4.5.2: Taxation Flashcards
What is progressive tax?
The proportion of income in tax paid increases with income (e.g. income tax).
What is regressive tax?
The proportion of income in tax paid falls with income (e.g. VAT).
What is proportional tax?
The proportion of income in tax paid is constant with income (e.g. income tax).
What are the factors that are affected by changes in taxation?
-Incentives to work.
-Tax revenues (the Laffer curve).
-Income distribution.
-Real output & unemployment.
-Price level.
-Trade balance.
-FDI.
How does a change in taxes affect incentives to work?
-Higher marginal rates of tax may discourage people from working, as they will gain less of what they have earned.
-Income tax has the biggest effect on incentives (e.g. less need for promotions).
-It can be argued people would work longer hours with higher taxes in order to maintain their income.
How does a change in taxes affect tax revenues (Laffer curve)?
-If tax rates are too high, they provide a disincentive to work.
-Tax rates are not the only factor affecting work incentives (e.g. benefits, hours).
How does a change in taxes affect income distribution?
-A progressive tax system increases income equality, as more money is proportionally taken from the rich than the poor.
-A regressive tax system increases income inequality, as more money is proportionally taken from the poor than the rich.
-A move from indirect (regressive) taxes to direct (progressive) taxes will improve equality.
How does a change in taxes affect real output & unemployment?
-A fall in direct taxes increases disposable income, causing a rise in AD.
-A fall in indirect taxes decreases costs for firms, increasing SRAS.
-Some taxes can affect LRAS because of their impact on work incentives or investment.
How does a change in taxes affect price level?
-Indirect taxes could cause cost push inflation (e.g. indirect taxes could increase the cost of inelastic cigarettes, if producers choose to pass the costs onto consumers).
How does a change in taxes affect trade balance?
-Tariffs could be imposed on imports, which should improve the trade balance.
-However, other countries might retaliate, so exports might also fall.
How does a change in taxes affect FDI?
-Low taxes on profit & investment can encourage businesses to invest for a higher level of return.
-‘Race to the bottom’ where countries lower their taxes to make them the lowest to encourage investment; the eventual result is a fall in revenues of all countries.
