4.5.2 Taxation Flashcards
What is a progressive tax?
Where those who are on higher incomes pay a higher proportion of tax. For instance income tax.
What is a regressive tax?
Where the proportion of income paid in tax falls as the income of the taxpayer rises.
This is like VAT.
What is a proportional tax?
Where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes.
E.G everyone pays 10% of their income on tax - regardless of income.
What are the impacts of tax changes on incentives to work?
High tax = less incentive to work = more benefits claimed.
OR High tax = more hours worked to maintain take home income.
High tax = high income earners move abroad.
High tax = taxes on poor = poverty trap
What is the Laffer Curve?
Why is revenue from indirect taxes uncertain?
Relies on consumer spending patterns
How can taxation change income distribution?
Progressive tax systems - more money proportionally taken from rich to poor. Most progressive tax is inheritance tax.
However the system needs to be supported with benefits.
Impact of Direct Taxes on AD
Higher direct taxes = ↓ disposable income = ↓ consumer spending = ↓ AD
↓ Business profits = ↓ investment = further ↓ AD
Effect on output depends on whether the economy is at full employment.
Impact of Indirect Taxes on AS
Higher indirect taxes (e.g., VAT) ↑ business costs = ↓ SRAS
Firms pass costs to consumers (cost push inflation risk) or cut production
Impact depends on economic conditions (full employment or spare capacity)
What is a direct tax?
A tax levied on income or wealth, paid directly to the government by individuals or businesses (e.g., income tax, corporation tax).
What is an indirect tax?
A tax on expenditure, imposed on goods and services, which is collected by businesses and passed to the government (e.g., VAT, tariff).
How does taxation affect the trade balance?
High tax = less disposable income = less consumption = less spending on imports.
However, in the long run, lower AD will reduce businesses need to invest and this could reduce competitiveness meaning that exports decrease.
How does taxation influence FDI flows?
Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return.
However, this can cause a “Race to the bottom” where countries race to lower taxes to “Win” FDI - eventually resulting in a fall in revenue for all countries.
What is Ricardian Equivilance theory?
Says homo economicus (rational consumers) know a reduction in tax or increase in spending will have future impacts and therefore they do not consume more and instead save to offset the expected future tax rises / reduction in spending that will occur due to current fiscal policy.
