Taxation

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Government Taxes

Taxation can be used by governments to influence the distribution of aggregate demand.

Progressive tax

Income tax is a form of progressive taxation, meaning that marginal rates increase as an individual's income increases.
E.g. If you earn up to £12,500 in the UK, you pay 0% tax. For every extra pound (£) you earn, you pay 20p in income tax up to £50,000.
For every £1 you earn between £50,000 and £150,000, you pay 40p in income tax.
For every £1 you earn over £150,000, you pay 45p in income tax.

Regressive tax

With a regressive tax, the average rate of tax paid falls as incomes rise.
For example, the Sugar Tax (a duty on sugary drinks and the like) would cost households on lower incomes more as a % of their income and so could be said to be regressive.
Policymakers may want to consider the distributional effects of taxes they implement.

Proportional tax

With a proportional tax, the marginal rate of tax is always the same and so, therefore, is the average rate of tax.
For example, some countries have a single rate of income tax paid by everyone.
This has the advantage of being simple to use but has different distributional effects to a progressive tax.

Direct taxes

Direct taxes are taxes on wealth and income (e.g. inheritance tax, income tax, national insurance contributions).

Indirect taxes

Indirect taxes are taxes on consumption (e.g. VAT, stamp duty, congestion charge, fuel duty, council tax).

Principles of Taxation

The famous 18th Century economist Adam Smith put forward four canons (rules) of taxation. These were his suggestions for what makes a 'good' tax.

Canon of equality

Taxes should be determined according to the ability to pay.
So richer people should pay more.

Canon of certainty

The timing and amount of tax must be certain to the tax payer so there are no shocks or unexpected tax bills.

Canon of convenience

It must be convenient to pay - in terms of how it is paid and when it is paid.

Canon of economy

The cost of collecting / enforcing a tax should be low relative to the amount collected.

Direct and Indirect Taxes

Direct and indirect taxes have a range of effects on the economy as a whole.

Incentive to work

Both direct and indirect taxes predominantly reduce the incentive to work.
Both direct and indirect taxes have a substitution effects by which labour views hours worked as decreasingly valuable compared to leisure time as the real disposable income earned will fall.
Direct taxes reduce nominal disposable income and indirect taxes increase prices, reducing real disposable income.

The Laffer Curve

However, there is an income effect from the taxes, by making work less valuable they result in workers having to work more in order to afford the same amount of goods and services. The Laffer curve shows that there is a tax rate between 0-100% which maximises tax revenue, if the tax is too low then little revenue is earned but if the tax is too high the disincentive to work can also reduce tax revenue.

Income distribution

Indirect taxes are usually regressive, this means that real incomes for those on lower incomes are reduced more than those on higher incomes as price changes are a greater proportion of the former’s income. This increases the range of income distribution.
Direct taxes are often more progressive which leads to a decrease in the range of income distribution. More so if the taxes are used to fund transfer payments to those on lower incomes.

Real output

Real output and employment are, ceteris paribus, both reduced by taxes.
Direct taxes reduce real incomes which leads to a fall in aggregate demand leading to reduced output and increased unemployment.
Indirect taxes reduce (short-run) aggregate supply leading to an increased negative output gap.
The price level changes differently depending on the type of tax.
A direct tax reduces aggregate demand which leads to a fall in the price level and inflationary pressure.
Indirect taxes increase the cost of production, reduces aggregate supply and therefore leads to an increase in the price level and inflationary pressure.

Balance of trade

Taxes also have an effect on the balance of trade.
Direct taxes reduce disposable income and therefore reduces household’s ability to pay for imports, improving the trade balance.
Indirect taxes make domestic goods more expensive and less competitive leading to a worsening of the trade balance.

Illustrative background for FDI ?? "content

FDI

Both types of taxes have an adverse effect on FDI flows.
Both direct and indirect taxes make domestic trade less profitable (increased costs of production and decreased real incomes). This makes inward FDI less attractive to foreign firms.

1Introduction to Markets

2Market Failure

2.1Market Failure

2.1.1Types of Market Failure

2.1.2Externalities

2.1.3The Deadweight Welfare Loss of Externalities

2.1.4A-A* (AO3/4) - The Externalities of Education

2.1.5Public Goods

2.1.6Information Gaps

2.1.7End of Topic Test - Market Failure

2.1.8Application Questions - Market Failure

2.2Government Intervention

2.2.1Government Intervention in Markets

2.2.2Subsidies & Price Controls

2.2.3Pollution Permits & Regulation

2.2.4A-A* (AO3/4) - European Emissions Trading

2.2.5State Provision & Information Provision

2.2.6Government Failure

2.2.7End of Topic Test - Government Intervention

2.2.8A-A* (AO3/4) - Government Intervention

3The UK Macroeconomy

3.1Measures of Economic Performance

3.1.1Measuring Economic Growth

3.1.2National Income Data

3.1.3Inflation

3.1.4Causes of Inflation

3.1.5Consequences of Inflation

3.1.6Employment & Unemployment

3.1.7Causes & Impact of Unemployment

3.1.8A-A* (AO3/4) - Hysteresis

3.1.9Balance of Payments

3.1.10Current Account Deficit & Imbalances

3.1.11End of Topic Test - Economic Performance

3.1.12Application Questions Macroeconomy

3.2Aggregate Demand

3.2.1Aggregate Demand

3.2.2Consumption

3.2.3Investment

3.2.4Government Expenditure

3.2.5Net Trade

3.2.6End of Topic Test - Aggregated Demand

3.2.7Application Questions - AD

3.3Aggregate Supply

3.3.1Aggregate Supply

3.3.2End of Topic Test - Aggregated Supply

3.3.3A-A* (AO3/4) -Aggregate Supply

3.4National Income

3.4.1National Income

3.4.2Injections & Withdrawals

3.4.3Equilibrium Level of Real National Output

3.4.4Multiplier Effect

3.4.5End of Topic Test - National Income

3.4.6Application Questions - National Income

3.5Economic Growth

3.5.1Causes of Economic Growth

3.5.2Output Gaps

3.5.3Business Cycle

3.5.4Impact of Economic Growth

3.5.5End of Topic Test - Economic Growth

3.5.6A-A* (AO3/4) - Growth

4The UK Economy - Policies

4.1Macroeconomic Objectives & Policies

4.1.1Possible Objectives

4.1.2Demand-Side Policies - Monetary

4.1.3Demand-Side Policies - Monetary 2

4.1.4A-A* (AO3/4) - The Future of Interest Rates

4.1.5Demand-Side Policies - Fiscal

4.1.6Demand-Side Policies in 2007-08

4.1.7Strengths & Weaknesses of Demand Side

4.1.8Supply-Side Policies

4.1.9Supply-Side Policies 2

4.1.10Conflicts Between Objectives

4.1.11A-A* (AO3/4) - Conflicting Incentives

4.1.12Phillips Curve

4.1.13End of Topic Topic - Policies & Objectives

4.1.14Application Questions - UK Policies

5Business Behaviour

5.1Business Growth

5.1.1Size & Types of Firms

5.1.2Business Growth

5.1.3Pros & Cons of External Expansion

5.1.4Demergers

5.1.5End of Topic Test - Business Growth

5.1.6A-A* (AO3/4) - Business Growth

5.2Business Objectives

5.2.1Business Objectives

5.2.2End of Topic Test - Business Objectives

5.2.3Application Questions - Business Objectives

5.3Revenues, Costs & Profits

5.3.1Revenue

5.3.2Costs

5.3.3Economies & Diseconomies of Scale

5.3.4Profits

5.3.5Profits 2

5.3.6End of Topic Test - Revenue, Costs & Profits

5.3.7A-A* (AO3/4) - Revenue, Costs & Profit

6Market Structures

6.1Market Structures

6.1.1Efficiency

6.1.2Perfect Competition

6.1.3Perfect Competition 2

6.1.4Monopolistic Competition

6.1.5Oligopolies

6.1.6The Prisoner's Dilemma

6.1.7Collusion in Oligopolistic Markets

6.1.8A-A* (AO3/4) - Which Factors Affect Collusion?

6.1.9Monopolies

6.1.10Price Discrimination

6.1.11Monopsony

6.1.12A-A* (AO3/4) - Models in Economics

6.1.13Contestability

6.1.14Benefits of Contestability

6.1.15End of Topic Test - Market Structures

6.1.16Application Questions - Market Structures

6.1.17A-A* (AO3/4) - Cereal Collusion

6.2Labour Market

6.2.1Demand for Labour

6.2.2Supply of Labour

6.2.3Labour Market Imperfections

6.2.4A-A* (AO3/4) - Labour Productivity & Unemployment

6.2.5A-A* (AO3/4) - What Level of Unionisation is Good?

6.2.6Wage Determination

6.2.7Elasticity of Labour Supply & Demand

6.2.8Intervention in Setting Wages

6.2.9End of Topic Test - Labour Market

6.2.10A-A* (AO3/4) - Labour Markets

6.3Government Intervention

6.3.1Reasons for Government Intervention

6.3.2Government Promotion of Competition

6.3.3Usefulness of Competition Policy & Examples

6.3.4A-A* (AO3/4) - Modern Competition Policy

6.3.5Privatisation

6.3.6Government Regulation

6.3.7A-A* (AO3/4) - Nationalisation vs Privatisation

6.3.8Government Protection of Suppliers and Employees

6.3.9Impact of Government Intervention

6.3.10End of Topic Test - Government Intervention

6.3.11Application Questions - Government Intervention

7A Global Perspective

8Finance & Inequality

8.1Poverty & Inequality

8.1.1Absolute & Relative Poverty

8.1.2Inequality

8.1.3Inequality 2

8.1.4Lorenz Curve

8.1.5Government Policy on Poverty

8.1.6End of Topic Test - Poverty & Inequality

8.1.7A-A* (AO3/4) - Inequality & Poverty

8.2Emerging & Developing Economies

8.2.1Measures of Development

8.2.2Factors Influencing Growth & Development

8.2.3Barriers to Development

8.2.4Barriers to Development 2

8.2.5A-A* (AO3/4) - The Bottom Billion

8.2.6Development Strategies

8.2.7Interventionist Strategies

8.2.8Aid

8.2.9International Institutions

8.2.10International Institutions 2

8.2.11End of Topic Test - Emerging & Developing

8.2.12Application Questions - Developing Countries

8.3The Financial Sector

8.3.1Role of Financial Markets

8.3.2Market Failure in the Financial Sector

8.3.3Role of Central Banks

8.3.4End of Topic Test - The Financial Sector

8.3.5A-A* (AO3/4) - Financial Sector

8.4Role of the State in the Macroeconomy

8.4.1Public Expenditure

8.4.2Taxation

8.4.3Public Sector Finances

8.4.4End of Topic Test - Role of the State

8.4.5Application Questions - Role of the State

9Examples of Global Policy

9.1International Policies

9.1.1Global Debt & Deficit Policies

9.1.2Poverty & Inequality Policies

9.1.3Changes in Interest Rates

9.1.4Competitiveness Policies

9.1.5End of Topic Test - International Policies

9.1.6A-A* (AO3/4) - International Policies

9.2Policy Responses to Shocks

9.2.1International Tax Policies

9.2.2Problems for Policymakers

9.2.3End of Topic Test - Policy Responses

9.2.4Application Questions - Policy Responses

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