Types of Taxation : Main classifications
Taxes may be classified as direct taxes on income, indirect taxes on expenditure, and social security contributions (social security benefits may be termed negative taxation, in the sense that taxes take money from citizens, whereas welfare benefits give money to citizens). Solving assignments based on Taxes is very helpful in getting clarity on the topic. Availing economics homework help, when stuck, is a good way of clearing doubts and queries.
- Taxes on income and capital (direct taxes) These comprise personal direct taxation, corporation tax, and other taxes paid to the Inland Revenue.
- Taxes on expenditure (indirect taxes) These are taxes which enter directly into the costs of production and distribution, such as customs and excise duties and VAT. Taxes on final buyers associated with the possession or use of particular goods (such as local authority rates on property and motor vehicle licence duties) are also treated as taxes on expenditure.
- Social security contributions These are included because they are compulsorily levied by the Government.
UK direct taxes
In the UK, the main direct taxes are:
- Personal direct taxation (income tax) provides the largest yield of any single tax imposed in the UK. The Finance Act of 1980 abolished the lower rate band of 25 per cent for the first £750 of taxable income (i.e., total income less personal and other allowances) and altered the band applicable to other rates of direct tax. The basic or standard rate was 30 per cent for 1981-82, with rates of 40, 45, 50, 55, and 60 per cent for higher taxpayers. These rates apply to both earned and investment incomes, although investment incomes are also liable to a surcharge of 15 per cent if they exceed £5500 per annum (1981 82).
- Corporation tax This is paid by companies on their profits. The tax purposely discriminates against distributed profits, as corporation tax is paid on both distributed and undistributed profits, but only distributed profits are liable to income tax.
- Capital transfer tax and capital gains tax These are taxes on capital but may be classified as direct taxes because they are paid to the Government directly, or at the source. Death duties, or estate duty, were introduced by Sir William Harcourt in the Liberal Government of 1894, the idea was to tax the property of the rich that would pass to others at their death. This tax marked the beginning of the introduction of progression into the British tax system. In 1974, capital transfer tax replaced estate duty. It is a tax on all transfers of wealth above £50 000. Its object is to deter large gifts previously made to avoid death duty. In simple terms, it is a method of charging death duties by advance instalments.Capital gains tax falls upon owners of property and shares who make a profit from long-term increases in the value of these assets.
Advantages of direct taxes
Some of the main advantages of direct taxes may be briefly summarized
- Progressive Direct taxes are usually administered following a graded scale and so are both progressive and equitable, especially as allowed. ances are made for dependants.
- Non-inflationary Direct taxes do not increase prices and, therefore, are not inflationary; they take money from consumers, thus reducing purchasing power and helping to keep prices in check.
- Exemption of very poor Several million workers pay no direct taxation at all, but despite the lower income groups being exempted, the number of direct taxpayers is continually rising as the population increases. Even when concessions are given to the lower-paid, it is not long before they work themselves back into a taxable category.
- Decrease in inequalities of wealth The Government taxes the richer members of the community and uses the money to subsidize widows, schoolchildren, students, expectant mothers, etc...
- Easier revenue estimation The Chancellor can estimate more precisely the likely revenue from direct taxation. (If taxes on commodities are increased, people may buy fewer of them.)
- Known tax liability Taxpayers will know exactly what they have to pay. Moreover, PAYE is deducted at an opportune moment following the principles of certainty and convenience.
UK indirect taxes
Direct taxes are more socially just than indirect taxes as the burden falls on those who are most able to bear them. A damning attack on the excess of indirect taxes was made in 1820, by Sydney Smith, in the Edinburgh Review, when he wrote:
The dying Englishman poured his medicine. which has paid seven per cent, into a spoon that has paid fifteen per cent flings himself back upon his chintz bed which has paid twenty-two per cent makes his will on an eight-pound stamp. and expires in the arms of an apothecary who has paid a licence of £100 for the privilege of putting him to death. His whole property is then immediately taxed from two to ten per cent. Besides the probate, large fees are demanded for burying him in the chancel; his virtues are handed down to posterity on taxed marble, and he is then gathered to his fathers to be taxed no more.
Indirect taxes are 'hidden' taxes. According to Professor Tanzi, in Taxation a Radical Approach: Although by almost any definition, French taxes are among the highest in the world, it is generally impossible to convince the average Frenchman that this is so. Professor Tanzi contended that the reason is the obvious one that in France the Frenchman is rarely aware of the taxes he pays because they are wrapped up in the prices of products. The main forms of indirect taxes in the UK are:
- Customs and excise duties These tariffs, placed upon some imported goods, provide the Government with income and supply a measure of protection for British industries. The main customs duties today are on tobacco, alcoholic drink, and petroleum products. Excise duties are placed on some home-produced goods and services such as British beer, wines, playing cards, matches, etc.
- VAT This was introduced in 1973 to replace purchase tax and selective employment tax (SET). A value-added tax is a sales tax collected, not in a single stage like purchase tax, but in instalments at each stage of the production and distribution process. Each manufacturer, wholesaler, or retailer is accountable for tax on the full value of what he sells but is allowed to take credit for tax already paid on his purchases. The tax paid by the manufacturer must be invoiced by him separately to the wholesaler; the tax the wholesaler pays must be invoiced separately to the retailer, and so on.
- Betting duties The principal betting duties are the general betting duty charged at a rate of 7.5 per cent of the stake money, except for on-course betting which is charged at 4 per cent; pool betting duty charged at a rate of 40 per cent of the stake money, and bingo duty charged at 7.5 per cent.
- Licences Since 1983, it has cost £85 a year to licence a car, annual licences have to be obtained for dogs, TV sets, fishing, guns, the sale of liquor, etc.
- Car tax A 10 per cent car tax is imposed on the wholesale value of both British manufactured and imported cars. VAT falls on the price including the car tax
Superseded by capital transfer tax in 1975 but sums are still due in respect of deaths that occurred before abolition.Customs duties and agricultural levies are accountable to the European Community as 'its own resources. Includes broadcast receiving licences, interest and dividends, oil royalties, and special sales of assets.
Advantages of indirect taxes
The main advantages of indirect taxes may be summarized:
- Less detrimental to production Indirect taxes, or 'outlay' taxes, do not deter overtime work as high direct taxes may do.
- Greater freedom of choice If indirect taxes are increased at the expense of direct taxes, then an individual will have more freedom of choice, i.e., he will be left with more of his earnings to spend as he likes, although many of the commodities he buys will be increased in price because of additional indirect tax.
- Avoidable It is possible to avoid paying indirect taxes by not having a TV or running a car. However, life would be very dull if one refused to buy all things subject to indirect tax.
- Choice of time for payment The taxpayer chooses his own time to pay indirect tax. He may stock up on cigarettes at the beginning of the week, and refrain from smoking until the end of the week.
- Hidden tax The fact that indirect taxes are 'hidden' is useful from the Government's point of view; the taxpayer is often unaware of the amount of tax he is paying, so it is almost painlessly extracted.
- Influence of the regulator The Government has the power of the 'regulator'; the Chancellor can move some indirect taxes by 10 per cent, and this is a useful method of deflating or reflating the economy.
- Fewer chances of evasion It is difficult to evade indirect taxes, whereas direct tax is dodged at every level, from the businessman who has an expense account to the working man who is paid for odd jobs done in his spare time.
- A corrective tax Taxes may be placed on goods that the Government does not want people to buy from abroad. When the UK has been short of dollars, extra taxes have been imposed on tobacco and petrol.
Some modern taxes
Although it is still useful to study the effects of taxation according to the main classifications, some present-day taxes cut across these classifications and no tax can be regarded in modern times as being simply imposed for the purpose of gathering revenue, Lady Hicks, in Public Finance (Cambridge Economic Handbook), distinguished between formal incidence', ie., the assumption that smokers pay the tax on cigarettes, and 'effective incidence', i.e., the ultimate reaction to the tax in the form of a changed pattern of consumption and production of tobacco. Alan Williams has pointed out, in Public Finance and Budgetary Policy (Allen and Unwin): 'Every tax that is levied has repercussions upon the economy which need to be investigated and appraised. In a book of limited length, we have only time to examine a few modern forms of taxation in detail, and for the rest, we must be content to classify them according to familiar categories. The British tax system, like Topsy, just grew". No radically new forms of taxation, apart from purchase tax, had been imposed for about fifty years, but since 1965 several fundamental changes have been made.
The Finance Act of 1965 introduced a corporation tax on profits to replace the system of company taxation whereby income tax and profits were paid. Since 1965-66 companies have deducted income tax from dividends and other distributions and paid it to the Inland Revenue. The 1965-66 corporation tax applied to distributed and undistributed profits at the same rate, but the income tax was no longer levied on undistributed profits; the tax was intended to encourage capital investment in the private sector of the economy and induce companies to plough back their profits. Distributed profits were subjected to income tax according to the liability of the individual shareholder. Corporation tax discriminates against distributed profits.
It is controversial whether a corporation tax encourages the retention of profits. A priori it would appear that the reinvestment of profits ought to be stimulated by such a tax. However, if a board of directors was determined to maintain net dividends, there would be less retention, although the Government would secure extra revenue that could be used for capital investment by the State. Even if the 1965-73 type of corporation tax did encourage reinvestment by existing well-established firms, it may have worked against growth firms and venture managements that needed more capital than their own retained profits. As distributed profits have declined, there is less opportunity for growth firms to obtain new capital from investors.
Capital gains tax
Capital gains accruing on the disposal of assets are liable to capital gains tax or in the case of companies. to corporation tax.
The rate of tax is normally 30 per cent, but in the case of individuals may be less depending on circumstances. For small businesses the tax on gifts and certainly deemed disposals of business assets may be deferred until the assets are sold. Certain assets may be exempt from tax. The four main exemptions from capital gains tax are:
- A principal private residence.
- Private motor cars.
- National Savings securities.
- Chattels worth less than £2000..
Forms of capital gains tax may be justified according to the principle of equity. Capital gains taxes are instrumental in redistributing wealth from the rich to the poor because, if an institutional investment is excepted, capital gains taxes are paid mainly by the richer members of society. On the other hand, capital gains taxes tend to depress investment and reduce the mobility of capital; they discourage switching between securities, which reduces the flexibility of the financial markets, and makes the raising more costly.
Selective employment tax (SET)
Although the SET was introduced in 1966 and abolished in 1973-74, it is an interesting type of tax and worthy of a brief study. This was a tax on the number of workers employed by a firm and was classified as a tax on expenditure, as it broadened the tax base to include services that had previously been taxed compared to products that had long been subject to excise duties and purchase tax. The purpose of this tax was to move people from such services as hotels, restaurants, shops, and entertainment, into more productive jobs.
From April 1973, VAT replaced SET and purchase tax A value-added tax is a sales or turnover tax designed to fall upon households' spending on both goods and services. The tax is paid at each stage in the chain of importing, producing, and distributing. The tax is levied on the value added to the product or service. Business organizations are taxed on their output but claim offsetting credits for the cumulative amount of tax previously paid on their inputs. Therefore, the tax paid is the difference between the total tax indicated in their output invoices and the total tax indicated in their input invoices. The main advantages of VAT include:
- An incentive to export as VAT is rebated to exporters.
- A disinclination to import as VAT is charged to importers.
- VAT is a neutral general tax whereas the taxes it replaced (purchase tax and SET) had non-neutral economic effects.
- It is beneficial for the UK because the EEC has a VAT system; the EEC's policy is to have a single European capital market.
- VAT broadens the base of indirect taxation, e.g compared with purchase tax.
- Although VAT is said to be a neutral tax, as it does not itself directly favour business efficiency between one firm and another, we have seen that it will have an indirect effect on the balance of payments by favouring exports against imports.
- VAT indirectly aids the efficient firm as the value-added output is taxed rather than a firm's profit, firms with high internal costs will pay the same rate of tax as competing firms with lower unit costs and there will, therefore, be an incentive towards increased productivity.
The main disadvantages of VAT are:
- It has been criticized as a relatively expensive tax to collect as the Customs and Excise Department, which is responsible for the administration of this tax, has millions of invoices to check.
- There are about 7000 tax officials employed on VAT work; it is a complex tax to administer.
- VAT has proved to be an inflationary tax in most European countries that have adopted it.
- It is a regressive tax.
- Although there will always be a standard VAT rate, complications arise when exceptions are made or higher rates are placed on petrol and exemptions upon the postage. Once any exceptions are allowed, then anomalies are likely to occur.
- In some circumstances, VAT discriminates in favour of capital-intensive industries.
- Although VAT is assumed to be passed on at every stage, producers in highly elastic markets find that it influences their pricing and profit policies more than producers in very inelastic markets.
Capital transfer tax
Capital transfer tax has replaced estate duty, which existed for 80 years. This tax is intended to block loopholes that existed until 1974 because it applies to all transmissions of personal wealth above a threshold of £50 000 whether in life or at death. A similar tax has existed for many years in 40 countries including the USA, Japan, most Commonwealth countries, and all other Western European countries. Capital transfer tax brings in more revenue than the old estate duty and should reduce inequalities created by inherited wealth.
A wealth tax has been suggested to tax concentrations of wealth and make for a broader distribution of the burden of taxation. The Green Paper, Wealth Tax, Cmnd. 5704, suggested an annual tax upon those who hold assets exceeding £100 000. The 'assets' would include houses, stocks and shares, bank accounts, money and other valuables, etc. Although there are difficulties concerning its operation, a wealth tax exists in 20 other countries including India, The Netherlands, Pakistan, Switzerland, West Germany, and the Scandinavian countries. The possibility of the introduction of a wealth tax lessened in the political and economic climate of the eighties.
Tax credit scheme
If the Conservatives had won the General Election of 1974, they intended to introduce a tax credit scheme. Ninety per cent of the population would have been involved in the scheme. Those who came within the scheme would have received a new tax credit for themselves and their families, to take the place of the main income tax personal allowances and family income supplement. According to the Green Paper, Proposals for a Tax-Credit Scheme (Cmnd. 5116), a person's earnings (and any national insurance benefits) would be taxed at the standard rate, but at the same time, he/she would be entitled to appropriate credits. The credits would be set against tax and only the net tax would be payable. If the value of the credit exceeded the tax, the difference would be paid out as a cash addition to earnings or benefits. This payment is sometimes referred to as negative taxation.
It is claimed that a tax credit scheme would have the following advantages:
- All credits for children, including the first child, would be paid to the mother. Mothers would get cash each week through the Post Office in the same way as they cash child benefit allowances.
- About a million pensioners would no longer need supplementary benefits.
- It would contribute to solving the problem of false poverty by reducing the extent of means-testing and removing three out of every four families in the so-called poverty trap.
- It is fairer than tax allowances, which help those who pay tax more than those who do not. It provides, without means-testing, a substantial and comprehensive benefit to lower-paid workers.
- It is very much simpler to understand, and the many separate PAYE codes under the present system would disappear.
The National Debt
The National Debt is the accumulated borrowing of the Government. It represents money owed by the Government mainly to its citizens, but a lesser extent to overseas governments and residents.
At the end of the financial year in March 1980, the National Debt amounted to £95 330 million. The Debt has grown to such an enormous sum that it cannot now be repaid. As Table 8.7 shows, the cost of wars is mostly responsible for the huge figure. The greatest increase has been from 1940 to 1980.
The Radcliffe Report (1959) on The Working of the Monetary System (Cmnd. 827) referred to the National Debt as an indispensable part of the British economy. The Government could not manage its finances without it. Taxes are collected in dribs and drabs, and quite a large proportion reaches the Exchequer at the tail end of the tax year. The Government sells Treasury Bills to discount houses that supply them to the banks. The money market would not exist without the need for National Debt management; the government broker intervenes in the form of open market operations, buying or selling securities as the need arises, thus altering the amount of currency and credit in the country. Interest rates and profit margins are also influenced by National Debt management.
Throughout our review of the problem of debt management, we have been aware of the monetary repercussions of every action taken or proposed. It is not merely that monetary action and debt management interact so that they ought to be under one control; they are one and indivisible; debt management lies at the heart of monetary control, and this unity must be adequately reflected in our institutional arrangements. (Radcliffe Report, para. 603.)
Although the National Debt must be recognized as 'indispensable' and even useful from the point of view of 'monetary control', this does not mean that the UK's National Debt is not excessive compared with the public debts of other countries. The fact that the burden of debt with resources in the UK is heavier than in other countries largely results from the fact that the debt incurred in other countries was either less than in the UK or was much reduced in value by inflation.
Table 8.7 The increase in the National Debt
|Date||National Dept||Points of interest|
|1689||664000||Parliament first responsible for national finances|
|1694||1200000||Foundation of Bank of England|
|1763||133 million||End of Seven Years' War|
|1785||244 million||End of the American War of Independence|
|1815||858 million||End of Napoleonic Wars|
|1914||656 million||Beginning of the First World War|
|1918||7800 million||End of First World War|
|1946||25000 million||End of Second World War|
|1980||95000 million||Including marketable and non-marketable debt|
What makes up the National Debt?
The National Debt may be divided broadly into:
- Marketable securities.
- Non-marketable securities.
Marketable securities can be bought and sold in the open market (the money markets and the Stock Exchange) in much the same way as the quoted shares of companies. Non-marketable securities must be held or redeemed by the original buyer. Twenty-three per cent of the National Debt is non-marketable (£19 000 million) and consists mainly of National Savings. The rest is marketable, in the form of three-month Treasury Bills and government stock of various redemption periods; short-dated (up to 5 years), medium-dated (5-15 years), long-dated (over 15 years), and undated (with no fixed redemption date).
The largest section of the National Debt is classified as UK official holdings. These official holdings include:
- Holdings of the National Debt Commissioners, e.g., investment in government securities, National Insurance funds, and money deposited in the ordinary accounts of the National Savings Bank.
- Holdings of the Bank of England's Issue Department as backing for the issue of bank notes.
- Holdings of the Banking Department of the Bank of England.
Most of the remainder of the National Debt is held by 'the market, of which the largest sector is private funds and trusts; this sector includes the holdings of individuals, much of which are in the form of National Savings. Another large sector is overseas holders-mainly central monetary institutions (i.e., the central banks of foreign countries) and the International Monetary Fund. Most of the rest of the market's holdings are shared among the banking sector, insurance companies, building societies, pension funds, and other financial institutions .
How much of a burden is the National Debt?
Although we have seen that the National Debt has increased enormously, curiously enough it can be argued that the National Debt today is not much more of a burden than before the Second World War. It is impossible to calculate the National Debt exactly (should we, for example, include the debts of local government councils?), but working based on the average debt per head, the burden of the interest on the National Debt is not much more in real terms than it was in 1939. Probably the fairest way of measuring the burden is to calculate the effect of the interest as a percentage of the National Income. The real burden of the National Debt depends upon the relationship between the rate of progression in direct taxation and the inequality of incomes.
As the National Debt is shared between a larger number of people (as the population has grown), and the value of money continues to fall (with rising prices), the National Debt is by no means an overwhelming burden. A National Debt is both useful and inevitable. As we have seen, most of the National Debt is internal and amounts to little more than transfer payments, i.e., the interest is transferred, often among our citizens. Those who pay the most income tax are more likely to own 3 per cent Treasury Stock (1985) than poorer people who pay no direct tax. As the National Debt consists mostly of such transfer payments, it is almost like taking money out of one hand and putting it in the other. If you did this, you would not be any worse off, and in this respect, the British economy is no worse off. The National Debt has continued to rise but much more slowly than national output: having reached roughly 290 per cent of GDP in 1946, the proportion fell substantially to about 57 per cent in 1978.
Between sections of the community, however, National Debt interest payments could result in a redistribution of income towards those who possess government securities and other forms of National Savings. As the Government has to find about £3300 million in interest annually, this represents money that might otherwise have been spent on schools and hospitals. The National Debt has increased more rapidly in recent years, by 98 per cent from 1975-79. compared with 40 per cent in the previous 11 years (1964-75). The largest increase was by £12000 million in 1977-78.
Some pay indirect taxes on cigarettes, beer, etc., and have no share in National Savings interest. Generally, the burden of the National Debt cannot be passed on to future generations; people living at the time must go without goods and services to make good the debt incurred.