Economics IB 2 HL
What are taxes?
Taxes are a compulsory transfer of money (or occasionally of goods and services from private individuals, institutions or groups to the government. It maybe levied upon wealth or income, or in the form of a surcharge on prices. Taxation is one of the principal means by which a government finances its expenditure.
Reasons for taxation
• To pay for government expenditure. Governments need to raise finance for their expenditure programmes. If the governments want to avoid inflation, then they will have to increase taxes or they can borrow a limited amount of money.
• To correct maker failure such as externalities. Governments can intervene in individual markets by changing taxes and this changing demand. Such as raising higher taxes in cigarettes in order to reduce the tobacco consumption, the VAT (value-added tax) could be increased. This way the taxation becomes a way of increasing economic efficiency.
• To manage the economy as a whole. Taxation can have an important influence on the macro-economic performance of the economy. Governments might increase taxes to prevent inflation, unemployment and balance of payments.
• To redistribute income. A government may judge that the distribution of resources is inequitable. To redistribute income, it may impose taxes which reduce the income and wealth of some groups in society and use the money collected to increase the income and wealth of other groups. (So it doesn’t create inequality of income, when there is a big ratio between the rich and the poor)
There are many type of taxes, but the most common ones are the direct taxes, indirect taxes.
Direct taxes is a tax levied directly on an individual or organization. One example of a direct tax is income tax because individual income earners are responsible for paying it. Corporation tax, is also a direct tax because companies have to pay it directly to the Revenue and Customs. Direct tax also includes transfer tax. Transfer tax is a tax on passing of title to property from one person to another, or it can be also called the estate tax which you inherit or the gift tax. .
Indirect taxes is a tax levied on goods and services such as the value-added tax (VAT) or excise duties. VAT rates vary in each country. Indirect taxes could be called the goods and services tax (GST). The GST is collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the consumer). An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products Examples could be such as the cigarettes tax, fuel tax or liquor tax. An excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately the manufacturer transfers the burden of this duty to the buyer of the car in form of a higher price. This shows that the indirect tax can be either passed on or shifted, examples could be pensions or the child benefits.
There are two main income taxes which are called the progressive taxes, regressive taxes and the proportional taxes. The progressive tax is a tax that takes an increasing proportion of income as income rises. So, basicly if you earn 3000 LVL per month and they you get promoted and you get 10 000 LVL now, then you will pay higher rate of tax or depends because there are categories which in each country it varies. The regressive taxes is a tax which takes a decreasing proportion of income as income rises. Regressive taxes are indirect taxes. Basicly the higher income consumer is paying a lower proportion of his income is taxed. The proportional tax is a tax which is levied at the same rate at all increase levels. Hence, it is intermediate between a progressive tax and a regressive tax. This tax is basicly if you someone earns 300 LVL per month they will pay the same tax rate as someone who earns 6000LVL. The rate is told by the government and countries who use this taxing system also vary from each other.
Taxes are likely to lead to a fall in supply and consequent reduction in the quantity demanded of the product or service being taxed. For instance
•VAT and excise duties in a product push the supply curve to the left which in turn leads to a fall in the quantity demanded of the product
•Income tax is likely to lead to a fall in the supply of labor to the market
•Corporation tax is likely to lead to a fall in the supply of entrepreneurs to the market.
Taxes are beneficial for some markets, but for most markets they cause distorts. Taxes could be benefit for those markets who are at a negative externalities because then taxes could bring the private costs and benefits into line with the social costs. Taxes could also, lead to a loss of efficiency. Loss of efficiency could lead to a market failure since the markets are no longer competitive with each other. If for example the petrol looses efficiency, then the marginal cost would no longer be equal to the price in the market.
Theory of the second best suggests that taxes which are broadly based are less likely to lead to efficiency losses than narrow taxes. Low rates of taxes spread as widely as possible are likely to be less damaging to the economic welfare than high rates of tax on a small number of goods or individuals.