Transcript Day 1_Session 4 - Basics of taxation and Exercices

Basics of Taxation
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To understand the impact of taxation to our
business and microeconomics we must
understand causality of taxation and
macroeconomics.
Taxes - required payments from citizens and
companies to governments. The payments fund
projects and expenditures that serve the public
interest.
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Why does the government tax?
 Benefit principle – rise revenue to finance government spendingg e.g.
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financing the public goods and services
Macro-economic demand management/ macro stability in inflation and
economic growth- changing the level and the pattern of demand
Micro economic effects of tax changes – influencing consumer choices
through the price mechanism
Influencing the distribution of income and wealth –using progressive
system of taxation to achive a more equitable distribution of final income
and welth between housholds
Helping to correct for market failure - e.g. environmental taxation can
correct for externalities
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Types of taxes:
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Income tax
National insurance
VAT
Corporation tax
Fuel duties
Council tax
Business rates
Other taxes and royalties
Stamp duties
Toabcco duty
Vehicle excise duty
Alcoholl duties
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 Inheritance tax
 Insurance premium tax
 Capital gains tax
 Customer duties
 Betting and gaming duties
 Air passenger duty
 Climate change lavy
 Land fill tax
 Aggregates levy
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Direct taxation
 levied on income, wealth and profit (include income tax,
national insurance contribution, capital gains tax,
corporation tax) the burden of direct tax cannot be
shifted.
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Indirect taxation
 levied on expenditure (on goods and services), incude VAT,
excise duties on fuel and alcohol, cigarets, car tax, betting
tax and tv licence.
 The burden of an indirect tax might be passed onto the
customer by the producer. This depends on price elasticity
of demand and suppy for the product.
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A value added tax (VAT)
 is a consumption tax added to a product's sales price. It represents a tax on
the "value added" to the product throughout its production process.
 The VAT system is invoice-based. Each seller in the product chain includes a
VAT charge on the buyer's invoice. Under a VAT taxation system, all sellers
collect the tax and then pay it to the government. The VAT gives sellers
along the supply chain a direct economic motivation to collect the tax,
thereby reducing the incidence of tax evasion.
 Don't confuse the VAT with sales tax. Under a sales tax, the tax is collected
only once at the consumer's point of purchase. The VAT tax, however, is
collected every time a business purchases products from other businesses
within the product's supply chain.
 The VAT is highly efficient flat consumption tax that reduces the incidence
of non-compliance. More than 100 countries have adopted it -- with rates
ranging from 10% - 25%.
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Progresive taxes
 the marginal rate of tax rises as income rises – as people
earn more income, the rate of tax on each euro earned
goes up
 This causes a rise in the average percentage rate of tax
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Proportional taxes
 with a proportional tax, the % rate of tax is constant
across all income levels
Regresive tax
 the rate of tax falls as income rise – duties on cigaretts
and alcohol in UK e.g.
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General effects of Taxation
 Personal Income: Tax which is presumed to fall entirely on
the legal taxpayers influences decisions to work, save, and
invest. These decisions affect other people.
 Corporate Income: Tax may simply result to lower
corporate profits and dividends. It may reduce their
income of all owners of property and businesses. The
company may move toward raising the prices of their
products
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Pro for indirect taxes
 Changes in indirect taxes are more effective in changing the pattern
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of demand for particular products
Indirect taxes are a useful instrument in controlling and correcting
for externality effects
Indirect taxes are less likely to distort the choice between work and
leisure and therefore undermine work incentives
Indirect taxes can be changed more easily providing the govermant
with increased flexibility
Indirect taxes provide an incentive to save and avoid the tax
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Arguments against indirect taxes
 Many indirect taxes have regressive effects on certain
consumers and thus make the distribution of income more
unequal
 Rising indirect taxes can cause cost-push inflation as
producers pass on higher taxes to retailers
 Revenue streams are uncertain particulatly when inflation
is low or there is an recession when consumer demand
falls
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How do changes in taxation affect
individual incentives?
 To spend money on specific goods and services?
 To work or not to work (take leisure)?
 To seve e.g. for retirement?
 To take risks e.g. self employement / enterpreneurship?
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Taxation and spending choices of
custommers
 Using taxation to achieve environmental aims, e.g. real
increase in the cost of fuel duty – effects?
 Reducing car tax on pollution efficient vehicles – effects?
 Higher duties on cigarettes – effects?
 Higher taxes on alcohol and fat foods – effects?
Problem: equity, effectiveness, measurement issues
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Exercise:
How Taxation and work incentives in the
labour market causality effects comapies?
 If the government reduced the basic rate of income tax
from 22% to 20% (other things being equal) would this
cause a rise in the labour supply? What is the reasoning
that people would work more? Why might people
substitute work for a greater amount of leisure time?
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Taxation and work incentives causality
depends of:
 Marginal tax rate
 Flexibility of hours
 Labour migration
 Leisure hours
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Income effects
 Takes less time working to achive the same amount of
income?
 Does leisure have a high income elasticity or demand?
 Will some people cut back on their hours having reached
a satisfactory target income?
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Substitution effects
 The opportunity cost of taking leisure time has risen,why?
 The post tax returns from working have increased.
 An incentive to work longer hours? But are you always
more productive?
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The Laffer Curve
 Often used as a justification for lower taxes as a supply
side policy to improve incentives
 Of contemporary relevance given the interest in flaterate taxes e.g. in Estern Europe
 Concept that there might be a government revenue
maximising tax rate – the peak of the L. Curve
 Raising taxes beyond this point could reduce tax yields
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The Laffer Curve
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Economic reasoning of the Laffer Curve
 The government offers a lump-sum tax rebate or lowers the
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basic/higher rates of tax
Post tax rates of return to working increase – imporved incentives to
work at the margin
Lower taxes may encourage inflowes of FDI
Higher disposabel incoms – boosts consumption
Less incentive to avoid/evade taxes
Lower company taxes increases planned investment and boosts stock
prices (reducing the cost of capital)
Lower taxes may lead to an improvement in the long run trend rate
of growth for the economy
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Conclusion of the exercise:
 The central question is the elasticity of work with respect to tax rates
– will people work longer if taxes are cut? – no guarantees. How
many people have flexibility in the working hours?
 Which is best – a lump sum tax rebate for government or a cut in tax
rates?
 Lower taxation will in the short term increase the size of the
government budget deficit, this will increase bond yields (interest
rates) which might have a negative effect on demand
 Really – the Laffer Curve is just an application of the idea of
dimicishing returns
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Taxation and the supply side economy
Tax system can have an important effect on the suppy side on an
economy:
 Income tax and the incentive to work
 Corporation tax - incentives to invest in new capital, tax competition
as a means of attracting foreign direct investment into a country
 Taxation and the incentive to spend on research and developement
 Employment taxes and the demand for labour
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Changes in direct and indirect taxes can have a
big effect on aggregate demand – how?
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Changes in direct and indirect taxes can
have a big effect on aggregate supply –
how?
 Labour market incentives – cuts in income tax might improve incentives for
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people to seek work and boost labour productivity
Capital spending – lower rates of corporation tax might stimulate a higher
level of business investment from domestic and foreign firms
Enterpreneurship and new business creation – government spending might
be used to found new small business start-ups
Research and developement and innovation – tax credits could be used to
encourage an increase in business research and development
Human capital of the workforce – higher spending on education and
training (designed to boost the human capital of the workforce), increased
investment in health and transport can also have very important suppy-side
effects
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