17

Taxation

Activity (p. 181)

Students own answers. A fiscal cliff occurs when temporary tax breaks expire
alongside cuts in government spending (due to the need to reduce the governments
budget deficit). This can therefore cause an already fragile economy to go back into
recession.

Exam practice (p. 182)

1 Income level Tax rate Amount of tax paid ($)
($) (%)

10000 0% First $10000 is tax free = $0
1000140000 10% Next $30000 is taxed at 10% = $3000
40001+ 15% Remaining $35000 is taxed at 15% = $5250
Total tax: $8250

Deduct 1 mark for each error, but apply the error carried forward rule as
appropriate.
2 Average tax rate = $8250 $75000 = 11%.

Activity (p. 184)

Tax Direct Indirect
Airport tax
Capital gains tax
Carbon tax
Corporation tax
Customs duties
Excise duties
Income tax
Inheritance tax
Stamp duty
Tariffs
VAT or GST
Windfall tax

Exam practice (p. 184)

1 a) Tax B is progressive (10% tax on $10000 compared to 18% tax on $25000).
b) Tax C is proportional (10% charged at all income levels).
c) A regressive tax charges those on lower incomes a higher proportional tax rate,
e.g. Tax A charges those earning $10000 a 10% tax but only 5% for those
earning $20000. By contrast, a proportional tax charges all income earners the
same percentage tax rate (10% in the case of Tax C).

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 17 Taxation

2 Tax system A Tax system B Tax system C

Regressive Proportional Progressive
Tax/Income Tax paid Tax / Income Tax paid Tax / Income Tax paid
($000) (%) ($000) (%) ($000) (%)
0.9 / 4.5 20 1.5 / 10 15 0.8 / 8 10
1.8 / 10 18 3 / 20 15 3 / 20 15
2.8 / 20 14 4.5 / 30 15 11.25 / 45 25

Deduct 1 mark for each error, but apply the error carried forward rule as
appropriate. Students must clearly identify which tax system is regressive,
proportional and progressive for full marks.

Exam practice (p. 185)

1 An indirect tax is a levy imposed on expenditure, such as VAT (value added tax) or
sales tax such as GST (goods and services tax).
2 Advantages to the economy of not imposing sales taxes include:
l Goods and services are relatively cheaper without the sales tax, so the cost of
living tends to be lower.
l Relatively lower prices can also encourage consumption and investment
expenditure, thus boosting aggregate demand in the economy.
l It can give domestic firms a competitive advantage, e.g. zero sales taxes in
Saudi Arabia, Gibraltar and Hong Kong compared to sales taxes of 20% in the
UK and 25% in Denmark.
l Indirect taxes can cause inefficiencies in the economy as they alter market
prices, i.e. distort equilibrium price.
Potential disadvantages to a country of not imposing sales taxes include:
l Opportunity cost of lost/potential tax revenues that could be gained from
having a sales tax.
l Sales taxes can act as a form of price control as the free market does not
always allocate resources efficiently, e.g. alcohol, cigarettes and petroleum
would be over-consumed without government intervention.
l Sales taxes can also be used to alter the pattern of consumption, e.g. higher
sales taxes on petrol-fuelled motor vehicles means that hybrid and electric cars
have become increasingly popular. In most countries, there is no taxation on
the provision of public transport.
l The absence of a sales tax might mean other, direct taxes have to be higher.
Higher direct taxes can cause disincentives to work, thus having negative
consequences on the economy.
Award 12 marks for an answer that shows limited understanding.
Award 34 marks for an answer that displays good understanding, but lacks
detail in places or is an unbalanced answer.
Award 56 marks for a detailed answer that is well balanced and clearly
examines the advantages and disadvantages to countries that do not have any
sales taxes.

Exam practice (p. 186)

1 Taxes can be used to reduce the inflation rate because:
l The national sales tax results in higher prices and hence lower levels of
consumption in the economy.

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 17 Taxation

l Other taxes, such as income tax or corporation tax, can also be used to lower
the level of consumption and investment in the economy.
l The reduced levels of consumption and investment dampen any effect of
demand-pull inflation in the Czech Republic.
2 An increase in taxation can conflict with the Czech Republic governments
macroeconomic objectives as outlined below:
l Higher taxes can create disincentives to work and reduced levels of
consumption and investment. This can therefore conflict with the goal of
economic growth.
l Higher taxes can also increase costs for businesses, leading to a negative
impact on profits and hence employment.
l Higher taxes can also reduce the international competitiveness of a country,
thus damaging its balance of payments account.
l If taxes are too high, disincentives to work and disincentives to invest can
actually cause deflation in the economy, rather than stable prices.
Note: only two macroeconomic objectives need to be analysed for full marks.
Award 12 marks for an answer that shows limited understanding.
Award 34 marks for an answer that displays adequate understanding, although
the answer lacks detail in places. Award up to 4 marks if only one macroeconomic
objective is analysed.
Award 56 marks for a detailed answer that clearly analyses how an increase in
taxation can conflict with any two government macroeconomic objectives.

Exam practice (p. 188)

1 A reduction in the sales tax can have the following impacts:
l increased consumption as prices are relatively lower
l higher consumer and business confidence levels as consumption should
increase following a fall in average prices
l improved international competitiveness as prices are lower on average
l overall, a rise in aggregate demand, boosting the economy out of recession.
2 The impacts of the increase in VAT to 20% include:
l higher prices in the UK, thus raising the cost of living and negatively affecting
consumers
l reduced consumption of goods and services due to the 20% tax, thus
negatively impacting on economic growth and employment
l reduced competitiveness for the UK economy (Finland, for example, has a 15%
sales tax)
l potentially higher government revenue to fund its escalating debts.

Accept any other impact that is adequately examined.

Award 12 marks for an answer that shows limited understanding.
Award 34 marks for an answer that displays adequate understanding, although
the answer lacks detail in places. Award up to 3 marks if less than three impacts
are examined.
Award 56 marks for a detailed answer that clearly examines three impacts of the
increase in VAT.

Activity (p. 188)

Students own answers. Students might also consider the advantages and
disadvantages of zero-rate taxes in income and company profits.

Cambridge IGCSE and O Level Economics Hodder & Stoughton 2013 3