What is Income Tax - Essay Example

Income Tax and VAT in UK Introduction Tax can be defined as a fee charged by a government on a good, service, or activity. It is a financial burden imposed upon individuals or organizations who seek a service from the market or the government. Taxes have legal back up and all the people or organizations are legally responsible for paying taxes whenever they seek some services from the government or the market. Tax is not a voluntary payment, but a legally enforced contribution, imposed by the governments Taxes can be of two types; direct tax and indirect tax. Direct taxes collected directly from the pocket of the tax payer by the government. No intermediations will be there in the case of direct tax. Property tax and income tax are better examples of direct tax. Indirect taxes are taxes levied on goods or services indirectly. A direct tax is fee imposed directly on the people. For example, sales tax, Value Added Tax (VAT), excise taxes etc are examples of indirect taxes. Indirect taxes are not collected directly from the customers. It is included in the declared selling prices of a good, service or commodity. When we purchase a television or mobile phone, we are paying the VAT also to the government. The dealer will get only the VAT value deducted from the selling price. The dealer should pay the VAT amount to the government one every selling of a good or commodity. Taxes are one of the major revenue sources of for the governments all over the world and United Kingdom is also not an exception. In U.K. tax is collected by the government department known as HM Revenue & Customs. In order to analyze characteristics of British tax system, it is better to analyze one direct tax (income tax) and one indirect tax (VAT) Income tax in UK Income tax is the tax levied by the government on the income of the individuals or the enterprises. In UK, total income of a person is not the taxable income. All the taxpayers have certain rebates and exceptions while calculating their taxable incomes. This tax free income is referred as the personal allowances in Britain. Some people may get tax exceptions even if they have taxable incomes. Same way some charitable organizations also get tax rebates while calculating their taxable income. In UK, those who have income up to £2,440 should pay 10%while persons having the income in the range of £2,440 - £37,400 should pay 20% as income tax. The income tax for people who have income in the range of 37,401 - £150,000 should pay 40% while those who have income above £150,000 should pay 50% of their income as taxes (Tax - In England, 2010) (See appendix 1) Even though all the taxes are against the will of the public, some of them are worst whereas some of them may comparatively good. It is better to analyze British income tax with respect to the cannons of taxation formulated by the the noted 18th century English economist, Adam Smith in order to learn more about the merits and demerits of it. According to Adam Smith’s four canons of judging a tax; The cost of collection must be low relative to the yield; The timing and amount to be paid must be certain to the payer; The means and timing of payment must be convenient to the payer and Taxes should be levied according to ability to pay (Income Tax Theories - Canons of Taxation - What makes a good tax?, 2010). In Britain, the employees have a tax code which helps the employers to calculate the amount of tax withheld from the employee’s salary as income tax. The tax code is the mechanism by which "pay as you earn" (PAYE) is operated in the UK, making it possible for most employees to have paid exactly the right amount of income tax by the end of each tax year. As a result, most employees in the UK do not have to complete an income tax return (Tax Codes, 2009). It is evident from the above description that the income tax is comparatively a better tax system in Britain according to the four cannons of Adam Smith. Tax payers don’t have to go through any complicated process for paying their income tax if they are employees. The income tax system is transparent and there is no confusion about the timing, amount and the capacity to pay income tax in Britain. The income tax slab system helps the government to collect taxes based on the financial capacity of the tax payer and hence complaints are less. According to modern views of economists; A tax must not hinder efficiency or should involve the least loss of efficiency; A tax should be compatible with foreign tax systems and the Tax should automatically adjust to changes in the rate of inflation (Tax - In England, 2010). British income tax system obeys the first two criteria whereas same thing cannot be said about the third criteria mentioned above. UK governments are reluctant in adjusting the income taxes based on the inflation. Inflation is a global phenomenon in which all the prices of the essential commodities skyrocketing while the real value of the money decreasing. The personal and family expenses may increase because of inflation and the UK governments are not ready to decrease the income tax collected from the public based in the inflation. In that sense, income taxes in Britain is not meeting the standards even though, it may have other essential characteristics of becoming a good tax system. VAT in UK Value Added Tax, or VAT, is that tax levied on top of the cost of a product or service. It generates revenue for a government. It is a special type of indirect tax in which a sum of money is levied at a particular stage in the sale of a product or service (Economy Watch, n. d). As mentioned earlier, in Adam Smith’s opinion, a tax should be equitable, convenient certain and economical in order to refer it as a good tax. VAT tax in Britain is a tax which treats all the customers equally. Those who are purchasing a good or service should pay VAT irrespective of from which community, location or class they belong. It is a fact that only financially sound people will go for the expensive goods whereas poor people will go for least expensive goods. For example, only the wealthy people will go for expensive cars whereas poor people will purchase normal cars. The VAT for the expensive goods will be higher while that of the normal goods will be lower. In other words, this tax considers the economy of the people. Since this tax is levied by the seller, the customer doesn’t have to rush here and there for paying this tax. As mentioned earlier, according to modern economists, a good tax system should have adequacy, neutrality and achievement. The first two criteria were met fully by the UK VAT system, but same thing cannot be said about the third criteria. UK VAT system is extremely neutral as it does not favour any particular group. All the consumers need to pay VAT if they purchase a good or service. But most of the sellers may not record their selling properly in order to escape from the VAT. Sellers normally give duplicate invoices to the customers in order to cheat the government. Only those customers who ask for an invoice will get the actual invoice. The seller will charge more for a good if the customer ask for an invoice and in order to avoid that most of the normal customers will satisfy with the duplicate invoice in order get goods for a cheaper price. Conclusions Income tax is one of the prominent direct taxes whereas VAT is an important indirect tax in UK tax system. It is difficult to have a perfect tax in any country if we analyse a tax system based on Adam Smith’s tax judging system of modern economist’s views. Income tax in UK seems to be a good tax in all the aspects except one; it is not adjustable by the government based on the inflation. VAT also has most of the characteristics mentioned by Adam Smith and other economists; but there are loopholes in collecting this tax because of the duplicate invoices provided by the sellers to the customers. References 1. Economy Watch, (n. d), VAT (Value Added Tax), Retrieved on 15 May 2010 from http://www.economywatch.com/business-and-economy/vat.html 2. Income Tax Theories - Canons of Taxation - What makes a good tax?, (2010), Retrieved on 15 May 2010 from http://www.bized.co.uk/virtual/economy/policy/tools/income/inctaxth1.htm 3. Tax Codes, (2009), Retrieved on 15 May 2010 from http://www.paypershop.com/faq/taxmean.html 4. Tax - In England, (2010), Retrieved on 15 May 2010 from http://www.adviceguide.org.uk/index/life/tax/income_tax_rates.htm Appendix 1 Income tax: taxable bands and rates 2010/2011 Taxable income rate of tax 0 - £2,440 10 per cent (starting rate for savings only) 0 - £37,400 20 per cent (basic rate) £37,401 - £150,000 40 per cent (higher rate) Over £150,000 50 per cent (additional rate) (Tax - In England, 2010) Read More