IGCSE-GCEO Level Taxation notes

Taxation

A Tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state.Taxes consist of direct tax or indirect tax.

A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government […] a payment exacted by legislative authority."

Purposes of Taxation

Financing government spending:

Taxes are justified as they fund government expenditure and activities that are necessary and beneficial to society.

Reduce gap between rich and poor

Progressive taxation can be used to reduce inequality in a society. According to this view, taxation in modern nation-states benefits the majority of the population and social development. Progressive tax system where higher income groups have to pay more tax is an effective way of reducing inequality of income.

Reduce consumption of demerit Goods

Taxes can be used as an effective tool to reduce the consumption of demerit goods like alcohol and tobacco. Higher taxes on these goods reduce the consumption. Examples include cigarette tax and excise duty.

Control Inflation

One of the causes of inflation is ‘too much money chasing too few goods’. Government can take away the extra disposable income of the people through higher taxes and thus reduce the aggregate demand in the economy and resulting in low inflation rate.

Balance of payments

Tariffs are taxes on imports. Government can correct an unfavourable balance of payment situation by increasing the tariffs. This will result in imports becoming expensive and will cause a fall in demand for the imported goods.

Protecting local industries

Government uses taxes as a mean to protect local/infant industries. Increasing tariffs on imports and charging lower taxes to local/infant industries may boost the demand for goods and services produced by domestic industry.

Classification of taxes

Progressive taxes

A progressive tax is a tax imposed so that the tax rate increases as the amount subject to taxation increases. In simple terms, it imposes a greater burden (relative to resources) on the rich than on the poor. It can be applied to individual taxes or to a tax system as a whole. Progressive taxes attempt to reduce the tax incidence of people with a lower ability-to-pay, as they shift the incidence disproportionately to those with a higher ability-to-pay. The result is people with more disposable income pay a higher percentage of that income in tax than do those with less income.

Example of Progressive tax in New Zealand
Income (New Zealand Dollar)	Tax rate (%)
Up to 38,000	19.5
38001-60,000	33
Above 60,001	49
Example of Progressive tax in Australia
Income (Australian Dollar)	Tax rate (%)
Up to 6000	0
6001-25000	15
25001-75000	30
75001-150000	40
Above 150000	45

Regressive Tax

The opposite of a progressive tax is a regressive tax, where the tax rate decreases as the amount subject to taxation increases. It imposes a greater burden (relative to resources) on the poor than on the rich. Regressive taxes attempt to reduce the tax incidence of people with higher ability-to-pay, as they shift the incidence disproportionately to those with lower ability-to-pay.
For example, if Jane has $10 and John has $5, a tax of $1 on a purchase would result in a different percentage of total income applied to taxation, 20% for John and 10% for Jane. Thus, a tax that is fixed to the value of the good/service would likely, in effect, result in a higher burden of taxation to people with less money.

Proportional Tax

A proportional tax is one that imposes the same relative burden on all taxpayers—i.e., where tax liability and income grow in equal proportion. In simple terms, it imposes an equal burden (relative to resources) on the rich and poor. Proportional taxes maintain equal tax incidence regardless of the ability-to-pay and do not shift the incidence disproportionately to those with a higher or lower economic well-being.

Direct taxes

Taxes which are collected directly from income and wealth are known as direct taxes.

Types of Direct taxes

Income tax

Income tax is collected on all incomes received by private individuals after certain allowances are made. In most of the economies Income tax is a major source of Government revenue.

Corporation tax

This tax is levied on profits earned by companies. It is a proportional tax which is levied at the constant rate.

Petroleum revenue tax

It is a tax levied on the profits of companies involved in drilling of oil and gas. This tax may or may not exist in other countries.

Capital gains tax

Capital gains tax is charged on the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

Property Tax

Many countries have Property tax, or millage tax. It is the tax which the owner pays on the value of the property being taxed.
The taxing authority requires and/or performs an appraisal of the monetary value of the property, and tax is assessed in proportion to that value. Forms of property tax used vary between countries and jurisdictions.

Stamp duty

Stamp duty is a form of tax that is levied on documents relating to immovable property, stocks and shares. Apart from transfers of shares and securities, stamp duties are also charged on the issue of bearer instruments and certain transactions involving partnerships.

Indirect Taxes

Indirect tax (such as sales tax, value added tax (VAT), or goods and services tax (GST)) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). The intermediary later files a tax return and forwards the tax proceeds to government with the return.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 would be fuel, liquor, and cigarette taxes. 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. Thus, an indirect tax is such which can be shifted or passed on.

All Indirect Taxes are regressive in nature. The poor will feel the pinch more than the rich.

Types of Indirect Taxes

Value added Tax

Value added tax (VAT), or goods and services tax (GST), is a consumption tax levied on value added. In contrast to sales tax, VAT is neutral with respect to the number of passages that there are between the producer and the final consumer; where sales tax is levied on total value at each stage, the result is a cascade (downstream taxes levied on upstream taxes).

Exports are consumed abroad and are usually not subject to VAT; VAT charged under such circumstances is usually refundable. This avoids downward pressure on exports and ultimately export derived revenue.

A VAT is an indirect tax, in that the tax is collected from someone who does not bear the entire cost of the tax.

Excise duties

Excise duty is a type of indirect tax charged on goods produced within the country. Lists of such goods are readily provided by governments.