Unit 5.2: Tax systems and types of taxes
Progressive taxes: the proportion (or percentage) of your income taken in tax rises as your
income increases. This simply means that those on higher incomes (the rich) will pay more tax
as a proportion of their income than those on low incomes. So, for example, Mr Fat Cat might
earn $1,000,000 (gross) a year and pay $300,000 in tax- therefore Mr Cat pays 30% of his
income as tax. Whereas, Mr. Murphy might earn $30,000 a year (gross) and pay $3,000 in tax.
Therefore Mr. Murphy pays _______ of his income as tax. INCOME TAX is a progressive tax.
Regressive taxes: the proportion of income paid in tax falls as income rises. This means
that those on lower incomes pay a greater proportion of their income in tax than those on
higher incomes. How is this equitable? VAT or SALES TAX is a regressive tax.
Proportional taxes: the proportion of income paid in tax is the same whatever the level of
income. CORPORATION TAX (taxes on business profits) is usually a proportional tax.
Direct and Indirect taxes
Direct taxes are taken directly from the person or firm who is responsible for
paying them. They cannot be passed on to anyone else. Income tax is a direct tax as
each worker must pay the tax from their income.
Indirect taxes are taken indirectly from incomes when spending occurs. For
example, indirect taxes such as sales tax or VAT are usually imposed upon
producers but they will pass on most of the tax (the burden) on to consumers when
they buy goods.
Types of Direct Taxes:
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Personal income tax- imposed on the income/earnings of individuals
Corporation (or profits) tax – imposed upon the profits of businesses
Capital gains tax- charged on profits made from the sale of shares, property
even jewellery and other assets that have increased in value over time
Wealth (e.g. inheritance and property) tax
National (Social) Security contributions- these are imposed on both
employers and employees and are specifically to raise funds for pensions,
unemployment benefit and other benefits.
Advantages of direct taxes
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They are a major source of tax revenue
Many are progressive and help to reduce
inequalities in incomes after tax
They take account of people’s ability to
pay
Disadvantages of direct tax
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Income taxes can reduce work
incentives
Taxes on profits can reduce profit
available to entrepreneurs to reinvest in their businesses
High tax rates can cause tax evasion
Types of Indirect taxes
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Value added tax (VAT)- this tax is added as a percentage of the selling price
on goods and services sold. Some necessities are exempt from this tax.
Excise duties – these are additional taxes charged on the quantity of
tobacco/alcohol/petrol purchased. For example, 10cents a litre of fuel/$4
per pack of cigarettes/$1 per litre of wine
Import tariffs – taxes specifically charged on imported goods entering a
country
User charges – charges for the use of toll roads, congestion charges (in
London)
Advantages of indirect taxes
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They are cost effective to collect
Anyone who buys goods and
services will pay some indirect
taxes
They can be used to discourage
consumption and production of
harmful products
Disadvantages of indirect tax
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The cost of collecting taxes falls to
businesses
They are regressive
Tax revenues are less certain because
they depend on spending patterns
They add to price inflation