Direct taxes - Taxes of income and expenditure e.g. income tax, corporation tax (levied on company profits)
Indirect taxes - Taxes such as VAT (value added tax), changes in this type of tax has a rapid effect on the level of economic activity. E.g. an increase in VAT will cut consumption
Taxation Objectives
The main objectives of the UK taxation system are:
- Equitable taxes
- To use them to correct market failure
- To improve incentives to work
- To tax spending (indirect) rather than income (direct)
- To keep the tax burden as low as possible
Indirect Taxes Advantages & Disadvantages
Advantages
- They can be used to influence demand
- They can be used to correct for negative externalities e.g. with cigarettes
- They have less impact on peoples incentive to work
- More flexible method
- They provide incentives to save
- They allow consumers choice
Disadvantages
- They can increase the inequalities in income as they can be regressive resulting in a loss of equity
- May cause cost-push inflation if they are too high
- In periods of recessions revenue levels are uncertain
- They are not transparent
Direct Taxation Advantages & Disadvantages
Advantages
- These two policies used to be the responsibility of the Chancellor of the Exchequer
- As monetary policy is now in the hands of the bank of England the chancellor now only deals with fiscal policy
- The Bank of England make decisions with a full awareness of the governments fiscal stance
Disadvantages
- May not be as progressive as they could be
- Levels of consumption don’t effect them
- Can act as a disincentive to work
- Can be exploited by high earners
- Not every one understands the system
Flat Rate Tax
The concept of one tax rate for all with a tax free bonus is seen as an fair and transparent method of taxation
Those in favour say they reduce bureaucracy and admin costs, increase incentives to work and save, increase taxation for the government and increase foreign investment
Equity
For a system to be equitable those that have the ability to pay will do so
It is equitable to have a tax free amount as it means the lowest earners will not be penalised
The benefit principal – this aims to ensure all that will benefit from public services such as healthcare and education meet the costs of them
Fiscal Policy
Fiscal policy can be used to influence demand – this can be caused by changes to indirect taxes
The government use taxation and subsidies to help correct market failure and account for externalities encouraging consumption of merit goods and discouraging consumption of demerit goods
Corporation and business taxes can influence the level of capital investment – if they are lower this is likely to stimulate investment levels
