Taxation

• There are three types of tax systems: progressive, proportional and regressive
• Progressive taxes are taxes that rise as income rises e.g UK income tax - this means the tax falls more heavily on the rich
• Regressive taxes that are taxes that decrease as income rises - this means the tax falls more heavily on the poor
• Proportional taxes are taxes that are constant as a percentage no matter the level of income e.g Bolivia has a tax rate of 13% irrespective of the income
• An increase in tax rates reduces the incentive to work for the unemployed or existing workers, this decreases productivity and output as well, lowering aggregate supply and employment
• An increase in tax rates increases tax revenue for the government which can prevent fiscal deficits and be invested in infrastructure
• The Laffer Curve is a graph that shows the relationship between tax revenue and tax rate.

  • The increased tax rates increase tax revenue up until a certain point. After this , workers will be disincentivized to work and people will actively tax avoid - tax revenue will begin to fall.

  
• An increase in indirect taxes results in increased inequality as they are regressive so the poorest are most affected.
• An increase in tax rates reduces the multiplier effect as it is a withdrawal, reducing aggregate demand
• An increase in tax rates improves the trade balance as there is less disposable income for consumers to spend, decreasing the level of imports
• An increase in the rate of corporation tax relative to other countries may deter inward flows of FDI
• An increase in indirect taxes could also increase cost of imported raw materials for firms and therefore higher costs of production causing cost-push inflation
• A decrease in tax rates increases the incentive to work increasing productivity of existing workers, output of the economy, aggregate supply and employment levels
• A decrease in tax rates decreases tax revenue, increasing chances of a fiscal deficit and less reinvestment into economy
• A decrease in regressive indirect taxes would be decreased inequality by relieving the poor
• A decrease in direct taxes will cause increased disposable income for consumers, increased consumption increases aggregate demand, potentially causing demand-pull inflation
• If the rate of corporation tax decreases relative to other countries, there will be an increased inward flow of FDI as they will be attracted by the ability to retain more profit
• A decrease in tax rates worsens the trade balance as consumers have higher disposable income which could be used on imports
• An increase in indirect taxes will improve the trade balance as taxes such as tariffs make it more expensive to import goods
• One example of a regressive tax are indirect taxes and national insurance which drops from 12% to 2% when earners beginning earning over £50,000