A tax is a levy or charge imposed by a government to raise costs of production and to reduce consumption of certain goods or services.
Taxation has several functions.
To raise revenues for the Government as well as for local authorities
To cause certain products to be priced to take into account their social costs. Taxes raise the costs of production and therefore can limit the output of certain demerit products, such as alcohol and tobacco.
To redistribute income and wealth in the economy.
To protect industries from foreign competition. Tariffs imposed on foreign goods and services help to protect domestic firms from overseas rivals.
The tax burden is the amount of tax that households and firms have to pay.
Canons of taxation
A ‘good’ tax is one that is:
equitable – those who can afford to should pay more
economic – the revenue should be greater than the costs of collection
transparent – taxpayers should know exactly what they are paying
convenient – it should be easy to pay
Types of tax
Direct taxes are paid directly to the government by taxpayers, either as individuals or companies, from their incomes.
corporation tax on the profits of businesses
national insurance contributions paid by employers and employees.
Governments can use direct taxes (imposed on income, wealth or profits) to reduce income inequalities in the economy.
Indirect taxes are collected for the government by retailers and local government bodies.
value-added tax (VAT) on the retail sales of many goods and services
excise duties on fuel, alcohol and tobacco products
business rates charged locally on the ownership of houses, apartments and business premises
Governments can use indirect taxation (imposed on spending) to affect consumer expenditure.
Governments can also impose tariffs (import taxes) to discourage the purchase of foreign goods and services in order to protect domestic businesses and jobs.