them from VAT.
[The main purposes of tax]
How is taxation used to manage the economy as a whole?
Taxation can have an important influence on the macro-economic performance of the economy.
Governments may change tax rates in order to influence variables such as inflation, unemployment and the balance of payments.
[The main purposes of tax]
How is taxation used to redistribute income?
To redistribute income, it may impose taxes which reduce the income and wealth of some groups in society and use the money collected to increase the income and wealth of other groups.
What does the Laffer curve show?
The relationship between increasing tax rates & the level of government revenues received.
The broad idea is that as tax rates increase, a point will be reached where disincentivized workers work less resulting in** less income & less government tax revenue. More people will actively seek to avoid paying tax (tax avoidance**) or try to move their income elsewhere.
- Individuals and businesses are ‘happy’ to accept taxes up to a point, where they become disincentivised to earn more, or make more profit.
