4.5.2 Taxation Flashcards
Progressive taxes (direct)
As income rises, a larger percentage of income is paid in tax (proportion increase, income increases)
- e.g UK income tax- 10%, 20%, 45%
Proportional tax (direct)
The percentage of income paid in tax is constant, no matter what the level of income
- e.g everyone pays same income tax - 20%
Regressive tax (indirect)
As income rises, a smaller percentage of income is paid in tax (proportion decreases, income rises)
- e.g excise duties on tobacco, alcohol & petrol
Effects of changes in direct tax
- tax revenue
- AD
- incentives
- income distribution
- real output & employment
Effects of changes in direct tax (tax revenue)
- increase tax = increase income = increase revenue = higher spending on healthcare and education
Effects of changes in direct tax (AD)
- income tax = less discretionary income to spend after income tax = lower levels of household spending
Effects of changes in direct tax (AD) evaluation
However, if the govt spend the tax revenue- overall AD will not be affected
Effects of changes in direct tax (incentive)
Higher income tax might act as disincentive for unemployed to accept jobs or to work overtime.
- substitution effect
Substitution effect
Higher tax leads to lower wages – and work becomes relatively less attractive than leisure. The substitution effect of a higher tax is that workers will want to work less.
Effects of changes in direct tax (incentive) evaluation
- Income effect
- However, if higher tax = lower wages, a worker may feel the need to work longer hours to maintain his target level of income.
- so, the income effect means that higher tax =some workers feel the need to work longer.
This means there is no guarantee of the impact of higher tax – it depends whether the substitution effect is greater than the income effect.
Effects of changes in direct tax (income distribution)
- progressive tax, like income tax, might redistribute income from those econ higher incomes to those on lower incomes if tax revenues raised are used for benefits to the poor
- Laffer curve
Impact of high tax in an example country
- Some argue that the high levels of tax in Nordic countries = disincentive to growth and investment.
- On the other hand, the stability of a welfare state, health care and education reduce uncertainty and problems such as health bankruptcy.
Impact of indirect tax
- tax on externalities
- incentives to work
- tax revenues - tax = inflation
- income distribution
- reduced FDI
Impact of indirect tax evaluation
The impact will depend on elasticity of demand
Laffer curve
Shows that tax rate cut could lead to an increase in tax revenue, or decrease in tax revenue, depending whether you have already passed the ‘optimal tax rate’
Reasons why total tax revenue fall if the tax rate increase
- increased rates of tax avoidance
- greater incentive to evade taxes
- disincentive effects
- ‘brain drain’ effects
Reasons why total tax revenue fall if the tax rate increase (tax avoidance)
Greater incentive tos eek out tax relief, make max use of tax allowance
Reasons why total tax revenue fall if the tax rate increase (evade taxes)
Illegal, ie non-declaration of income & wealth
Reasons why total tax revenue fall if the tax rate increase (disincentive effects)
Possible disincentive effects in the labour market (depending on which taxes have been increased)
Reasons why total tax revenue fall if the tax rate increase (‘brain drain’ effects)
Possible ‘brain drain’ effects (ie loss of highly skilled, high income taxpayers
Evaluating the laffer curve
- low tax
- depends relative to benefits
- might take more leisure time
- Keynesian explanation
Evaluating the laffer curve (lower tax)
Encourage lower tax rates on high income earners however it can lead to income inequality
Evaluating the laffer curve (depends on benefits)
- if benefits are larger than the tax imposed, the benefits might affect incentives more
Evaluating the laffer curve (leisure time)
Tax cuts might cause highly paid ppl to take more leisure time instead of work (backward bending Labour supply curve effect)
Evaluating the laffer curve (Keynesian)
cuts in tax increases real disposable income so lead to increase consumption and increased AD
Impact of indirect tax (tax on externalities)
- internalise the cost
Impact of indirect tax (incentives to work)
They will work harder if there are higher taxes on goods
Impact of indirect tax (tax revenues)
Impact of indirect tax evaluation
Tax = inflation
Impact of indirect tax (income distribution)
Often regressive or disproportionate effect
Impact of indirect tax (reduced FDI)
Less likely to invest
Income tax
- A direct tax taken out of a person’s income. Income tax = increased econ growth since ppl increase work = increase saving = invest more
- this is progressive so those earning more, pay a higher proportion of their income in tax
Income UK tax
£12, 571 = 20%
£50, 271 = 40%
Over £150,000= 45%
Corporation tax
Increased tax on the profits of a corporation.
- business confidence
- a reduction in corporation tax rate could result in higher wages & employment, decrease tax, increase demand labour = increases wages
(Progressive)
Corporation tax UK
UK: 19%
Ireland:
National insurance
Used to fund govt benefits program e.g state pensions
- UK govt announced a 1.25% increased from April 2022
- increased national insurance = decreased disposable income = i decreased consumption as a % of GDP = increase in real GDP
(Regressive)
National insurance UK
13.8%
Council tax
- local taxation collected by authorities
- levied on residential property on an annual basis based on the value of that property
(Regressive due to property value rather than income)
Value added tax
- levied on the purchase. It is reflected in the price paid when items are bought & is collected from traders
Excise duties
Indirect taxes applied to the sale/use of goods such as alcohol, tobacco & energy products
Transfer pricing
Give on microeconomic impact of tax on plastic packaging
- increase private costs to producers= encourage them to innovate to find ways of reducing plastic (unless business find ways to cut plastic cost will rise & profits will fall)
- regressive effect
- reduce externalities
Give on macroeconomic impact of tax on plastic packaging
- increase inflation (cost push inflation) . Producers will pass on higher costs to consumers (shown through diagram showing inward shift of SRAC.
- however depends on significance of plastic in supply costs. In many industries, labour and energy costs are more important so effect on inflation is limited.
- in addition, firms will have incentive to re formulate their packaging = long run = lower unit cost
Conclusion of plastic tax
- long run benefits to environment
