4.5.2 Taxation Flashcards
Explain what direct tax is and examples
- Direct taxation is levied on income, wealth and profit
- Direct taxes include income tax, inheritance tax, national insurance contributions, capital gains tax, and
corporation tax (a tax on business profits) - The burden of a direct tax cannot be passed on to someone else
Explain indirect tax with examples
- Indirect taxes are usually taxes on spending
- Examples of indirect taxes include excise duties on fuel, cigarettes and alcohol and Value Added Tax (VAT) on
many different goods and services together with the sugar tax - Producers may be able to pass on an indirect tax – depending on price elasticity of demand and supply
What are progressive taxes and give an example?
- With a progressive tax, the marginal rate of tax (MRT) rises as income rises.
- As people earn more, the rate of tax on each extra pound goes up. This increases the average rate of tax.
- Income tax in the UK is a progressive tax.
What are the the three rates that income tax is charged?
o Personal tax allowance (zero tax) up to £12,500
o Basic rate taxed on taxable income between £12,501 and £50,000
o Higher tax taxed on taxable income between £50,001 to £150,000
o Additional 45% marginal tax rate on any taxable income in excess of £150,000
What are regressive taxes?
- With a regressive tax, the rate of tax paid falls as incomes rise – I.e. the average rate of tax is lower for people on higher incomes. Examples include: Duties on tobacco and alcohol or VAT.
- A tax is said to be regressive when low income earners pay a higher proportion or percentage of their income
in tax than high income earners.
What is the Laffer Curve?
It is a (supposed) relationship between economic activity and the rate of taxation which suggests there is an
optimum tax rate which maximises total tax revenue
Why might total tax revenues fall if the tax rate increases?
o Increased rates of tax avoidance – greater incentive to seek out tax relief, make max use of tax
allowances
o Greater incentive to evade taxes (illegal) – i.e. non–declaration of income and wealth
o Possible disincentive effects in the labour market – depending on which taxes have been increased
o Possible “brain drain” effects – including the loss of highly skilled and high-income taxpayers
What does the Laffer Curve look like?
Give some evaluation points of the Laffer Curve
- Lower top rate taxes might increase income inequality
- Little evidence that high top rates of income tax is a barrier to inward migration of skilled labour
- Many people are on fixed hours / Zero Hour contracts – so tax rates may have little bearing on work incentives
- For some people, tax cuts will cause them to take more leisure time instead of work – a backward bending
labour supply curve effect – especially at higher wages/ earnings - There is a Keynesian explanation for some aspects of the Laffer Curve – cuts in direct and indirect taxes
increase real disposable income and therefore lead to higher consumer spending and aggregate demand
Explain the impacts of changes in different taxes on AD (tax rates, income, corporation, national insurance, VAT)
- Changes in tax rates and tax allowances have direct and indirect effects on the level/growth of AD
- Changes in income tax and national insurance have a direct effect on people’s disposable incomes
- Changes in corporation tax affect the post-tax profit available for businesses to invest
- Changes in employers’ national insurance affect the cost of employing extra workers in the labour market
- A change in value added tax brings about changes in retail prices and affects the real incomes of consumers
Explain the impacts of changes in different taxes on AS (tax rates, VAT, direct taxes, business taxes)
- Changes in tax rates and tax allowances have a direct and indirect effect on SRAS and LRAS
- Changes in VAT affect business costs e.g. the VAT applied when buying component parts / supplies
- Changes in direct taxes can influence work incentives
- Changes in business taxes might affect the level of foreign direct investment into a country
- Taxes can also affect the incentive to start a business or to spend money on research and development
Explain the impact of cuts in corporation tax
Evaluate the impact of a cut in corporation tax
- Impact depends on the scale of the tax cut and whether it is long-lasting or considered to be a temporary
measure - Many factors affect capital investment e.g. the pace of technological change and strength of market
competition - Some extra investment may lead to a loss of jobs through capital-labour substitution effects
What is the effect of a rise in VAT on inflation?
Higher inflation in short run as business pass on tax
What is the effect of a rise in VAT on economic growth?
Slower economic growth as real incomes and demand falls
