UK Economy

• The UK has a mixed economy with a private sector and a government-administered public sector
• Public sector


  Needs to be financed through taxation, government borrowing, and charges for some services
• Reasons the public sector is needed

  • Public goods would not exist
  • Merit goods would be under-provided
  • Demerit goods would be over-provided
  • Some sections of society need assistance with basic needs
  • Provides a method of making income distribution fairer
• Four canons of taxation (Adam Smith)

  • Equity - Taxes should be charged according to ability to pay
  • Efficiency - Taxes should be relatively inexpensive to collect
  • Certainty - Taxpayers should know how much tax they are to pay
  • Convenience - Taxes should be paid when suitable to the taxpayer
• Direct taxes in the UK

  • Income Tax
  • National Insurance contributions
  • Corporation Tax
  • Council Tax
  • Business rates
  • Capital Gains Tax
  • Inheritance Tax
  • Stamp duties
• Direct taxes


  Taxes on income and wealth, levied by the Inland Revenue
• Indirect taxes in the UK

  • Value Added Tax (VAT)
  • Customs duties
  • Excise duties
  • Petroleum Revenue Tax
  • Motor vehicle duties
• Indirect taxes


  Taxes on spending, usually paid indirectly to the seller but collected by HM Revenue and Customs
• Other sources of government revenue

  • Charges for some services
  • Central government charges (e.g. prescription charges, police fines)
• The three largest sources of UK government revenue in 2013 were Income Tax, VAT, and National Insurance
• In 2013, 15% of UK government revenue came from borrowing
• In 2013, 36% of UK government revenue came from Income Tax and National Insurance combined
• In 2013, 21% of UK government revenue came from VAT and excise duties combined
• Examples of other government revenue


  • Charges for public services
  • Fines and penalties
• Reasons the government may need to borrow money

  To finance public sector activities when tax revenue is insufficient
• Progressive tax


  A tax that takes a larger percentage of income as income rises, taking into account ability to pay
• Regressive tax


  A tax that takes a larger percentage of income from lower-income individuals compared to higher-income individuals
• Most direct taxes in the UK are progressive
• Indirect taxes are generally regressive
• The balance between direct and indirect taxation in the UK has shifted towards more indirect taxation in recent years
• Effect of taxation on individuals

  Reduces disposable income, affects consumption and saving decisions
• Effect of taxation on firms

  Increases costs, reduces profits, may affect investment and pricing decisions
• Main types of government expenditure

  • Public services (e.g. health, education, defence)
  • Social security payments
  • Interest payments on government debt
  • Investment in infrastructure
• Reasons for government expenditure

  • Provision of public goods and merit goods
  • Redistribution of income
  • Stabilisation of the economy
• Balanced budget

  Government revenue equals government expenditure
• Budget deficit


  Government expenditure exceeds government revenue
• Budget surplus


  Government revenue exceeds government expenditure
• A budget deficit requires the government to borrow to finance the shortfall
• A budget surplus allows the government to pay down existing debt or accumulate savings
• Progressive tax


  A tax which takes account of a person's ability to pay and takes a larger percentage of income as income rises
• Regressive tax


  A tax which takes no account of a person's ability to pay, where lower income earners pay a higher percentage of their income in tax than higher income groups
• An extreme example of a regressive tax was the Community Charge, or "Poll Tax", introduced in the 1980s where a worker on a £10,000 yearly income paid exactly the same as a millionaire
• Vehicle licence duty is a regressive tax
• Recent governments have started to restructure the balance of taxation away from direct to indirect
• The top rate of income tax has been cut from 83% to 40% and the basic rate for all taxpayers cut from 33% to 20%
• The share of income tax of all government revenue has fallen from 45% to 25%
• Cuts in taxes on business, e.g. lower corporation tax and business rates, have allowed firms to keep more of their profits and so encourage investment
• Income tax has been recouped from the extension of VAT to cover more goods and services and excise duties on alcohol and tobacco have been increased by more than inflation
• VAT was 8% in the 1970s, but is currently 20%
• As direct taxes tend to be progressive, this shift has disadvantaged those on lower incomes