Taxation Purpose and Effect

1. Taxation Purpose and Effect

2. Taxation A tax is a government policy that allows the government to obtain a sum of money from consumers or firms for various purposes. 1. For government to obtain funds to run the country or to affect the economy. 2. For government to reduce or curb the consumption or use of an undesirable good (eg. demerit goods like cigarette, alcohol etc) 3. To help government to reduce the income difference by redistributing monies from higher income earners to lower income earners. [demerit good - a good whereby if the government left it to the free market, will be over produced to the extent that it gives of negative externalities and causing markets failure) 4 To curb imports so that the leakage of funds will be reduced so as to achieve a positive and high balance of payment.

3. Taxation 1. For government to obtain funds to run the country - By using direct tax - eg income tax, tax on property etc. (direct tax meaning the one has to pay the government directly) - By using indirect tax - eg Goods and Service Tax (GST), Electronic Road Pricing (ERP) (indirect tax meaning someone will pay the tax to the government on your behalf eg. the 711 store, petrol station etc.

4. Taxation 2. Demerit goods like cigarettes and alcohol affect the environment negatively as well as give rise to social ills. Because of this, the government needs to reduce their consumption through an Indirect tax (eg. GST) P How Taxes reduce demand for a demerit good Assuming that the initial market equilibrium (E0) the market clearing price and output is P0 and Q0 respectively. When an indirect tax is applied (eg. GST), this will increase the cost of production of a firm. (or a producers). As such, owing to the tax, the supply curve will shift leftward from S0 to S1 as now less is being produced at every price level owing to the tax. Owing to the tax, the prices will increase from P0 to P1 and output will be cut back from Q0 to Q1. With a tax, the government objective of reduction of the demerit good is achieved as its consumption is now decreased from Q0 to Q1. S1 S0 E1 P1 E0 P0 D Q Q1 Q0

5. Taxation Amount of GST (an indirect tax) as represented in the diagram. P After the tax is levied, Consumers pay P1 for a box of cigarettes while Producers receive P2 for a box of cigarettes S1 S0 Total Amount of Taxation on the good is = Area P1P2ZE1Z It is equals to P1P2 X Q1 E1 P1 E1 P1 E0 Per unit tax P2 Z P0 Consumer portion of tax D P2 Z Producer portion of tax Q Q1 Q0 The total amount of tax is shared and not fully born by buyers. This is called the incidence of tax.

6. Taxation 3. For the re-distribution of wealth (direct tax eg. Income tax, corporation tax, capital gains tax). - The difference in incomes between the highest earners and lowest earners in a country is called the income gap. - If the income gap is too wide, this means that the rich are getting richer and poor are getting poorer. The governments needs to ensure that the people’s incomes are as equitable as possible so that the poor will not be exploited. - Taxes have the ability to take some from the richer to help supplement the poorer people’s income.

7. Taxation 4. To reduce imports so as to maintain a positive and stable balance of payment US, Cellphone Market P - Domestic cellphone too expansive compared to Chinese imported cellphone, P0<P1 S - Q1 (quantity demanded) > Q0 (quantity supplied) (Domestic US Price) P0 Import amount before Tariff P2 Tariff, T (Import price , China) P1 - Government levies, a tariff (T), to reduce imports D Import amount after Tariff Q Q0 Q1 Amount of imported cellphones Q1-Q0 A tariff can therefore reduce imports and reduce the amount of funds flowing out of a country leading to positive BOP

8. Taxation Progressive and Regressive Taxation and Ad Valorem Tax How equitable (fair) is taxation? In the above example, the income tax rate increases with increasing income/wealth. We call this PROGRESSIVE taxation. Progressive type of taxation is fair as the wealthier pay more tax.

9. Taxation Progressive and Regressive Taxation and Ad Valorem Tax How equitable (fair) is taxation? In the above example, the income tax rate is constant at 10% regardless of how much one makes. We call this REGRESSIVE taxation. This form of tax is not equitable.

10. Taxation Progressive and Regressive Taxation and Ad Valorem Tax How equitable (fair) is taxation? An ad valorem tax is a tax that is a percentage of the value of the item being taxed. (eg. value of a house, estate tax etc). This form of tax is regressive as the higher the value, the percentage of tax does not increase. (eg. Proportional tax - A tax system that requires the same percentage of income from all taxpayers, regardless of their earnings. A proportional tax applies the same tax rate across.)

11. Taxation Progressive and Regressive Taxation and Ad Valorem Tax How equitable (fair) is taxation? • Question: Which one of the following taxes in Singapore is regressive? Explain your answer: • GST, • Electronic Road Pricing (ERP) • Property Tax, Petrol Tax • Electricity Tax (Tariff) Answer: Except for income tax and electricity, the rest are regressive. This is because the actual amount of tax paid (say $200 of GST, ERP, PT or ET) will affect someone who makes $1000/month more severely than someone who earns $20,000/month. To the $20,000 a month person, $200 is nothing while to the other person $200 is a lot.

12. Taxation Difference between direct and indirect tax • Direct tax is (eg income tax) is paid directly to the government while indirect tax is paid via the producer. 2. Direct tax is accrued when you earn someething (eg. Income, inheritance etc). Indirect tax ( eg. GST aka consumption tax) only occurs when you pay or consume something. 3. The amount of the tax can be shifted between producer and consumers. Q: Should Singapore government increase GST and lower income tax in light of the fast aging population? (Hint: Which will give gov more tax revenues?)

13. P S0 S1 P0 P1 D Q Q0 Q1