Taxation 4.5.2

Question 1

Progressive taxation

Answer 1

as income rises, a larger percentage of income is paid in tax – UK income Tax

Question 2

Proportional taxation

Answer 2

the % of income paid in tax is constant, no matter what the level of income

Question 3

Regressive taxation

Answer 3

as income rises, a smaller % of income is paid in tax – VAT

Question 4

Impacts of direct taxation

Answer 4

• Incentives to work
• Tax revenue – increasing tax rates lead to more tax evasion and avoidance, more tax exiles - laffer curve
• Income distribution
• real output and employment
• price level
• trade balance

Question 5

laffer curve

Answer 5

relationship between tax revenue and tax rate

Question 6

other impacts of direct taxation

Answer 6

Could also lead to lower disposable income = less derived demand for labour as demand for goods and services has fallen, so there is reduced:

employment, output and inflation

Question 7

Incentive to work

Answer 7

• argued that high marginal tax rates will ​discourage individuals from working​. Free market economists argue supply of labour elastic and a reduction in marginal taxes on income will lead to significant increase in work as individuals work longer hours, accept promotions and more people join the workforce.
  ● High taxes on high income earners could encourage them to ​move abroad and taxes on the poor may lead to a ​poverty trap​.
  ● It is i​ncome tax ​which is important: high income tax reduces incentives more than high VAT. Thus, a switch from direct to indirect taxes may increase incentives.

Question 8

Income distribution

Answer 8

● A ​progressive tax system will increase the equality of income distribution as more money is proportionally taken from the rich than from the poor. A ​regressive one will decrease income equality. Since direct taxes tend to be progressive and indirect taxes regressive, a move from indirect to direct taxes will improve equality.

Question 9

Real output and employment

Answer 9

● Some taxes affect AD whilst others affect AS. A rise in direct taxes will reduce the level of disposable income an individual has, which will cause a fall in their spending and thus a ​fall in AD. It could also cause a fall in leftover profits for businesses and therefore a fall in investment. The effect this has on output will depend on where the economy is: whether it is at full employment or not.
● On top of this, higher indirect taxes and NICs increase costs for firms and this will decrease SRAS​. This impact will again depend on where the economy is producing.
● It can be argued that income taxes cause a ​disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive

Question 10

Price level

Answer 10

Cost push inflationary pressure or malign deflation

Question 11

Trade balance

Answer 11

● 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 12

FDI Flows

Answer 12

● 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