Syllabus A6. Value Added Tax A6b. The overall function and purpose of taxation

A6b. The purpose of tax

Syllabus A6b)

The overall function and purpose of taxation in a modern economy

The Economic Purpose

Tax can be used by governments to affect:

  1. Inflation

    Higher tax levels should decrease inflation

  2. Employment

    Higher tax levels should increase employment (if spent by governments in the right way!)

Tax can also be used by governments to affect businesses and individuals:

  • It encourages saving by offering NISAs (new individual savings accounts)
    It encourages charity donations by offering Gift Aid tax relief
    It encourages new businesses by offering investment tax relief

  • It discourages motoring by fuel duties
    It discourages drinking alcohol by imposing high duties etc

Social Justice Purpose

This can be done through Progressive taxation:

This simply means the higher earners pay a higher % of their income as taxes - thus redistributing the wealth in society from the rich to the poor

So, income tax is an example of a progressive tax

The opposite of this is Regressive taxation where higher earners pay a lower % of their earnings as tax

Ad Valorem Principle
Here everyone pays the same % of tax regardless of income

- e.g., VAT on a computer is the same regardless of your income

The final form of tax is Proportional Taxation

This is where the tax levels (% of earnings) remain the same regardless of income levels