<4.3 FISCAL POLICY> 

• DIRECT TAXES are TAXES ON INCOME. The tax payment is paid directly by the person/firm that is responsible for paying it to the government.

• CONSUMER => GOVERNMENT

• INDIRECT TAXES are TAXES PLACED ON GOODS AND SERVICES. 

• It is ADDED TO THE PRICES OF GOODS & SERVICES and it is INCLUDED IN THE PRICE PAID BY CONSUMERS while purchasing the good or service. 

• It is called indirect because it is paid indirectly through the producer, by the consumer to the government.

• CONSUMER => PRODUCER => GOVERNMENT

• (+) HIGH REVENUE as all workers above a certain income level MUST pay income taxes, the revenue from this tax is very high.

• (+) REDUCE WEALTH-GAP as they are PROGRESSIVE IN NATURE – HIGHER TAXES ON THE RICH THAN ON THE POOR which helps reduce income inequality.

• (+) IMPOSSIBLE TO EVADE as THE TAX IS ALWAYS COLLECTED  when the good or service is purchased so it CAN'T BE EVADED.

• (+) CAN HELP REDUCE USE OF HARMFUL/DEMERIT GOODS, such as CIGARETTES & ALCOHOL.

• (+) FLEXIBLE indirect tax rates are EASIER AND QUICKER TO CHANGE THAN DIRECT TAXES. Thus their EFFECTS ARE IMMEDIATE.

• (-) LEADS TO INFLATION as the prices of products will increase when indirect taxes are added to it, causing inflation.

• (-) WORSENS INCOME INEQUALITY as the tax is REGRESSIVE* since all people pay the same amount of money, irrespective of their income levels, the tax will fall heavily on the poor than the rich as it takes more proportion of their income.

• (-) ENCOURAGES BLACK MARKET as high domestic prices can encourage SMUGGLING.

DO HIGH-INCOME EARNERS PAY MORE THAN LOW-INCOME EARNERS?

• Equity: the tax rate should be justifiable rate based on the ability of the taxpayer.

• This means fairness in the sense that the amount of tax people and firms have to pay, should be based on their ability to pay. A rich person has a greater ability to pay tax than a poor person.

IS THE TAX EASY TO WORK OUT FOR YOURSELF?

• A tax should be easy to understand, and households and firms should be able to calculate the amount of tax required to be paid by them

IS THE COST OF TAX COLLECTION < THE TAX REVENUE?

• The cost of implementing and collecting the taxes must be kept to a minimum and shouldn’t exceed the tax revenue itself.

DOES THE TAX REVENUE AUTOMATICALLY CHANGE?

• It should be possible to change the tax if economic activity changes or government aims change. 

• The revenue from some taxes changes automatically to offset economic booms and slumps. For example, tax revenue rises from income tax and sales tax, without any change in the rates, when there is an economic boom. This is because more people will be employed, incomes will rise and people will spend more. Such a rise in tax revenue may slow down the rise in aggregate demand and prevent inflationary pressure from building up.

DOES THE TAX IMPROVE ECONOMIC PERFORMANCE?

• A tax should improve the performance of markets or at least not significantly reduce the efficiency of markets. For example, an extra one-off tax, sometimes called a windfall tax, imposed on high supernormal profits of banks may encourage banks to reduce the charges they impose on customers. A tax on pollution may result in a cleaner environment. Income tax rates should not be set so high that they discourage effort

INCENTIVE TO WORK:

• • • The HIGHER [LOWER] the DIRECT INCOME TAX RATE, the LOWER [HIGHER] the INCENTIVE for the UNEMPLOYED TO SEEK WORK - or for existing workers to work overtime.

INCENTIVE TO INVEST:

• • • The HIGHER [LOWER] the DIRECT CORPORATION TAX RATE, the LOWER [HIGHER] the INCENTIVE for NEW BUSINESSES TO BE SET UP - or for existing firms to INVEST and EXPAND their operations.

• HIGHER INDIRECT TAXES, => HIGHER COSTS OF LIVING:

  • INCENTIVE TO WORK INCREASES as people now have to work harder and onger in order to maintain their STANDARD OF LIVING.

  • INCENTIVE TO WORK DECREASES as people are able to buy less with their income, so therefore LOSE MOTIVATION and stop work.

• • • A PROGRESSIVE INCOME TAX SYSTEM collects a greater amount of tax from high-income earners to redistribute to those with lower incomes, hence INCOME INEQUALITY is REDUCED.

    • However, as mentioned above, if the TAX RATE IS TOO HIGH, then it can DISCOURAGE people and firms from working. In fact, they can even relocate to low-tax countries.

• If the government also has very HIGH REGRESSIVE TAXES such as GST then the burden wll fall more heavily on low-income earners WORSENING INEQUALITY. 

The higher the rate of dierc

• • • An increase in direct 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, as these extra labour costs will be passed on to the consumer as higher prices.

• • • Increasing Indirect tax rates increase costs of production for firms possibly leading to cost-push inflation.

• HIGHER DIRECT TAXES => LOWER INCOMES => LESS SPENDING ON IMPORTS => IMPROVEMENT IN THE TRADE BALANCE

• HIGHER INDIRECT TAXES => HIGHER PRICES => PRICE OF EXPORTS RISING => LESS EXPORTS DEMANDED => WORSENING OF TRADE BALANCE