4.5.2 Taxation

• Impacts of Changes in Tax


  -Incentive to work

  -FDI flows

  -Income distribution

  -Price level

  -Trade balance

  -Output and employment

  -Tax revenue
• Incentives to Work


  High tax rates reduce disposable income thus workers become demotivated and productivity falls e.g Healey raised basic income taxes from 33% to 35% and lowered VAT from 10% to 8% which made goods cheaper thus reducing incentives to work.
• Tax Revenue

  Raising taxes only increases tax revenue to a certain point as incentives to work begin to decrease as taxes rise thus forming a Laffer curve where the highest point shows the optimal tax rate.

  
• Income Distribution

  Thatcher reduced the basic income tax to 30% and the top income tax to 63% while raising VAT from 8% to 15% thus increasing income inequality due to the regressive effects of VAT.
• Price Level


  Increased disposable income increased consumption and AD thus the PL rises, but high VAT reduces consumption so AD and the price level fall
• Output and Employment


  Decreased income tax increases derived demand for labour so employment increases, however higher VAT leads to decreased consumption and AD so output and employment fall
• Trade Balance


  Decreasing income tax and increasing VAT increases demand for cheap imports as VAT is not paid on imports and as part of the EU, which is a customs union, the UK had a common external tariff which dropped from 5.7% to 3.6% between 1986 and 1994
• FDI Flows


  Decreased income tax attracts FDI, but high VAT means prices have to be higher so firms earn less profit so FDI may fall