4.5.2 - taxation Flashcards
What is progressive taxation?
As income rises, a larger proportion of income is paid in tax, eg. income tax
What is proportional taxation?
The percentage of income paid in tax is constant, no matter what the level of income. The tax is levied at a constant rate.
What is regressive taxation?
As income rises, a smaller percentage of income is paid in tax. The tax is levied at a decreasing rate, eg. VAT/excise duty
What is a direct tax?
A tax levied on income and wealth eg. income tax, corporation tax, capital gains tax
What is an indirect tax?
A tax paid by a producer, levied on expenditure, increasing cost of production, eg. VAT = burden of the tax may be shifted onto consumers from the producers.
What is the effect of a change in direct and indirect taxation on incentives to work?
Direct taxation - higher rates of income tax may act as a disincentive for the unemployed to accept jobs or for those in employment to work overtime.
Indirect taxation - may encourage people to work harder to maintain their current spending patterns, or they may increase borrowing
What is the effect of a change in direct and indirect taxation on tax revenues?
Direct taxation - Laffer curve = at lower levels of taxation rates, tax revenues will rise until an optimal level is reached where the maximum tax revenue is achieved. After the optimal, is tax rates continue to rise, tax revenues fall due to disincentive effects, eg. tax evasion and tax avoidance.
Indirect taxation - if VAT rises, it will likely cause a rise in tax revenue rates because the goods they are levied on are price inelastic to a large degree (food and fuel, etc.) However, if one producer is singled out to pay more taxes, consumers may switch other substitutes and tax revenues fall.
What is the effect of a change in direct and indirect taxation on income distribution?
Direct taxation - progressive taxes such as income tax tend to redistribute income from those on higher income to those on lower incomes if tax revenues raised are used to benefit the poor.
Indirect taxation - these taxes have regressive effects because people on lower incomes spend a higher proportion of their income on indirect taxes than those on higher income, so there is more income inequality.
What is the effect of a change in direct and indirect taxation on real output and employment?
Direct taxation - an increase in taxes will reduce aggregate demand as they are a leakage from the circular flow, decreasing real output and unemployment levels. The decrease in AD would also decrease prices in an economy. However it may be used by a government to invest in capital projects creating a multiplier effect, targeting specific structural weakness in the economy.
Indirect taxation - An increase in indirect taxes shifts SRAS curve left because firms will supply less at any given price level, reducing real output and employment levels. In nearly all cases, an increase in indirect taxation will increase price levels, the amount depends on the PED of the good/service.
What is the effect of a change in direct and indirect taxation on the trade balance?
Direct taxation - as increases in income taxes will reduce household incomes, reducing levels of imports, improving the balance of trade. As consumption falls, firms invest less creating a negative accelerator effect on investment.
Indirect taxation - VAT change will have little impact on the trade balance. Changes in tariffs will have greater impact - improving trade balance in the short run
What is the effect of a change in direct and indirect taxation on FDI flows?
Direct taxation - higher tax rates deter investment because owners of firms will see incomes fall as income taxes rise, this is especially true for footloose firms
Indirect taxation - deters FDI because prices of finished goods will be higher, however if the product is aimed at a foreign market, rises in indirect taxation will have a much smaller impact.
What is the effect of a change in direct and indirect taxation on rate of inflation/price levels?
Direct taxation - an increase in direct taxation eg. income tax, could reduce disposable incomes and purchasing power, leading to a reduction in consumption levels, reducing aggregate demand and therefore eliminating inflationary pressures.
Indirect taxation - an increase in indirect taxes could be inflationary as it may cause a wage-price spiral eg. increased indirect taxes causes a rise in prices leading to increased wage demands from workers causing firms’ costs to rise, and a rise in prices of goods and services.
