5.2 – Taxation Flashcards
What are taxes?
Taxes are a compulsory payment made to the government by all people in an economy.
Why Taxes?
Taxes are a major source of government revenue used to finance all government expenses.
To manage the macroeconomy through fiscal policy (taxes are used in fiscal policy see Topic 5.1)
To promote equality in income between the poor and the rich. People with higher incomes are taxed heavier that people with low incomes.
To discourage the consumption and production of demerit goods (alcohol, tobacco). How taxes affect production and consumption will be discussed later in this topic.
To protect the environment. More tax can be imposed on firms and products that create a lot of pollution and environmental damage.
What are Progresssive Taxes?
The proportion of income taken into tax rises as income rises. That is, people with higher incomes are taxed heavier that people with low incomes.
What are Regressive Taxes?
The proportion of income paid in tax falls as income rises. That is taxes fall heavily on the poor than the rich.
What are Proportional Taxes?
The proportion of income paid as tax is same whatever the income.
What are Direct Taxes?
tax on individual or firm’s income or wealth. The burden of tax payment falls directly on the person or individual responsible for paying it. They are progressive taxes as more the income, more the tax levied.
What are the Advantages of Direct Taxes?
High revenue: as all people above a certain income level have to pay income taxes, the revenue from this tax is very high.
Can reduce inequalities in income and wealth: as they are progressive in nature- heavier taxes on the rich than the poor- they help in reducing the difference between the income levels of the rich and the poor.
What are the Disadvantages of Direct Taxes?
Reduce work incentives: people may rather stay unemployed (and receive govt. unemployment benefits) rather than be employed if it means they would have to pay a high amount of tax. Those already employed may not work productively, since any extra income they make, the more tax they will have to pay.
Reduce enterprise incentives: corporation taxes may demotivate entrepreneurs to set up new firms, as a good part of the profits they make will have to be given as tax.
Tax evasion: a lot of people find legal loopholes and escape having to pay any tax. Thus tax revenue falls and the govt. has to use more resources to catch those who evade the taxes.
What are Indirect Taxes?
taxes on the goods and services sold (it is called indirect because it indirectly takes money as tax from consumers incomes). Indirect taxes are normally paid by producers, but they will shift the tax burden onto consumers by fixing higher prices. They are regressive taxes; even though all consumers pay the same tax, it will take more proportion of income of the poor, thus falling heavily on them than the rich.
What are the Advantages of Indirect Taxes?
Cost -effective : the cost of collecting indirect taxes are low compared to direct taxes.
Expanded tax-base: directs taxes are paid by those who make a good income, but indirect taxes are paid by all people (young,old,unemployed etc) who consume goods and services.
Can achieve specific aims: for example, excise duty (tax on demerit goods) can discourage the consumption of harmful goods; similarly, higher and lower taxes on particular products can influence their consumption.
Flexible: indirect tax rates are easier to alter/change than direct tax rates. Thus their effects are immediate in an economy.
What are the Disadvantages of Indirect Taxes?
Inflationary: The prices of products will increase when indirect taxes are added to it, causing inflation.
Regressive: since all people pay the same amount of money, irrespective of their income levels, the tax will fall heavily on the poor than the rich as it takes more proportion of their income.
Tax evasion: high tariffs on imported goods or excise duty on demerit goods can encourage illegal smuggling of the good.
