Unit 5.2: Taxation

How taxes are used

Obviously tax revenue is one of the most important sources of finance for governments. But governments use taxes for a number of other reasons:

Taxes can be used to manage the macroeconomy. If an economy is slowing down or even in a recession (where there is a __________________ rate of economic growth), the government may change the level of taxation as part of expansionary ___________ policy.
Taxes can be used to reduce inequalities in income. One of the key features of income tax is that the rich will pay a greater percentage of their income in tax compared to the poor.
Taxes can be used to discourage spending on imports. A _____________ is a tax that is often imposed on imports.
Taxes can discourage the consumption and production of harmful products. Alcohol and tobacco often have additional taxes imposed on them because these are products that are a major source of _______________ costs.
Taxes can be used to protect the environment- this is similar to the reason above. Airline passengers often pay additional taxes as do consumers of _____________________ vehicles.

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What is a good tax?

No one really likes paying taxes but some taxes may be considered better than others. What makes a tax ‘good'?

1. Equity- this means that taxes should be fair. For example, people earning roughly the same incomes should pay roughly the same in income tax. Would it be fair to tax some people more because of their race? height? religion?


2. Non-distortionary- taxes shouldn't distort or change sensible economic behavior. That is, taxes shouldn't be so high that they discourage people from working.

3. Convenience and simplicity- it should be relatively straightforward for people and businesses to calculate how much tax they should pay and how/where they should pay it. In Hong Kong, for example, an income tax bill is sent to workers every April. It stipulates how much tax they should pay, how it was calculated and how you can pay.
4. Administrative efficiency- taxes should be cheap and easy to collect.


Task: Look at the imaginary taxes proposed below. For each one consider whether or not it is a good tax or bad tax from the point of view of:

The taxpayer
The government
The economy


The taxpayer
The government
The economy
New tax office set up at annual cost of $15 million to administer taxes on pets. Expected to raise $12 million each year from pet owners



Pay-as-you-earn income tax to be abolished. Taxpayers will receive a tax bill every five years instead



Overtime to be taxed at 95% of earnings.



All taxes to be abolished and to be replaced by equal tax payment of $2000 per year per person over 18.



Height tax to be introduced for all wee men.