A tax is a government levy on income or expenditure. There are various reasons why the government imposes taxes. For example:
• Taxes on salaries and profits raise government revenue and can be used to redistribute income and wealth in the economy.
• Taxes on goods and services raise the costs of production and therefore can limit the output of certain demerit products such as alcohol and tobacco.
• Tariffs imposed on foreign goods and services help to protect domestic firms from overseas rivals
- The tax burden is the amount of tax that households and firms have to pay.
Types of taxation
There are various classifications of taxes, including the following:
• Direct taxes – This type of tax is paid from the income, wealth or profit of individuals and firms. Examples are taxes on salaries, inheritance and company profits.
• indirect taxes – These are taxes imposed on expenditure on goods and services. For example, countries such as Australia and Singapore use a goods and services tax (GST), whereas the European Union uses value added tax (VAT). Other examples are taxes on petrol, alcohol and cigarettes.
• Progressive taxation – Under this tax system, those with a higher ability to pay are charged a higher rate of tax. This means that as the income, wealth or profit of the taxpayer rises, a higher rate of tax is imposed. Examples of progressive taxation are income tax, capital gains tax and stamp duty.
• Regressive taxation – Under this tax system, those with a higher ability to pay are actually charged a lower rate of tax: that is, the wealthier the individual, the lower the tax paid as a percentage of income. For example, although a high-income earner pays the same amount of airport tax or television license fee as a less wealthy person, the amount of tax paid is a smaller proportion of the wealthier person’s income.
• Proportional taxation – Under this tax system, the percentage of tax paid stays the same, irrespective of the taxpayer’s level of income, wealth or profits. An example ·would be a flat rate sales tax, such as VAT or GST. Sales taxes vary considerably from country to country: for example, Denmark has a 25 per cent GST, whereas sales taxes in India and Japan arc as low as 5 per cent. Another example is an income tax which is 20 per cent for all individuals regardless of level of income.
The impact of taxation
• Impact on price and quantity – The imposition of sales tax will shift the supply curve of a product to the left due to the higher costs of production. This will increase the price charged to customers and reduce the quantity produced and sold.
• Impact on economic growth – Taxation tends to reduce incentives to work and to produce. By contrast, tax cuts can boost domestic spending, thus benefiting businesses and helping to create jobs. Nevertheless, tax revenues are essential to fund government spending (for the construction of schools, hospitals, railways, airports, roads and so on), which fuels economic growth.
• Impact on inflation – As taxation tends to reduce the spending ability of individuals and the profits of firms, it helps to lessen the impact of inflation. By contrast, a cut in taxes boosts the disposable income of households and firms, thus fueling inflationary pressures on the economy.
• Impact on business location – The rate of corporation tax and income tax will affect where multinational businesses choose to locate. For example, high corporation tax rates in Argentina (35 per cent), Pakistan (35 per cent) and Cameroon (38.5 per cent) can put off some companies thinking of locating in these countries. As a result, foreign direct investment in these countries might be lower than otherwise. By contrast, it might be easier to attract workers in low income tax countries such as Bulgaria (10 per cent), Macedonia (10 percent), Belarus (12 percent) and Hong Kong (15 per cent).
• Impact on social behavior – Taxation can be used to alter social behavior with the intention of reducing the consumption of demerit goods. For example, taxing tobacco and alcohol should, in theory, reduce the demand for such products. Taxes are also used to protect the natural environment by charging those who pollute or damage it. For example, countries such as the UK and China tax cars based on the engine size because vehicles with larger engines tend to cause more pollution.
• Impact on incentives to work – lf taxes are too high, this can create disincentives to work. For example, France tried to introduce a 75 per cent income tax rate in 2012 for individuals earning incomes in excess of€1 million ($1.28 million per year). However, the proposals were overturned, with some economists arguing that the government would actually receive more tax revenues by cutting tax rates. This is because lower rates of tax can create incentives to work
• Impact on tax avoidance and tax evasion – Some taxes are preventable. Tax avoidance is the legal act of not paying taxes: for example, non-smokers do not pay tobacco tax and non-overseas travelers do not pay air passenger departure taxes. However, tax evasion is illegal as it refers to non -payment of taxes due, perhaps by a business under-declaring its level of profits. High levels of taxation will tend to encourage both tax avoidance and tax evasion.
• Impact on the distribution of wealth – The use of taxes can help to redistribute income and wealth from the relatively rich to the poorer members of society. For example, wealthier individual will pay more income tax, sales taxes and stamp duty on their private properties. These funds can be used by the government to support education, health care and social benefits for less affluent individuals in the economy.