4.5.2: Taxation

Question 1

What is proportional tax?

Answer 1

• A tax with a constant marginal rate
• Also known as a flat tax

Question 2

What is progressive tax?

Answer 2

• Where those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax

Question 3

What is regressive tax?

Answer 3

• Where the proportion of income paid in tax falls as the income of the taxpayer rises
• Those on higher income pay a smaller percentage of their income on the tax

Question 4

What is direct tax?

Answer 4

• A tax imposed on the income of individuals or profits of business
• Taxes directly paid to the government include income, corporation, inheritance tax and national insurance contributions

Question 5

What is indirect tax?

Answer 5

• Imposed on goods or services eg VAT

Question 6

What are hypothecated taxes?

Answer 6

• Taxes raised for a specific purpose.
• In theory, the revenue raised is ring fenced for a clearly identified use
• Example: TV licence is a form of taxation where all revenues go towards the provision of broadcasting through the BBC

Question 7

How do tax changes impact the incentive to work?

Answer 7

• High marginal rates of tax will discourage individuals from working.
• High taxes on high income earners could encourage them to move abroad and taxes on the poor may lead to a poverty trap

Question 9

How do tax changes impact tac revenue

Answer 9

• The Laffer curve
• High tax rate, higher revenue up until a certain point (50%)
• 100% tax rate, 0 tax revenue as no one would be willing to work

Question 10

How do tax changes impact income distribution?

Answer 10

• 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 system will decrease income inequality as it affects people of lower incomes proportionally more than higher incomes

Question 11

How do tax changes impact real output and employment?

Answer 11

• A rise in direct taxes will reduce the level of disposable income, reducing AD
• Higher indirect taxes increase costs for firms and will decrease SRAS

Question 12

Other impacts of tax changes

Answer 12

• FDI flows
• Trade balance
• Price level