What is a tax?
Taxation is money paid to the Government by individuals and businesses. This money is usually spent by the Government on essential services such as health or education.
Why do we pay tax?
Financing government spending
Taxes are the main way of raising money for the Government.
To 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.
To 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.
To control Inflation and to promote economic growth
If people try to spend too much at once, this can cause prices to rise. Raising taxes can reduce the amount of money consumers have to spend. In this way taxes can be used to affect the economy. Lowering taxes may help to boost employment opportunities.
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.
To protect the environment
Taxes can be used to protect the environment. For example, taxes on patrol can be used to reduce car use and air pollution. Those industries which emit too much carbondioxide can also be taxed appropriately to encourage them to use more fuel efficient and lesser polluting methods.
Type of taxes
Direct and Indirect Taxes
A tax placed directly on an individual or business, and the individual or the business upon which the tax is levied also has to bear the burden of making the tax payment to the government.
– Income tax – taken out of an individuals wage
– Corporation tax – paid by businesses out of their profits
– National Insurance – taken out of an individuals wage
A tax placed on a good or service. It is known as indirect because the person who pays tax does not bear the burden of making the tax payment to the government.
– VAT – this is put onto the price of most goods and services. e.g GST in Maldives.
– Council tax – paid on the value of an individual’s property.
– Excise duty – extra tax imposed on certain products e.g. petrol, cigarettes.
Progressive and Regressive taxes
Generally, indirect taxes are seen as regressive; the proportion of income paid in tax decreases as income rises. However, this does not mean that the rich pay a lesser in taxes, this just means that the money paid as tax is smaller in percentage compared to their total income.
Direct taxes are progressivee because the proportion of income paid in tax increases as income rises. With a progressive tax, the marginal rate of tax exceeds the average rate of tax. As a result, progressive taxes act to reduce inequalities in the distribution of income.
Next topic: The government’s influence on private producers