Taxation (CIE IGCSE Economics)

Progressive

• As income rises, a larger percentage of income is paid in tax
• In the diagram, when personal income rises from Y₁ to Y2, the tax rate rises from TR₁ to TR₂

Regressive

• As income rises, a smaller percentage of income is paid in tax
• In the diagram, when personal income rises from Y₁ to Y2, the tax rate falls from TR₁ to TR₂
• All indirect taxes are regressive
• In the USA, Federal income tax is progressive but almost all State taxes are regressive (the bottom 20% of income earners pay as much as 6x the % of their income than the top 20%)

Proportional

• As income rises, the same percentage of income is paid in tax
• In the diagram, when personal income rises from Y₁ to Y2, the tax rate remains constant at 20%
• In 2022, Bolivia was using this system with a proportional tax rate of 13%
  

Personal Allowance

Up to £12,500

0%

0

Basic Rate

£12,501 to £50,000

20%

 £37, 499 at 20% = £7499.80

Higher Rate

£50,001 to £150,000

40%

£10,001 at 40% = £4,000

Additional Rate

Over £150,000

45%

0

Total Tax Paid on £60,000

£7499.80 + £4,000 = £11,499.80

Incentive to work

• The higher the tax rate, the lower the incentive for the unemployed to seek work - or for existing workers to work overtime

Government tax revenues

• There is a relationship between increasing tax rates & the level of government revenues received
• The broad idea is that as tax rates increase, a point will be reached where disincentivized workers work less, resulting in lower incomes & less government tax revenue
• More people will actively seek to avoid paying tax (tax avoidance) or try to move their income elsewhere

Income distribution

• A progressive tax system redistributes from those with higher income to those with lower income & reduces income inequality
• Sometimes the benefits of a good progressive tax system are lost by the penalties imposed through multiple regressive (indirect) taxes

Economic growth

• Tax rate increases will likely cause a reduction of total (aggregate) demand as firms & households have less disposable income
• Tax rate decreases will have the opposite effect
• As total demand slows down, fewer workers may be required for production & unemployment may increase

Inflation

• Increasing Indirect tax rates increase costs of production for firms possibly leading to cost-push inflation
• An increase in indirect taxes reduces disposable income & so workers may petition their employer for a salary increase
• If they receive the increase the economy may face a wage-price spiral

The trade balance (X-M)

• An increase in taxes can reduce disposable income which is likely to reduce the level of imports
• This may improve the trade balance (exports - imports)

Business location

• If the rate of corporation tax increases relative to other countries, it may result in less inward foreign direct investment by multi-national corporations