Aquinas College Economics Department

Fiscal Policy & Taxation

ECON4

Aquinas College Economics Department

Fiscal Policy

• Manipulation of – Public Spending– Taxation– Borrowing

• To achieve macroeconomic objectives

• Fiscal Policy is going to have impacts on Individuals and Business

Aquinas College Economics Department

Taxation Objectives

• Funding Government Spending– As always government need to fund

their spending, taxation can also curb inflationary pressures

• Management of the Economy– Rate of tax can influence inflation,

unemployment, growth and the balance of payments

Aquinas College Economics Department

Taxation Objectives

• Income redistribution– Taxes, through higher and lower rates

and the welfare system can distribute income more evenly

• Correct Market Failure – Taxes can discourage consumption of

demerit goods such as alcohol or tobacco, or reduce negative externalities on some goods

Aquinas College Economics Department

Direct Taxes

• These are paid by the individual to HMRC

• Are often progressive taxes– Income Tax– Corporation Tax– Inheritance Tax– Capital Gains Tax

• They are direct as the liability can’t be passed onto anyone else.

Aquinas College Economics Department

Direct Tax Levels in the UK

Tax Rate (2013-2014)

Income Tax

Basic Rate (£0-£32,010)

20%

Higher Rate (£32,011 - £150,00)

40%

Highest Rate (£150,001+)

45%

Inheritance Tax 40% over £325,000

Capital Gains Tax Between 18%-28%

Corporation Tax 21%Source HMRC

Aquinas College Economics Department

Indirect Taxes

• Tax Liability can be shifted depending on the price elasticity for that product

• These often include– VAT (Value Added tax)– Fuel Duty– Alcohol Duty– Tobacco Duty

• They are regressive

Aquinas College Economics Department

Indirect Tax Levels in the UK

Tax Rate (2013-2014)

VAT

Standard Rate 20%

Reduced Rate 5%

Alcohol Duty* 10p per Pint

Tobacco Duty† 16.5% (Plus other Conditions)

Oil Duty‡ £0.58 per Litre

Source HMRC

*Alcohol Duty varies depending on Alcohol and type – Amount shown is for General Beer†Tobacco Duty varies for different types – Amount shown is for Cigarettes‡ Price for Unleaded Petrol only

Aquinas College Economics Department

Arguments with Indirect TaxArguments in Favour Arguments Against

Influence consumer spending patterns

Inflationary Effects

Correcting Externalities Lack of Knowledge

Inventive effects (less incentive not to work)

Regressive Nature goes against distributional policies for income

Flexibility – doesn’t require a budget to change it, but often does

Crime – high rates may encourage an increase in crime

Choice – consumers don’t have to buy the product in question

Aquinas College Economics Department

Hypothecation of Tax

• Taxes are raised for a specific purpose

• E.g. Government in the last 10 years announced that tobacco duty would fund NHS

• Quite often known as the Benefit Principle– The argument that taxes should be

linked to the benefits received by tax payers

Aquinas College Economics Department

Progressive | Regressive | Proportional

• Progressive:– Proportion of tax increases as incomes

increase

• Regressive– Proportion of tax falls as income

increases

• Proportional– The proportion of tax to income stays

the same as incomes increase