Taxation

Question 1

Taxation

Answer 1

• Progressive Tax: This occurs when those on higher income levels pay a higher % of their income in tax, e.g. top rate (50%) of UK income tax is progressive.
• Regressive Tax. This occurs when an increase in income leads to a smaller % of their income going on the tax; e.g. excise duties and VAT take a bigger % of low-income earners.
• Proportional taxation – takes same % of income whatever income band.
• Direct Taxation – taken from people’s earnings directly. E.g. income tax, NI.
• Indirect Taxation – Paid by firm selling goods. E.g. VAT is included in final price consumers pay.

Question 2

Impact of Increasing Rate of Income Tax

Answer 2

• Higher income tax should increase tax revenues. The government can spend more on public services and benefits to reduce inequality.
• May encourage tax evasion, e.g. higher rates of income tax could encourage people to work in another country. Therefore increase in tax revenues may be less than expected.
• May reduce incentives to work and do overtime (substitution effect). However, the income effect of higher tax may make people work more to maintain their target income.
• Higher rates of income tax can help redistribute income from high earners to low earners.

Question 3

An increase in government spending as a % of GDP could imply 1

Answer 3

Government Spending as a % of GDP shows the proportion of government spending that occurs in the economy. An increase in government spending as a % of GDP could imply.
• Investment in education and infrastructure. The government can use tax revenues to overcome market failure in areas such as transport, education and health. Providing goods with positive externalities can lead to greater social efficiency. It can also help improve indices of economic development such as literacy rates.
• In a recession, government spending may be effective in stimulating the economy. E.g. government borrowing can offset a rise in private sector saving.

Question 4

An increase in government spending as a % of GDP could imply 2

Answer 4

• Redistribution. The government can spend money to redistribute income amongst people on low incomes. This can help promote a more equal society and improve economic welfare. Countries with the highest levels of government spending (Norway, France, UK) have the most developed welfare state which provides safety net and health care for the poorer members of society.
• The increase in government spending as a % of GDP 2007-2010 is a consequence of the recession causing a fall in GDP, but higher government spending.

Question 5

Evaluation 1

Answer 5

• Higher income tax rates could create disincentives to work. Higher corporation tax could discourage firms from setting up in that country.
• Inefficiency of government spending. Often government bodies lack a profit incentive to be efficient. Therefore government spending could be wasteful, misused and inefficient.
• Vested interests of public sector. Once the government has started certain spending projects it can be difficult to stop or reduce size of government because vested interests lobby government to maintain jobs and spending.

Question 6

Evaluation 2

Answer 6

• Crowding out. An increase in the government sector has an opportunity cost – a decline in the size of private sector. If the government spend more then it reduces private sector enterprise.
• It depends on what the government is spending the money
- e.g. spending on welfare benefits (transfer payments) may increase equality but be detrimental to efficiency.
- Spending on transport links (capital spending) can help economy become more efficient and competitive in long term.
• Government spending could become more efficient through competitive tendering and public-private partnerships, which involve both public and private sectors.

Question 7

Taxation principles 1

Answer 7

Adequacy: taxes should be just-enough to fund essential public services.
Broad Basing: taxes should be spread over the population of the economy, to minimize the individual tax burden.
Convenience: Want voluntary compliance
Restricted exemptions: tax exemptions must only be for specific purposes (such as to encourage investment) and for a limited period.
Predictability and regularity

Question 8

Taxation principles 2

Answer 8

Earmarking: a direct cost-and-benefit link between the tax source and the expenditure, such as use of motor fuel tax for road maintenance.
Efficiency: tax collection should not cost a high percentage of tax revenues.
Equity: taxes should equally burden all individuals.
Neutrality: taxes should not favor any one group
Simplicity: Easy to pay and understand