Tax

Question 1

Type of tax 3

Answer 1

Progressive - higher incomes pay higher marginal rate of tax

Regressive - proportion of income paid falls as income of taxpayer rises. Most indirect taxes are regressive

Proportional tax - Proportion of tax paid remains the same regardless of income. Russia’s tax is 15% for almost everyone (13% for lowest earners)

Question 2

Laffer Curve

Answer 2

Rise in tax rates will not necessarily increase tax rev. Laffer thinks optimum point is around 50%

Question 3

Affect of taxes on AD & AS

Answer 3

Rise in direct taxs (e.g. income) reduces disposable income, thus reduces AD

Higher indirect taxes & NICS increase costs for firms, reducing LRAS (extent depends on where country is producing)

Can be argued that income taxes reduce incentive to work, thus reduce LRAS as skilled workers go abroad

Question 4

Effect of taxes on trade balance LR & SR

Answer 4

A rise in taxes will decrease income and therefore decrease consumption, theoretically this will also mean consumers spend less on imports . Imports in the UK have been found to be highly income elastic. As a result, the trade balance will improve in the short run

However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease.

Question 5

Tax impact on FDI Flows

Answer 5

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. ● The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries.

E.g. Ireland (12.5% corp tax) attracting Amazon & huge tax rev from that, UK is 25% for large firms

Question 6

Automatic Stabilisers

Answer 6

Automatic stabilisers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilisers.

In a recession, benefits increase as more people are unemployed and so the benefits are a stabiliser as it means that the overall fall in AD is reduced, preventing too much change in the economy. On the other hand, during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high.