Taxation

• Taxation is a fee levied by a government on a product, income or activity. It is involuntary and is enforced.
• Taxes are enforced on:
  Income: wages, salaries, interest, rent, profit tax.
  Expenditure
  Wealth: part of the value of a person’s assets to the government

Distribution of Taxes

• Proportional Tax: all taxpayers pay the same percentage of their income despite their income level
• Progressive Tax: those with higher incomes pay a larger percentage of their incomes
• Regressive Tax: lower incomes pay a larger percentage of their incomes

Types of Taxation

1. Direct Taxes

• Placed on income, wealth, capital
• Income tax: raises most revenue
• Corporation tax: proportional tax on the profits of companies
• Capital gains tax: taxing the profit made sold by selling assets at a higher price than at which they were bought
• Inheritance tax: proportional tax on inherited wealth
• Stamp duties: taxation on shift of ownership of property

Advantages	Disadvantages
Progressive	Disincentive to work
Cheap and easy to collect	Discourages savings
Important to government policies	Unavoidable

2. Indirect Taxes:

• Levied on expenditure
• They are indirect as the person responsible for paying the tax may pass on all or part of the burden of the tax in the form of higher prices
• Value Added Tax (VAT): 15% rate on all value added
• Excise duties: home-produced products and imported goods
• Customs duties: import taxes, tariffs & quotas
• Car tax: in addition to VAT in buying new cars

 

Advantages	Disadvantages
Discourage harmful consumption	Regressive
Raises government revenue	Contribute to inflation
Consumers have a choice- not imposed
Does not have a disincentive to work

 

Qualities of a Good Tax

• Fair (progressive is the fairest): should take into consideration people’s ability to pay
• Not be easily evaded
• Should be certain
• Convenient
• Economical
• Preserve incentives
• Flexible: to allow the government to control the level of AD in the economy

Reasons behind Taxation

• Achieve government’s social objectives
• Achieve government’s economic objectives
• Discourage harmful consumption
• Finance government spending
• Influence aggregate demand
• Protects environment

Effects of Taxation

Income:

• Reduces inequality in distribution of income
• Negatively affects people’s incentive to work harder

Expenditure:

• Raises government finance
• Discourages harmful consumption
• Increases inflation

Wealth and Capital:

• Positive multiplier affect
• Boosts aggregate demand by encouraging spending and not saving
• May be difficult to estimate market value for family heirlooms

Advantages of Taxation

• Raises revenue for government
• Discourages harmful consumption
• Controls pollution
• Controls imports
• Equality of income
• Controls aggregate demand and multiplier affect

Disadvantages of Taxation

• Contributes to inflation
• Incentive to work lost
• Tax evasions
• Reduce economic welfare
• Reduces economic efficiency by causing loss
• Unemployment

Effect on Price

• Increases price because consumer price= producers’ price + cost of taxation
• Tariffs- tax on imported goods
• Quotas- upper limit on how much of a good can be imported
• If a good has an inelastic demand, tax will not change the level of demand, therefore raising revenue for the government
• However, if a good has an elastic demand, tax will result in a fall of demand and tax revenue will be even less than before