Taxation

Question 1

Reasons for Taxation

Answer 1

To pay for government expenditure

To correct market failure such as externalities - Governments can impose taxation on certain goods eg demerit goods, in order to discourage use. (Negative externalities of consumption) or remove tax on merit goods (positive externalities of consumption)

To manage the economy as a whole - Taxation can have an important influence on the macro-economic performance of the economy. Governments may change tax in order to influence inflation, unemployment, and the balance of payments.

To redistribute income

Question 2

Effects of Changes in Direct Tax Rates

Answer 2

Incentives to work - increase income tax may cause disincentive to work, the unemployed and those who are inactive would be less willing to take jobs. Workers currently employed would be less willing to do overtime, more likely to decrease working hours, more likely to retire early, and less willing to apply for promotion.

Question 3

The Laffer Curve

Answer 3

A curve which shows that a low levels of taxation, tax revenues will increase if tax rates increased. However, if tax rates are high, then a further rise in rates will reduce total tax revenues because of the disincentive effects of the increase in tax.
https://s.hswstatic.com/gif/trickle-down-economics-1.gif
Revenue Maximising Point is the Optimum Level.

The Laffer Curve shows:
An increase disincentive to work
An increase in tax avoidance, which is legal
An increase in tax evasion, which is illegal.

Question 4

Real Output and Employment

Answer 4

• Increase in tax - decreased disposable income, decrease consumption, decrease AD, decrease actual GDP, increase unemployment.
• All fall in price level (disinflation) - Good or bad? Dependent on inflation target/price
• Trade Balance - increase income tax - decrease disposable income, decrease consumption, improve the current account balance in the balance of payments.
• FDI Flows - an increase in direct taxes is likely to deter inward FDI

Question 5

Effects of Changes in Indirect taxes

Answer 5

An increase in price level if indirect taxes increases.

Imports increase, more likely to result in deficit.