Taxation

1. Taxation Learning outcome Y • Explain the reasons for taxation • Describe the main UK taxes • Explain progressive, proportional and regressive taxation • Describe the canons and characteristics of a ‘good’ tax • Evaluate direct and indirect taxes • Explain the impact of taxation on incentives Reading: Units 11 & 79

2. Direct and indirect taxation Direct tax • A tax levied directly on an individual or organisation Indirect tax • A tax on a good or service

3. Reasons for taxation To pay for government spending • Governments need money to finance their spending programmes • This money comes from the revenues of taxation • Some money can come borrowing but the majority must be from tax revenues

4. Reasons for taxation Correct market failure • Government can intervene in markets by changing tax and therefore altering demand • Governments may increase the tax on products that create negative externalities i.e. cigarettes, alcohol, cars etc. • Governments may give ‘tax breaks’ to products that create positive externalities i.e. solar powered heating

5. Reasons for taxation Redistribute income • The government may wish to reduce the gap between rich and poor in society • They can redistribute income from richer parts of society to poorer parts of society • The idea is that the benefits to the poorer groups are greater than the losses of the richer groups

6. Reasons for taxation Manage the economy • Taxation influences macro-economic performance • Tax can impact inflation, unemployment and the trade balance • Changes in taxation can affect aggregate demand and aggregate supply

7. Taxation in the UK Income tax • This is the largest source of income for the government • It is a tax on an individuals income over one year • Everyone is allowed to earn a set amount before they pay any tax, this is known as a tax allowance • Any income earned over that limit (tax threshold) is known as taxable income • Taxable income is then split into tax bands, the basic rate of 20% and the higher rate of 40%

8. Taxation in the UK Corporation tax • A tax on company profits • The rate of corporation tax was lowered from 30% to 28% in 2007 • Companies can claim tax allowances to lower their tax payment i.e. investment allowances

9. Taxation in the UK Sales tax (VAT) • VAT stands for value added tax • VAT is a tax on expenditure • It is added to the cost of products • The current rate is 17.5% • There are some goods that have a lower rate such as food, water, children’s clothes, books and public transport

10. Taxation in the UK National insurance contributions (NIC’s) • This is a separate tax to pay for social welfare i.e. pensions and unemployment allowances • NIC’s are collected from an individuals income Inheritance tax • A tax on the value of assets left on the death of an individual • There is a tax allowance of around £250,000 after which assets are taxed at 40%

11. Taxation in the UK Council tax • A tax set by local authorities to pay for local services i.e. rubbish collection, traffic management, street cleaning etc. • It is based on the value of an individuals home, the higher the value of their home the more they pay Business rates • A tax set by local authorities • It is based on the value of business property, the higher the value of their property the more they pay

12. Taxation in the UK