4.5.2 Taxation Flashcards

1
Q

Taxation

A

The way in which governments raise taxation.

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2
Q

What are the Canons of Taxation?

(Context)

A

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.

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3
Q

Canons of Taxation

A

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.

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4
Q

What can tax systems be classified as?

A
  • Progressive
  • Proportional
  • Regressive
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5
Q

Progressive taxes

A

As income rises, a larger percentage of income is paid in tax. This system is built around the idea of marginal tax rates.

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6
Q

UK examples of progressive taxes

A
  • Income tax
  • National insurance
  • Corporation tax
  • Capital gains tax
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7
Q

UK examples of regressive taxes

A
  • Poll tax
  • Air passenger duty – same amount paid by all passengers regardless of class (i.e. economy and first class pay the same).
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8
Q

Example of the use of proportional taxes

A

In Bolivia, the tax rate is 13% - regardless of income.

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9
Q

Regressive taxes

A

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.
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10
Q

Proportional taxes

A

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.
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11
Q

The main purposes of tax

A
  • To pay for government expenditure
  • To correct market failure such as externalities
  • To manage the economy as a whole
  • To redistribute income
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12
Q

[The main purposes of tax]

How is taxation used to pay for government expenditure?

A

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.

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13
Q

[The main purposes of tax]

How is taxation used to correct market failure (such as externalities)?

A

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.
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14
Q

[The main purposes of tax]

How is taxation used to manage the economy as a whole?

A

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.

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15
Q

[The main purposes of tax]

How is taxation used to redistribute income?

A

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.

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16
Q

Taxes and the incentive to work

A

The higher the tax rate, the lower the incentive for the unemployed to seek work - or for existing workers to work overtime

  • In 2022, the Adam Smith Institute calculated that average earners in the UK work from the 1st January to the 8th June to pay their taxes - all income after that point belongs to them.
17
Q

The significance of changes in tax rates on the economy

A

Changes in direct & indirect tax rates influence a range of economic variables.

The greater the size of the change, the greater the ripple effects through the economy.

18
Q

What does the Laffer curve show?

A

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.
19
Q

Positives of a progressive tax system redistributing income

A

A progressive tax system redistributes from those with higher income to those with lower income & reduces income inequality

  • Greater equality and therefore an improvement of Gini Coefficient.
  • This group of people have a higher MPC, meaning there is increased consumption so AD increases.
20
Q

Negatives of a progressive tax system redistributing income

A
  • This might drive some higher earners to relocate because it disincentivises people to earn more – reducing productivity.
  • It may also disincentivise those who want to get a job – unused labour so inside of PPF.
  • Less savings by those with a high MPS, which dampens investment because there is less liquidity in the banking system meaning there is fewer loans and therefore less investment.
  • However, this all depends on where an economy is on the Laffer curve.
21
Q

How does changes in tax rates affect real output and employment?

A

If the tax rate increases, more money is withdrawn from the circular flow of income (leakage).

This will likely cause a reduction of aggregate demand (AD) as firms & households have less disposable income.

As AD slows down, fewer workers may be required for production & unemployment may increase.

22
Q

Political influence and taxes

A

It is important to consider what stage of the electoral cycle the country is in.

There are often tax cuts shortly before an election, with the aim of winning more voters. This is solely done for political – not economic – reasons.

23
Q

How does changes in tax rates affect flows of FDI?

A

If the rate of corporation tax increases relative to other countries, it may result in less inward foreign direct investment.

24
Q

How does changes in tax rates affect the trade balance (exports - imports)?

A

An increase in taxes can reduce disposable income which is likely to reduce the level of imports.

This may improve the trade balance (exports - imports).

25
Q

How does changes in tax rates affect the average price levels?

A

An increase in indirect taxes reduces disposable income & so workers may petition their employer for a salary increase.

If they receive the increase the economy may face a wage-price spiral.

Indirect taxes also increase costs of production for firms possibly leading to cost-push inflation.