3.8 - taxes as policies to reduce income and wealth inequalities, direct and indirect, recessive progressive and proportional

effect of taxation

• income redistribution

types of taxes

• direct taxes

• indirect taxes

direct taxes

paid directly to the government tax authorities

types of direct taxes

• personal income taxes

• corporate income tax

• wealth tax

• social insurance contributions/ pay roll taxes

personal income taxes

• PROGRESSIVE

• taxes paid by households/ individuals on their income (what earned → tax → disposable income)

• most important source of government tax revenues

• paid on income

  • wages

  • rent

  • interest

  • profit

corporate income tax

taxes on the profits of the corporations, assessed on their net income after expenses and allowable deductions.

PROGRESSIVE

corporation → a legal body that is legally separate from its owners

wealth taxes

taxes levied on the net wealth of individuals or households, targeting accumulated assets and property

PROGRESSIVE

• property tax

• inheritance tax

social insurance contributions/ pay roll taxes

taxes paid by employees and employers to fund social insurance programs such as Social Security and Medicare

PROPORTIONAL

• tax revenues are not paid into government’s budget

• paid into specific fund and are used to finance specific expenditures

indirect taxes

taxes that are not directly paid by individuals but are instead included in the price of goods and services

ALL REGRESSIVE

• sales taxes

• excise taxes

• tariffs/ customs duties

sales taxes/ general expenditure taxes (VAT → value added tax)

taxes on spending/ selling on goods and services

• fixed % of retail price of goods and service

• may exclude/ offer different rate for some goods and services on ground of equity

excise tax

tax paid on specific goods or services (usually demerit)

• eg. on cigarettes, alcohol etc

tariffs/ customs duties

taxes imposed on imported or exported goods

• aimed at regulating trade and generating revenue for the government.

why are all indirect taxes regressive

! indirect taxes account for a bigger proportion of income of low-income households compared to high-income households

example:

car price = 10 000

sales tax = 10%

income A = 20 000

income B = 100 000

*both pay 1 000 $ od tax

but

A = 1 000/ 20 000 = 5%

B = 1 000/ 100 000 = 1%

tax rate

tax as % of income

the 3 natures of taxes

• proportional taxation

• progressive taxation

• regressive taxation

proportional taxation

tax rate remains constant regardless of income level

examples:

• pay roll taxes

progressive taxation

tax rate increases as income increases,

• reduces income inequality

• the more progressive taxation the more equal after-tax distribution of income

examples:

• personal income tax

• corporate income tax

• wealth tax

regressive taxation

tax rate decreases as income increases

• places higher burden on low-income households

examples:

• all indirect taxes

  • sales tax

  • excise tax

  • tariffs

calculation of taxes

• marginal tax rate

  • the amount of tax paid on an additional dollar of income

• average tax rate

  • the total tax paid divided by total income

marginal tax rate and average tax

• tax brackets

• applying a different marginal tax rate to each bracket

example calculation based on the photo:

• calculate the amount of income tax paid on an annual income of $59 000

  (0 × 10 000) + (0.09 × 15 000) + (0.22 × 30 000) + (0.40 × 4 000) = 0 + 1350 + 6600 + 1600 = 9550$

average tax: 9550$/ 59000$ = 16.2% or 0.162

calculating indirect taxes

a = value after indirect tax (disposable income)

x = indirect tax

in = income after income tax

s = amount of spending on indirect tax/ value of indirect tax

a+ax = in

eg.

60 000 = total income

15 000 = value of income tax

60 000 - 15 000 = 45 000 = income after income tax

12.5% = indirect tax

so:

a + 0.125a = 45 000

0.125a = 45 000

a = 40 000

s = 45 000 - 40 000 = 5 000

average rate of indirect tax

arit = indirect tax value/ total income

60 000 = total income

s = 45 000 - 40 000 = 5 000

arit = 5 000/ 60 000 = 8.33%

total average indirect tax rate

tatr = (income tax + indirect tax)/ total income

60 000 = total income

15 000 = value of income tax

5 000 = value of indirect tax

tatr = (15 000 + 5 000)/ 60 000 = 33.33%

percentage of redistribution that occurs through tax system

25%

downsides of progressive taxes

(in theory more progressive taxes = more equal distribution of income)

disincentive effects

• income tax reduces after-tax income, acting as a disincentive to work

  • lower quality of labour offered in the market

  • lower quantity of savings

    • lower investment

    • lower production of new capital goods

      • lower economic growth rate

lower income taxes may not lead to more work

lower corporate taxes need not to lead to greater investment